Tracking Consumer Choices

Question 1

What similarities do groups and individuals have?

Answer 1

Economics is all about HOW groups and individuals make choices and WHY they choose the things that they do.

Economists have spent a great deal of time analyzing how groups make choices, which as it turns out tend to be very similar to individual choice behaviour.

Question 2

What does individual choice behaviour focus on?

Answer 2

CONSUMER BEHAVIOUR

Because most of the choices people make on a day to day basis involve which goods and services to consume.

Question 3

What other things might real-life choices involve?

Answer 3

People must make choices about long term things such as:

Whether to get a job or continue in education

Whether to continue negotiating or declare war

Question 4

Why must Human beings make choices?

Answer 4

Because our wants almost always exceed our means.

Limited resources, aka SCARCITY, is at the heart not only of economics, but also ecology and biology i.e. Darwinian evolution is all about animals and plants competing over limited resources to produce the greatest amount of progeny.

Economics is about human beings choosing among limited options to maximise happiness.

Question 5

What can be gained from studying choice behaviour?

Answer 5

A lot.

Because if we can understand the HOW AND WHY of the choices people made in the past, we stand a very good chance of understanding the choices they’re going to make in the future.

Question 6

Why is understanding and predicting future choice behaviour important?

Answer 6

Because major shifts in the economic environment typically are the result of millions of small decisions that add up to a major trend.

Question 7

Outline the three stage process used to predict how self-interested individuals make their choices.

Answer 7

1) Evaluate how happy each possible option can make you
2) Look at the constraints and trade-offs limiting your options
3) Choose the option that maximises your overall happiness

Question 8

What are three common objections to the three stage process used to predict how self-interested individuals make their choices?

Answer 8

1) Are people really so self-interested? Aren’t people often motivated by what’s best for others?
2) Are people really aware at all times of all of their options? How are they supposed to choose rationally among new things that they never tried before?
3) Are people really free to make decisions? Aren’t they constrained by legal, moral and social standards?

Question 9

What do economists assume to be the basic motivation driving most people?

Answer 9

In a nutshell, A DESIRE TO BE HAPPY

This assumption implies that people maake choices on the basis of whether or not those choices are going to make them as happy as they can given their circumstances.

Question 10

What do economists mean by UTILITY?

Answer 10

Economists suppose that you can compare all possible things that you may experience with a common measure of happiness or satisfaction - called utility. Things you like a lot have a high utility, whereas things you like only a little have a low or negative utility.

Question 11

From the perspective of an economist, what is important about utility?

Answer 11

The important thing for economists is that people can ascertain and compare the utilities of various possible activities. utility acts as a common denominator that allows people to compare even radically different things sensibly.

Question 12

How might an economist view the desire to help others?

Answer 12

Economists take it as a given that people make choices in order to maximise their personal happiness.

i.e. the mother who doesn’t eat in order to give what little food she has to her infant may be pursuing a goal (helping her child) that maximises the MOTHER’S own happiness. The same can be said about people who donate to charities. Their selfless action is motivated by ‘selfish’ intention.

Economics is concerned with how people achieve their goals instead of questioning the morality of those goals.

Question 13

What did Adam Smith believe about society?

Answer 13

He believed that if a society is set up correctly, people chasing their own individual happiness can provide for other people’s happiness as well.

Question 14

In “the Wealth of Nations”, published 1776, what was meant by “it is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest”

Answer 14

To put it bluntly, the butcher, the brewer and the baker don’t make stuff for you because they like you, but because they want your money. Yet because they want your money, they end up producing for you everything that you need to have a nice meal. When you trade them your money for their goods, everyone is happier.

Question 15

What do Economists recognise from the “invisible hand”?

Answer 15

Because economists recognise the invisible hand, they’re less concerned with intent than with outcome, and less concerned with what makes people happy than with how they pursue the things that make them happy.

Question 16

Name some obvious constraints on human happiness.

Answer 16

PHYSICAL LIMITATIONS OF NATURE

Supplies of oil, water, fish, the number of radio frequencies on which to send signals and the hours of sunshine to drive solar powered cars.

Question 17

How does technology expansion relate to productivity?

Answer 17

As Tech improves over time, people are able to produce more from the limited supply of resources on our planet. And so, we have more, and better choices from which to choose.

Question 18

Why might tech be considered a constraint that limits choices?

Answer 18

Because tech improves slowly, how advanced the tech is at any given time limits our choices. Fortunately though, tech does improve over time - meaning that if we just wait, more and better choices will come along.

Question 19

What is opportunity cost?

Answer 19

The opportunity cost of anything is the value of the next best alternative thing you have done instead. It doesn’t matter whether you have 3 or 3000 alternatives.

Question 20

When can opportunity costs tell you NOT to do something?

Answer 20

Ex. you may love ice cream, but you love cake even more. If someone offers you only icecream you’re going to take it. But if you’re offered both, you’re going to take the cake. |The opp. cost of eating the ice cream is sacrificing the chance to eat cake. Because the cost of not eating the cake is higher than the benefits of eating ice cream, it makes no sense to choose ice cream.

Question 21

What is the third and final stage of the economic choice model?

Answer 21

COST-BENEFIT ANALYSIS

In the third stage, you simply choose the option for which the benefits outweigh the costs by the latest margin.

This model is only good at describing all-or-nothing decisions like whether or not to eat ice cream.

Question 22

What is a much more powerful version of CBA?

Answer 22

MARGINAL UTILITY

It tells you not just whether you’re going to eat ice cream, but also HOW MUCH ice cream you’re going to decide to eat.

To see how MU works, you need to recognise that the amount of utility that a given thing brings depends on how much of that given thing a person has already had.

Question 23

Using an example, describe the phenomenon of diminishing marginal utility.

Answer 23

If you’ve been really hungry, the first slice of pizza that you eat brings you a lot of utility. The second slice is also pleasant, but not quite as good as the first because you’re no longer as starving. The third, in turn, brings less utility than the second. If you keep forcing it down, you may find that the 12th or 13th slice may make you feel sick and brings you negative utility.

Question 24

When making decisions, what do economists assume about people?

Answer 24

Economists assume that people are fully informed and totally rational when they make decisions.

That’s a pretty strong assumption - you’d be justified in asking if its remotely realistic.

The answer to your question is that it varies over a range of decisions we make and the type of behaviour we’re looking at.

Question 25

How do you evaluate whether sitting on top of Mount Everest for five minutes is better than hang gliding over the Amazon for ten minutes?

Answer 25

if you’ve never had either experience, you aren’t well informed about the constraints and costs of the choice and probably don’t even know the utilities of the two options.

Politician with novel new programmes often ask people to make similarly uninformed choices. They make their proposals sound as good as possible, but in many cases nobody really knows what they might be getting into.

Question 26

What are three of the most common choice errors made?

Answer 26

Sunk costs are sunk costs

Mistaking a big percentage for a big pound amount

Confusing marginal and average

Question 27

Sunk costs are sunk costs EXAMPLE

You just spen £15 to get into an all you can eat buffet.

1) How much should you eat?
2) When deciding how much to eat, should you care about how much you paid to get in?

Answer 27

1) Eat exactly the amount of food that makes you the most happy.
2) How much it costs you to get in doesn’t matter because whether you eat one plate or 80, the cost is the same. In other words, because the cost of getting in to the buffet are in the past, it should be completely unrelated to your current decision of how much to eat.

Question 28

What is a sunk cost?

Answer 28

Costs that have already been incurred and which should therefore not affect your current and future decision-making.
Rationally speaking, you should only consider the future, potential marginal costs and benefits of your current options.
After all, if you were offered £1000 to go next door and leave the buffet for a competitors would you refuse because you felt you had to stay and eat a lot in order to get your money’s worth. Of course not.