Unit 2

Question 1

How do you draw and label a diagram, showing the relationship between total and marginal utility curves?

Answer 1

.2 diagrams (one is directly above the other).
. X-axis (for both): ‘Quantity’.
. Top diagram: Y-axis: ‘Total Utility (TU)’.
- Horizontal line at top.
- n-shaped curve that starts steep at origin then gets less steep (this point is labelled ‘TU is decreasing by less) then becomes flat when it hits horizontal line (This point is labelled ‘Max TU’ then goes down for a small bit (This point is labelled ‘Total utility is decreasing’).
- horizontal short line labelled ‘20’ on y-axis, equilibrium of this line and n-shaped curve labelled ‘1’ on x-axis with vertical line that goes from equilibrium through x-axis then to x-axis of bottom diagram (this point is labelled ‘1’ also).
. Bottom diagram: Y-axis: ‘Marginal utility (MU)’.
- same short horizontal line as top diagram that goes diagonally downwards when it hits vertical line and ends up at point that is labelled ‘point of satiation’.
. Vertical straight line from ‘Max TU’ point to X-axis of bottom diagram. This point at the x-axis is labelled ‘point of satiation’.
.

Question 2

What is the point of satiation?

Answer 2

. The quantity at which extra consumption yield no extra utility.
. When marginal utility=0.

Question 3

What is the gradient of the total utility curve equivalent to?

Answer 3

The value of the marginal utility.

Question 4

Define rational behaviour:

Answer 4

Rational behaviour means acting in a sensible manner to attempt to maximise one’s own welfare (satisfaction or utility).
. Firms’ decision makers are also expected to aim to maximise their utility.

Question 5

What is the difference between traditional orthodox economic theory and behavioural economic theory?

Answer 5

. Traditional economic theory assumes that economic agents act rationally.
- assumes that individuals have perfect knowledge and use it with perfect logic.
. Behavioural economic theory uses psychological (and sociological) insights to explain how individuals make choices and decisions and may not end up with an ideal outcome.
- it recognises that while agents may attempt to do maximise their welfare, they may not succeed.

Question 6

Define bounded rationality:

Answer 6

Means there are limits to the ability to maximise their welfare due to a) imperfect information, b) limited brain power and c) time constraints.

Question 7

Define bounded self-control (with example):

Answer 7

. When individuals fail to have the self-discipline or ability to do what is best for themselves.
. E.g. people sign up for a gym and then don’t go.

Question 8

Define utility:

Answer 8

The satisfaction or economic welfare that an individual obtains from consuming a good or service.

Question 9

Define marginal utility:

Answer 9

The additional satisfaction or welfare gained from consuming one extra (the last) unit of a good.

Question 10

What is the “law” or hypothesis of diminishing marginal utility?

Answer 10

If states that the extra benefit of consuming one more unit declines with every extra unit consumed (given the same quantity of other products consumed and within a limited time).

Question 11

Give a list of things that constrain maximisation of utility:

Answer 11

Imperfect information, limited brain processing power, limited incomes or set budget, prices, time.

Question 12

How does the information problem link to utility?

Answer 12

The information problem occurs when people make suboptimal decisions because they do not possess or ignore the relevant accurate data (can lead to market failure) therefore don’t maximise their own utility.

Question 13

What is asymmetric information (give example)

Answer 13

. When one economic agent in a transaction knows more than the other.
. Often firms know more about their products than consumers and unethical firms are likely to exploit their extra information to benefit themselves at the expense of the customer (leads to allocative inefficiency).

Question 14

Define cognitive bias:

Answer 14

Occurs when economic agents make biased or sub-optimal decisions due to preferences and personal experience.

Question 15

Define conformation bias:

Answer 15

Occurs when people only accept evidence that confirms what they already believe and discount equally valid evidence against what they believe.

Question 16

Define bandwagon effect:

Answer 16

When people tend to do what they think other people are doing rather than work it out themselves.

Question 17

Define availability bias:

Answer 17

Occurs when individuals place too much weight on the probability of an event occurring (or its cost or benefit) because of how easy it is to bring to mind.

Question 18

Define social norms:

Answer 18

When people make decisions based on what others think or do or what is culturally acceptable.

Question 19

Define anchoring:

Answer 19

A cognitive bias of relying too heavily on the first piece of information offered or a recently heard statistic which can influence the overall decision.

Question 20

Define rule of thumb:

Answer 20

A rough, quick, practical method to help make decisions with limited calculations.

Question 21

Give the two cases in which economic agents may not aim to maximise their own utility:

Answer 21

. Altruism means being more concerned for others than for oneself.
. Seeking fairness or equity.

Question 22

Give some policies to improve social welfare in the light of behavioural economics insights:

Answer 22

Nudges, choice architecture, default choice, mandated choice, restricted choice, framing.

Question 23

Define nudges:

Answer 23

Policies that use subtle measures to influence behaviour in a subtle less obvious way. They use behavioural and psychological insights to change behaviour to more beneficial actions.

Question 24

Define choice architecture (give example)

Answer 24

. Describes how the decisions we make are affected by the layout/sequencing/range of choices that are available.
. For example the salad bar could be placed before the hot meal to increase take-up of salad.

Question 25

What is a default choice?

Answer 25

The option that is made if the person does not opt out or change anything (for example donating organs).

Question 26

Define mandated choice:

Answer 26

Where people by law must make a decision. People in Switzerland are forced to vote or face a fine.

Question 27

Define restricted choice:

Answer 27

Providing a limited number of options - many people become confused if there are too many options to process. This may lead to them not making any decision at all.

Question 28

Define framing (with example):

Answer 28

Refers to how a question is presented.

For example, what will sell more: ‘a product that is 90% fat free’ or ‘10% fat’?

Question 29

Define alturism:

Answer 29

Means being more concerned for others than for oneself. It may be that some people do not seek to maximise their own welfare, but are selfless.

Question 30

Define anchoring:

Answer 30

Is the cognitive bias of relying too heavily on the first piece of information offered or a recently heard statistic which can influence the overall decision.

Question 31

Define availability bias:

Answer 31

Occurs when individuals place too much weight on the probability of an event occurring (or its cost or benefit) because of how easy it is to bring to mind.

Question 32

Define behavioural economic theory:

Answer 32

The use of psychological (and sociological) insights to explain how individuals make choices and decisions and may not end up with an ideal outcome.

Question 33

What are biases in decision making?

Answer 33

Occurs when economic agents make biased or sub- optimal decisions due to preferences and personal experience

Question 34

Define bounded rationality:

Answer 34

Means there are limits to the ability to maximise their welfare due to a) imperfect information, b) limited brain power and c) time constraints.

Question 35

Define bounded self control (with example):

Answer 35

Means individuals fail to have the self-discipline or ability to do what is best for themselves. E.g. people sign up for a gym and then don’t go.

Question 36

Define choice architecture:

Answer 36

Describes how the decisions we make are affected by the layout / sequencing / and range of choices that are available. The architecture is the way choices can be presented.

Question 37

Define default choice:

Answer 37

The option that is made if the person does not opt out or change anything. A website might already have an expensive one day delivery option ticked with cheaper options available.

Question 38

Define economic incentives (with example):

Answer 38

Monetary inducement to do something. E.g. set up a business in order to maximise profit.

Question 39

Define framing (with example):

Answer 39

Refers to how a question is presented. E.g. would you like 90% fat free or 10% fat product.

Question 40

What is the hypothesis of diminishing marginal utility?

Answer 40

states that the extra benefit of consuming one more unit declines with every extra unit consumed (given the same quantity of other products consumed and within a limited time.)

Question 41

Define mandated choice (for example):

Answer 41

Where people by law must make a decision. e.g. People in Switzerland are forced to vote or face a fine.

Question 42

Define marginal utility:

Answer 42

The additional satisfaction or welfare gained from consuming one extra (the last) unit of a good.

Question 43

Define nudges:

Answer 43

Policies that use measures to influence behaviour in a subtle less obvious way. They use behavioural and psychological insights to change behaviour to more beneficial actions.

Question 44

Define rational economic decision making:

Answer 44

Means acting in a sensible manner to attempt to maximise one’s own welfare (satisfaction or utility).

Question 45

Define rule of thumb:

Answer 45

A rough, quick, practical method to help make decisions with limited calculations.

Question 46

Define social norms:

Answer 46

When people make decisions based on what others think or do or what is culturally acceptable.

Question 47

Define restricted choice:

Answer 47

When a limited number of options are provided.

Question 48

What is traditional economic theory?

Answer 48

This assumes that individuals will aim to maximise their utility and also tend to achieve it.

Question 49

Define utility:

Answer 49

The satisfaction or economic welfare that an individual obtains from consuming a good or service.

Question 50

Define utility maximisation:

Answer 50

Gaining the lost benefit from a set budget.