1.2 Individual economic decision making

Question 1

Rational behaviour

Answer 1

acting in pursuit of self-interest, which for a consumer means attempting to maximise the welfare, satisfaction, or utility gained from the goods consumed

Question 2

What does traditional economic theory state?

Answer 2

consumers engage in rational behaviour

Question 3

Demand

Answer 3

the quantity of a good that consumers are willing and able to buy at given prices in a given period of time

Question 4

Utility

Answer 4

the satisfaction or economic welfare an individual gains from consuming a good

Question 5

What are the units of utility?

Answer 5

Utils

Question 6

Marginal utility

Answer 6

the extra satisfaction gained from consuming one extra unit of a good within a given time period

Question 7

Point of satiation

Answer 7

when marginal utility equals zero

Question 8

Principle of satiation

Answer 8

the effect whereby the more of a good one possesses the less one is willing to give up to get more of it

Question 9

The law of diminishing marginal utility

Answer 9

for a single consumer the marginal utility derived from a good diminishes for each additional unit consumed

Question 10

Why does the marginal utility curve slope downwards?

Answer 10

The law of diminishing marginal utility

Question 11

Describe the relationship between the marginal and total utility curves

Answer 11

• the TU curve rises as long as the MU curve is positive
• the TU curve is highest when MU passes through the quantity axis

Question 12

Behavioural economics

Answer 12

a method of economic analysis that applied psychological insights into human behaviour to explain how individuals make choices and decisions

Question 13

Bounded rationality

Answer 13

when making decisions, an individual’s rationality is limited by the information they have, the limitations of their minds, and the finite amount of time available in which to make decisions

Question 14

Bounded self-control

Answer 14

limited self-control in which individuals lack the self-control to act in what they see as their self-interest

Question 15

Imperfect information

Answer 15

where economic agents are not completely and immediately aware of costs, benefits, or prices that are relevant to their decisions, such as the external costs and benefits

Question 16

Information gap

Answer 16

the difference between the perceived and true cost, benefit, or price

Question 17

Asymmetric information

Answer 17

when one party to a market transaction possesses less information relevant to the exchange than the other

Question 18

Rule-of-thumb

Answer 18

a rough and practical method or procedure that can be easily applied when making decisions. Mental shortcuts for decision making to help people make quick and satisfactory decision

Question 19

Demerit good

Answer 19

a good, such as tobacco, for which the social costs of consumption exceed the private costs. Alternatively or additionally, an information gap exists so consumers over appreciate the benefits of consumption

Question 20

Merit good

Answer 20

a good, such as healthcare, for which the social benefits of consumption exceed the private benefits. Alternatively or additionally, an information gap exists so consumers underappreciate the benefit of consumption

Question 21

Adverse selection

Answer 21

the tendency of those who are at greatest risk to take out insurance

Question 22

Loss aversion

Answer 22

people’s tendency to prefer avoiding losses to acquiring equivalent gains

Question 23

Framing

Answer 23

how something is presented influences the choices people make

Question 24

Sunk costs

Answer 24

costs that have already been incurred and cannot be recovered

Question 25

Cognitive bias

Answer 25

a systematic error in thinking that affects the decisions and judgements that people make

Question 26

Availability bias

Answer 26

occurs when individuals make judgements about the likelihood of future events according to how easy it is to recall examples of similar events

Question 27

Confirmation bias

Answer 27

the tendency for humans to only remember information that supports their own views

Question 28

Representativeness bias

Answer 28

when people are assessing the similarity of objects they are likely to judge wrongly because the fact that something is more representative does not actually make it more likely

Question 29

Altruism

Answer 29

concern for the welfare of others

Question 30

Fairness

Answer 30

the quality of being impartial, just, or free of favouritism

Question 31

Inequity aversion

Answer 31

the preference for fairness and resistance to incidental inequalities

Question 32

Equality

Answer 32

everyone is treated exactly the same. A completely equal distribution of income means that everybody has the same income.

Question 33

Equity

Answer 33

means that everyone is treated fairly

Question 34

How does altruism challenge traditional economic theory?

Answer 34

- rational consumers would only consider personal utility maximisation when making consumption decisions - altruists can often act in a way that has a great personal cost

Question 35

Anchoring

Answer 35

a cognitive bias describing the human tendency when making decisions to rely too heavily on the first piece of information offered (called the anchor). Individuals use an initial piece of information when making subsequent decisions

Question 36

Status quo bias

Answer 36

people generally prefer that things remain the same, or change as little as possible

Question 37

Herd behaviour

Answer 37

making decisions based on the behaviour of others, which can cause people to make decisions as a group that they wouldn't make as individuals

Question 38

Choice architecture

Answer 38

a framework setting out different ways in which choices can be presented to consumers, and the impacts of that presentation on consumer decision making

Question 39

Shove

Answer 39

any method of altering people's behaviour that either forbid a number of options or changing economic incentives. E.g. banning the use of recreational drugs, taxes, subsidies

Question 40

Nudge

Answer 40

any aspect of choice architecture that alters people's behaviour in a predictable way without forbidding any options or significantly changing economic incentives. The intervention must be easy and cheap to avoid. E.g. putting fruit at eye level

Question 41

Sensory cues

Answer 41

evocative smells and sights

Question 42

Salience enhancements

Answer 42

making a choice relatively noticable

Question 43

Convenience enhancements

Answer 43

making it easier to make certain choices

Question 44

Default choice

Answer 44

an option that is selected automatically unless an alternative is specified

Question 45

Mandated choice

Answer 45

people are required by law to make a decision

Question 46

Restricted choice

Answer 46

offering people a limited number of options so that they are not overwhelmed by the complexity of the situation. If there are too many choices, people may make a poorly thought-out decision or not make any decision