Behavioural economics

Question 1

bounded rationality

Answer 1

making decisions based on limited information and from a narrow range of heuristics (simple rules)

Question 2

choice architecture

Answer 2

The theory of consumer choice is influenced by the ways goods are presented. For example, complementary goods placed together can help sales. Related to the concept of a nudge.

Question 3

cognitive bias

Answer 3

when we look at issues with a certain bias, for example, we see the data which confirms our point of view and we filter out data which is inconvenient

Question 4

discrimination

Answer 4

when people discriminate on grounds of age/sex

Question 5

dual-system theory

Answer 5

the idea we have two decision making elements. One is impulsive, the other is more rational, cognitive and analytical. Similar to ‘hot-cold’ states.

Question 6

endowment effect

Answer 6

when we give greater weighting to what we already have.

Question 7

fairness and reciprocity

Answer 7

the importance of fairness and returning favours in economic decisions

Question 8

gift-giving

Answer 8

the concept that giving gifts is an important aspect of social life. These transactions do not fit into standard supply and demand analysis.

Question 9

herding behaviour

Answer 9

the tendency of individuals to follow the collective perceptions and beliefs of the majority – particularly likely in finance.

Question 10

irrational exuberance

Answer 10

when people get carried away by rising asset prices

Question 11

mental accounting

Answer 11

how individuals separate their budget into different accounts, limiting on particular aspects of expenditure

Question 12

Optimism bias

Answer 12

A tendency to wishful thinking and over-confidence in our plans.

Question 13

Present bias

Answer 13

a tendency to value payoffs in the present moment more than equivalent costs/benefits in the future. Also, we can discount future payoffs in a time-inconsistent way.

Question 14

Prospect theory

Answer 14

the idea we suffer comparatively more from losses than gains. It also places emphasis on a relative starting point. We judge utility from our loss/gain – rather than our finishing point.

Question 15

Rational economic man

Answer 15

This is the classical view of individual behaviour. It assumes individuals 1) Are rational and well informed. 2) Seek to maximise their utility. Behavioural economics is based on challenging this conventional wisdom.

Question 16

Reciprocity

Answer 16

The strong social pressures that we try to reciprocate treatment. If we are treated ‘badly’ we can seek to ‘punish’ the person – even if it leads to loss of our own utility. Similarly, we try to reward good behaviour (e.g. concept of gift-giving)

Question 17

Salience

Answer 17

when we give a greater weighting to one-off recent events. For example, if we have a bad experience with British Airways, we never want to travel with them again.

Question 18

The social dimension of creating trust.

Answer 18

We may incur losses to give the impression of trust and honesty.

Question 19

Social Norms

Answer 19

Decisions where social norms outweigh personal decisions of utility, e.g. voting because it is considered social duty – even if we know voting makes no difference anyway.

Question 20

Status Quo Bias

Answer 20

A preference for the existing situation rather risk change.

Question 21

Sunk-cost fallacy

Answer 21

Placing too much importance on sunk costs (irretrievable costs) – costs that cannot be got back.

Question 22

Nudges

Answer 22

Factors which encourage consumers to change behaviour through small suggestions

Question 23

understanding decision making

Answer 23

How individuals make decisions in the real world – as opposed to economic models.

Question 24

changing behaviour

Answer 24

Using knowledge of behavioural economics to change behaviour through nudges.

Question 25

behavioural finance

Answer 25

Psychology of bubbles – rapid rises in asset prices
Positive feedback loop – when two events positive reinforce each other. For example, rising house prices increases confidence in the housing market, and increased confidence in housing market leads to rising prices.