Booklet 5 micro - Trad theory and behavioural economics

A measure of the benefit and satisfaction we get from purchasing or consuming a good/service.

The benefit gained from consuming one extra unit of a good.

For each additional unit of a good that’s consumed, the marginal utility gained decreases, as well as the price that consumers are willing to pay.

(this is why the demand curve slopes downwards)

Rationally in order to maximise utility.

→make decisions solely to max. utility without any external influence.

Marginal utility = price

The idea that consumers always act rationally is unrealistic. There are social, psychological, and emotional factors that impact decision making.

Compare costs and benefits of alternatives.

→ Limited time available to make a decision e.g. ordering at restaurant

→ Imperfect or asymmetric information prevents individuals from making rational decisions (trad. economic theories assume there is perfect info, which is needed for rational decision making) e.g. car dealerships, COVID vaccine

→Individuals may be unable to process and evaluate the considerable data involved in decision making e.g. technical or legal jargon.

BOUNDED RATIONALITY

Satisficing, so making satisfactory rather than rational decisions (an attempt at being rational).

Total self control → only act to max. utility

They have ‘Bounded self-control’ → Individuals have good intentions but lack self-discipline to see it through e.g. losing weight, giving up smoking, saving money etc.

• Rule of thumb → Mental shortcuts based on personal experiences that may lead to systematic biases e.g. buying middle-priced option when faced with a range of similar products.

• Anchoring → When individuals place too much emphasis on one piece of info (often first piece of data they’re exposed to), usually due to lack of knowledge/experience e.g. first price quoted for a job influences their view on what’s a fair price.

• Availability bias → judgements based on info at the forefront of your mind, overshadowing other relevant info e.g. a recent flood influencing much of a community to buy sandbags, despite flooding being rare in the area.

• Social norms → The influence of others upon individual decision making (peer pressure - can be pos. or neg.) e.g. someone may stop buying cigarettes if none of their friends smoke, COVID 19 masks.

• Habitual behaviour → Doing the same thing over and over e.g. shopping at the same place regardless of benefits of shopping elsewhere.

Trad economists may argue people donate to charity to gain utility in doing it (e.g. makes them feel good), Behavioural economists would argue that not everyone acts in self-interest and may choose to act altruistically.

E.g. firms may pay employees above min. wage because they think it’s fair.

Choice architecture → where an individual’s choice is influenced by the way the choice is presented to the decision-maker.

• Default options → where opting-in is the default choice e.g. organ donation opt-out and pension enrolment opt-out.

• Framing → context in which info is presented can influence choice, particularly the use of wording and numbers e.g. presenting life insurance premium payments as ‘less than £3 a day’ sounds better than £1000 per year.

• Nudges → Whereby an option is made easier to choose than others without removing freedom of choice e.g. green footprints leading to a bin.

• Restricted choice → Too much choice can sometimes ‘paralyse’ individuals from making effective choice (e.g. savings), so limiting choice may force more conscious decision making.

• Mandated choices → Legal requirements to make a choice e.g. decision about organ donations on passport and driving license.

Can be used to complement traditional policy methods, often via social norms and loss aversion (people’s preferences to avoid losing compared to gaining the equivalent amount.)

e.g. adverts to reinforce a social norm of wearing a seatbelt, as it is difficult to police.

e.g. 5-a-day campaign, traffic light labelling on unhealthy food, calorie counts on menu (UK)

The idea that it’s possible + legitimate for institutions nudge certain behaviours while also respecting freedom of choice.