1.7 Behavioural Economics Flashcards
(33 cards)
What is behavioural economics?
“A method of economic analysis that applies psychological insights
into human behaviour to explain economic decision-making”
What are we going to look at today?
When people do not behave in their best interests?
Decision vs experience utility; affective forecasting
government intervention.
What is decision utility?
Is the consumer’s perceived utility at the time of decision-making. It is the forecast of what the consumer thinks experience utility will be when
consumption takes place. ( buying the good)
When you are in decision utility what state is usually referred and explain it?
You are in the Hot state. - high level of emotions, can impact rational decision making.
What is a reason for decision utlitiy? ( HINT ABOUT PREDICTIONS)
Affective forecasting - is predicting how you will feel in the future.people are generally inaccurate in predicting their future emotional states s (see Kahneman and Thaler, 2006) see more in the reading.
What is experience utility?
Experience utility is the actual utility at the time the good is consumed ( consuming the good, you regret decision in hot state)
What state are you in experience utlitiy?
Cold state - is one that is not being influenced by emotion and is usually more rational and logical.
What is the uncompensated demand here don’t necessarily tell us the old fashioned compensated demand but just draw the graph(s)?
The sign infront of X1 is an index of how much the person values an extra unit of good x1.
Non-satiation holds but convexity doesn’t ( the second derative with respect to x1 = 0.
So corner solution depending on the MRS in relation to price ratio.
If MRS> price ratio = THE MU of good 1> good 2, since equally priced, the person only buys good 1.
If MRS< price ratio. Then MU2> MU1, since equally priced, the person only buys good 1.
If MRS = 1, they are indifferent so can spend anywhere.
How can we use Decision and experience utlitiy to illustrate this example?
So imagine that the consumer in decision utility buys good 1, what does this mean?
In experience utility the consumer buys good 2, what does this mean?
USE HOT AND COLD STATE !!!!
in Experience Utility the MU is decreasing for each bite of good 1.( regret)
What is are 3 thing that can cause you to be in a hot state?
Being distracted by payoff-irrelevant cues ( marketing)
• you associate the colour of an object with something nice
Acting on instinct
• using intuitions rather than thinking things through
Time lag ( between making decision and when you experience consequence of decision)
Dan kahnerman(1933) wrote a book thinking fast and slow He asked the question A bat and a ball cost $1.10 in total. The bat costs $1.00 more than the ball. How much is the ball? A. 5 cents B. 10 cents C. 15 cents D. 20 cents. What is the fast answer and slow answer?
Fast answer ( when fast we don't make rational decisions - 10 cents... but its wrong. ball at $0.1 + bat $1.10 = $1.20 Slow answer ( when slow we make rational decisions - 5 cents. A ball at $0.05 + $1.05 = $1.10
To summarise if the decision utility is in hot state and consumption is in cold state then what?
The consumer is maximising the wrong function
In experience utlitiy of theta 1 x1 + x2, were theta is less than 1 so they should of consumed all of x2, but what did they actually consume?
so x1 = m
x2 = 0
leading to them to experience a ultity of theta lm < m
If they had spent money on good 2, there utility x2 = m/p2 = m gets them to utlitiy m,
meaning they welfare optimise at the consumption bundle (x1,x2) = (0,m), but don’t the utility is lower.
What do advertisements and companies do to enhance our decision utility?
Advertisers understand how to frame-decisions to make us like products
• creating “imagery” to enhance our decision utility
• And some businesses use high-pressure sales tactics to get us to buy
something before we have thought it through
What is the effects of people making wrong decisions( decision utility? )
There is welfare loss from making wrong decisions.
What are some government solutions to solve the welfare loss in society?
1)banning/taxing some products
2) regulating ‘choice architecture’ ( how items are laid out in shops)
3)“cooling-off” clauses which allow you to change your decision
e.g. cancelling motor insurance, a mobile phone contract or a loan
without penalty within 14 days
4) Even apps ( that track)
What is another way to think of hot state to cold state?
Internality, ( present self imposing a negative externality on your future self hence regret and lower utility in future.)
• Back to our example, where in the hot state the consumer buys only good 1
while future self would like to consume only good 2. Is tax an extreme solution and what would the good have to be? What is some of the problems imposing tax on good 1?
Extreme solution… it would have to be really bad for you.
- Requires the state to know best and act in the interests of citizens
- What about consumers who are not prone to bias?
How might behavioural biases be linked to poverty?
poverty could lead to problematic decisions. e.g. you are homeless, with 3 children and book a hotel on credit, this is problematic in the LR or like pay day loans( large interest payments)
.
If there is poverty is government intervention more necessary?
Yes to help those more deprived groups.
lets say we have 2 individuals and we are trying to tax good 1
1 individual ‘hot self likes good 1 and cold self likes good 2.
2 individual hot and cold set likes good 1.
How do we know there are biases
Would the tax have to be for the consumer to consume all of good 2 if we assume theta is 1.2?
Remember that the relative prices = 1/1
What does it mean for individual 2?
We know there are biases through the theta its different for individual 1 so bias, whereas its different for individual 2.
We know that MRS> p1/p2 means they consume all of good 1
we want MRS< p1 + t/p2 so they consume all of good 2.
If the MRS = 1.2 we need a tax or an increase in price of at least 20%.
This reduces the utility of individual B, as they are worse off. ( they can afford less)
So taxing good 1 means pareto effieicency cannot happen, who cannot make someone better off without making them worse off.
What is a indirect way of influencing A without distorting B
Nudges:
Create a default option of x1 = 0
• Allow A-types to opt out to choose x1 > 0 ( delay decision making)
• Requires effort/thought, so helps one make the choice in the cold state
e.g. you go shop. you are given carrots, but you say no can you give me cookies, this requires effort and allows you to eventually think no)
What are some of the ways for studying to avoid decision utility of going on phone?
Leaving phone in another room ( but this requires commitment)
Lets look at example of preferences of saving. When you are young you spend lots, meaning you have less when older. When people are older they which they had saved more in the current period rather than consumed lots ( and could potentially accumulate debts, we will not show that.), Now show the decision and experience utility using a utlitiy function a cobb-douglas one?
