2 Behavioural Economics Flashcards
(145 cards)
1
Q
What is the name for the traditional orthodox economic theory that contrasts behavioural economics?
A
Utility theory
2
Q
Utility theory assumes people behave…
A
Rationally
3
Q
What does it mean to say economic actors behave rationally?
A
They try to maximise their personal welfare or utility from goods or services
4
Q
What is utility?
A
The welfare gain to the consumer from consumption of a good or service
5
Q
What is marginal utility?
A
The welfare gain to the consumer from consumption of the latest unit of a good or service
6
Q
Key thing when plotting marginal utility graphs against total utility graphs?
A
Marginal utility points are plotted on the halfway points between the last point and the next
7
Q
What happens to marginal utility, generally, as the number of units consumed continues to increase?
A
Marginal utility falls
8
Q
When marginal utility passes zero we have reached…
A
The point of satiation
9
Q
What is the name of extra units consumed after the point of satiation?
A
Marginal disutility
10
Q
Units in marginal disutility on a total utility curve are shown by…
A
The descending part of the total utility curve
11
Q
Units in marginal disutility on a marginal utility curve are shown by…
A
y-negative points
12
Q
What fundamental economic hypothesis is shown by the persistent negative gradient of the marginal utility curve?
A
The hypothesis of diminishing marginal utility
13
Q
What is the hypothesis of diminishing marginal utility?
A
As the number of units of a good or service consumed increases, marginal utility falls, CETERIS PARIBUS
14
Q
How can we explain Adam Smith’s diamonds and water paradox?
A
Marginal utility and scarcity
The marginal utility from the last unit of water consumed is quite low because it is not scarce - we may consume up to the point of satiation. Scarcity - water is not scarce in much of the world.
15
Q
Why is marginal utility theory important to behavioural economics?
A
It is the central theory of traditional (orthodox) economic theory - households are seeking to maximise their personal utility through their consumption
16
Q
If in traditional economic theory we assume that the consumer is attempting to maximise personal TOTAL utility, what is the relevance of marginal utility?
A
If consuming Good A gives us a marginal benefit of 5 utils, and consuming Good B gives us a marginal benefit of 9 utils, regardless of income availability, rational consumers will consume B because it provides the biggest boost in welfare.
17
Q
The point of satiation can also be expressed as…
A
The point at which MPB = MPC
No because we may reach MPC > MPB before the point of satiation.
18
Q
What is revealed preference theory and what relevance does it have to behavioural economics?
A
It is impossible to measure the value, in utils, of a good or service. Paul Samuelson devised a theory called revealed preference theory whereby economists observe consumer behaviour and subsequently deduce what utility they gain from consuming a given good or service.
19
Q
What is the problem with revealed preference theory?
A
Does not factor in behavioural economic problems such as bounded rationality or irrational purchasing behaviour
20
Q
Give an example of negative marginal product?
A
If you are a farmer, chances are you use your best factors of production producing the first unit of crop since you are a rational utility maximiser - however, by the last, you may be using unskilled workers since all the skilled workers are already working.
21
Q
4 things that affect the consumer’s level of consumption in a rational model?
A
- Marginal utility from other goods
- Marginal utility from the target good
- Budget
- Consumer preferences
22
Q
What is maximising behaviour?
A
The tendency of economic agents to maximise (presumably utility) given the constraints of budget and other factors in a given situation
23
Q
Is imperfect information an example of irrational behaviour by consumers? Explain your answer using an analogy.
A
No
If a consumer spends a lot of money to go to a concert by a famous artist, which turns out to be awful, they may not derive a lot of money’s worth of utility. Hence this money was wasted.
24
Q
Why is imperfect information one of the first problems with traditional economic theory?
A
Without perfect information, consumers cannot be assumed to make decisions which maximise their own utility
25
What is a particular case of information failure that can lead to traditional economic theory being stumped?
Asymmetric information
26
What is adverse selection?
When asymmetric information leads to poor market decisions
27
What is the argument made in Akerlof's 'lemons' article regarding asymmetric information in the second hand car market?
Prices are low in the second hand car market despite the fact that many of the cars traded there are good since the presence of 'lemons' in this market has devalued the market and lowered the equilibrium price.
28
4 things which limit consumers in utility theory?
1. Limited income
2. A given set of prices
3. THE TWO ABOVE MAKE the budget constraint
4. Limited time available
29
Who wrote Nudge?
Richard Thaler and Cass Sunstein
30
When was behavioural economics embraced by the UK and US and evidence?
UK 2010 Behavioural Insights Team
US had a similar thing going on
31
What is the counterpoint by Milton Friedman in 1953 defending traditional economic theory?
Friedman said this was the wrong approach - critique instead the validity of their predictions.
32
What do we call the economic agent in traditional economic theory?
Homo economicus
33
Homo Economicus makes decisions with what four things?
1. Pure self-interest
2. Complete knowledge of the consequences of their actions
3. Consistent tastes and preferences
4. Desire to maximise utility or satisfaction from a given good or service
34
What prevents people from making decisions like Homo Economicus?
Bounded rationality
35
What 3 factors make up bounded rationality?
1. Imperfect information
2. Limited mental processing capability
3. Time constraint
36
In behavioural theory, we ____ utility. Why?
Satisfice
## Footnote
We cannot possibly, given bounded rationality, consistently make maximising decisions.
37
In utility theory, we ______ utility
Maximise
38
What other concept prevents people from behaving in a utility maximising mode, besides bounded rationality?
Bounded self-control
39
Give an example of bounded self control at work?
Cigarette addiction
40
Who came up with the idea of System 1/System 2 thinking? Where?
Daniel Kahneman
## Footnote
Thinking Fast and Slow
41
What is System One and System Two and how does it relate to economics?
System One are automatic decisions taken via instinct or without reflective thought - System Two decisions are decision taken with deliberative judgement.
42
Where are cognitive biases at their most extreme? Why?
System One decisions
## Footnote
We don't use rational judgement.
43
5 cognitive biases to know?
1. Confirmation bias
2. Availability bias
3. Current moment bias
4. Positive expectation bias
5. In-group bias
44
What develops from our biases to help us make system one decisions?
Heuristics, a.k.a. rules of thumb
45
What is a heuristic?
A mental shortcut
46
What is the availability bias and an example?
People wrongly judge the probability of future events based on exposure they have had to previous comparable events.
## Footnote
Increase in concern about safety on passenger flights following accidents despite the fact that aviation is safer than any other form of transport.
47
What is anchoring and an example?
A predictable, systematic bias whereby people have a tendency to judge the reasonability of certain events based off of their experience of comparable events.
## Footnote
For example, if restaurants deliberately set high prices for one or two meals on the menu, few people will order these dishes.
48
Example of biases based on social norms?
Many people instinctively decide not to smoke in public places as the social norm has developed away from smoking in public places in recent years.
49
Give an example of a positive social norm evolution?
Public smoking - government reports in Ireland have found that prohibiting smoking in public places caused people to smoke less frequently in other people's homes.
50
Can altruism be incorporated into utility theory?
Yes - maybe you derive utility from helping people
51
What is choice architecture?
The term used by behavioural economists to describe how government policy makers can create situations where consumers are nudged towards a desired option.
52
Choice architecture employs...
Nudges
53
4 types of choice architecture?
1. Default choice
2. Framing
3. Mandated choice
4. Restricted choice
54
Which key concept underlines default choice?
Anchoring
55
Example of an opt-out system and the result?
In 2020, organ donation in England became opt-out
## Footnote
Organ donation rose.
56
What is the other example of an opt-out system in the UK?
2012 - Automatic Pension Enrolment
57
Famous example of framing?
Vote Leave bus - 350 million to the NHS which was not factoring in expenditure.
58
When do mandated choices work best?
Simple yes/no decisions
59
Example of mandated choice?
Cookies on a website - vast majority select 'recommended' as a heuristic.
60
How do restricted choices work?
Reduce the available outcomes to a select few
61
Why do restricted choices work?
Play to bounded rationality and allow our inability to process large amounts of information to flourish.
62
What is the main criticism of behavioural nudge policies?
Overly paternalistic
63
What is a shove policy?
A policy which doesn't merely advise but seeks to actively change - not a nudge.
64
What percentage of long-term smokers will die from smoking related illnesses and why is this relevant?
50%
## Footnote
Irrational to consume cigarettes.
65
What are the chances of winning the National Lottery jackpot?
45 million to 1
66
Why does default choice work?
Status quo bias
67
4 ways we could use choice architecture?
1. Simplify the presentation of options
2. Automatically evoke particular associations through language or imagery
3. Making one option more prominent such as by highlighting it
4. Making one option easier to choose (not the same as the default choice)
68
Example of framing?
In 2015, Osborne claimed the Tories had more than halved the budget deficit, but this is only true when measured as a % of GDP.
69
What is the actual figure sent to the EU each week? What did Leave.EU say?
163.5 million
## Footnote
350 million.
70
Framing uses ____
Loss aversion bias
71
Framing is assisted when we use choice architecture to create a...
Narrow frame of reference
72
Example of a successful mandated choice and the benefit?
Illinois - all drivers must decide whether they are organ donors before they can be re-issued a licence.
73
How can firms use bounded rationality to exploit consumers? Example?
Make it as confusing as possible
## Footnote
CMA found that many firms were pricing fruit and vegetable per kilo, and others were doing it per fruit/vegetable.
74
What is another example of regulation that could rectify problems in behavioural economics?
Transparency regulation for firms
75
How can firms or governments combat information failure and an example?
Collaborative filtering to provide feedback on goods or services
## Footnote
Skyscanner.
76
How can incentives be used in behavioural economics and the problem? Example?
We can implement them into choice architecture to improve outcomes.
## Footnote
People respond in perverse ways e.g. the Israeli nursery where a lateness charge created an increase in parents arriving late.
77
What have studies revealed about incentives?
The more we are offered to do a task, the more suspicious we become of that task.
78
4 criticisms of nudge theory
1. Paternalistic
2. Heuristics can be satisficing given bounded rationality
3. Limitations - cannot be used on murder
4. Price mechanism shove interventions often just as effective and raise tax revenue
79
Why can altruism not be completely engulfed by utility theory?
It is people's first instinct
80
How can altruism and fairness affect behavioural economics?
It can affect purchasing decisions as people try to be ethical.
81
What are search costs and how do they interact with behavioural economics?
They are the costs associated with seeking perfect information when making an economic decision.
82
Why can marginal revenue be negative?
If you need to change the price of all other units sold to sell the next one, then it could be negative.
83
Marginal product
The amount of extra output produced by an extra unit of input
84
Marginal propensity to consume?
The increase in consumer spending for a given increase in disposable income
85
Example of the margin in Chapter 4?
Diminishing marginal returns to variable factors of production
86
Example of diminishing marginal returns in a restaurant?
If we have fixed factors of production (capital/land) and variable (labour) then we could add more waiters.
87
Marginal tax
The extra tax one must pay from extra consumption, production or income
88
4 determinants of consumer behaviour according to utility theory?
1. Marginal utility from that good
2. Utility from substitute goods
3. The budget available to the consumer
4. Preferences
89
Traditional economic theory depends on what model of behaviour? What does this entail?
Rational behaviour
## Footnote
People always try to make decisions in their self-interest or to maximise their private.
90
What happens to the marginal product of the last waiter?
Eventually, the marginal product falls to the point where marginal cost > marginal revenue.
91
What is marginal tax?
The extra tax one must pay from extra consumption, production, or income.
92
What are the 4 determinants of consumer behaviour according to utility theory?
1. Marginal utility from that good
2. Utility from substitute goods
3. The budget available to the consumer
4. Preferences
93
What model of behaviour does traditional economic theory depend on?
Rational behaviour
## Footnote
People always try to make decisions in their self-interest or to maximise their private benefit.
94
What is utility?
The pleasure or satisfaction obtained from consumption - the gain to economic welfare from consumption.
95
What do a total utility curve and a marginal utility curve show?
The same information, but cumulatively and non-cumulatively respectively.
96
What is the economic 'law' underlying utility theory?
Diminishing marginal utility theory
## Footnote
Increased consumption of a good X will result in diminishing marginal utility, ceteris paribus.
97
How can marginal utility affect price and who argued this?
Goods with high marginal utility (i.e. scarce) have higher prices, even if the total utility received from their consumption is very low.
## Footnote
E.g. diamonds. Marginal utility is very high because they are scarce. But total utility is still below that of water, which is much cheaper. Adam Smith pointed this out.
98
Why are orthodox economists sceptical of the government?
They believe all economic agents act in their own self-interest, including the government.
99
Is a decision made on the basis of imperfect information irrational?
Not necessarily; it might be rational to think a rock concert will be worth the price etc.
100
Why are prices for 'lemons' and in all second hand markets often too low?
Asymmetric information
## Footnote
Sellers are more likely to sell when their product is deficient. So they have asymmetric information. Buyers only accept low prices.
101
What was Friedman's defence of orthodox economic theory?
1953 - Assumptions are valid if they produce sound predictions, regardless of their own validity.
102
What is recency bias?
Your most recent actions and learning are important.
103
Example of how social biases could be used to solve economic problems?
Many people drink heavily because they believe it is what their peers are doing. If we show them evidence that this is not the case, they might stop.
104
What is the difference between sanctions and nudges?
Nudges are suggested and not enforced. Sanctions have punishments/consequences.
105
Example of how nudges can be more effective than sanctions?
It is illegal for teachers to not show up to work in India. But Esther Duflo won a Nobel Prize in Economics for her work reducing teacher absenteeism using behavioural economics, asking teachers in 120 schools to take photos with their class before school every day to reinforce the bond between teacher and student.
106
Can altruism be accommodated within utility theory and what is the caveat?
Yes
## Footnote
But most people do altruism as their first instinct, even young children and animals.
107
Are maximising theory and behavioural economics incompatible?
Not really. Behavioural complements rational theory.
108
What reduction in air travel was seen in the months after 9/11? What is this an example of?
31.3% reduction (IATA)
## Footnote
Availability bias/hysteresis.
109
What is rational behaviour?
People making decisions which are in their self-interest which maximise their private benefits.
110
When choices are required, what does the rational consumer do?
Always selects the best alternative i.e. the one which most supports their private benefit or utility.
111
For a total returns curve, how are diminishing marginal returns shown?
By the declining gradient of the TR curve, including the part where it becomes negative.
112
What is the point of satiation?
The point at which marginal utility is zero.
113
What are the evaluations for the law of diminishing marginal utility?
1. Does not occur for all goods e.g. education - many say the optimum level is infinite
2. Some goods e.g. chess pieces have rising marginal utility before it eventually declines
3. Consumer perception of marginal utility can be wrong if the good contains internalities or externalities.
114
What is price solely determined by in rational consumer theory?
Marginal utility
## Footnote
This is really useful to know.
115
If there were no constraints on consumption, what would consumers consume to in the rational model?
The point of satiation FOR ALL GOODS/SERVICES.
116
What are the 4 constraints on consumption in the rational model?
1. Limited income
2. Limited time
3. Budget constraint
4. Given set of prices - price takers.
117
What is adverse selection and what concept creates it?
When a lower price prevails in a market due to the presence of some products with lower marginal utility, even though many or most products in the market yield a higher marginal utility.
## Footnote
Asymmetric information.
118
What concept could be used to explain how consumers can benefit from the lemons market?
Producer surplus is transferred.
119
When was Akerlof's Lemons article published? What happened to it?
1970
## Footnote
Got the 2001 Nobel Prize in Economics.
120
What is behavioural economics?
A method of economic analysis that applies psychological insights to help analyse economic behaviour.
121
Who claimed that the problem with economics was that theory came before facts? What did he say?
Dan Ariely in his book Predictably Irrational
## Footnote
Conferred how behavioural economists differ, instead observing behaviour and making a theory from this, in the ordinary sense of economic theory.
122
What is a key point when answering policy solution questions in A Level economics?
Say how behavioural insights could supplement - rarely are they powerful enough to displace.
123
What does economics necessarily do for its models? What is one of the key insights of behavioural economics?
Make simplifications and assumptions about the world.
## Footnote
Challenging the validity of these assumptions - not necessarily the validity of making assumptions in the first place.
124
Do behavioural economists care about all instances of human irrationality? Which ones do they care most about?
No, only those where a significant gulf exists between orthodox theory and real life.
## Footnote
These 'anomalies' suggest theoretical flaws. Consistent failures, which are categorised as biases.
125
Example of bounded self-control?
How many people stick to their New Year's commitments regarding alcohol and fitness?
126
What are automatic and reflective thinking used to describe?
Daniel Kahneman's Thinking Fast and Slow.
127
Example of how one can go from thinking slow to thinking fast?
Learning to skateboard.
128
When are cognitive biases most significant?
System One decisions.
129
What is cognitive bias?
A systematic error in thinking.
130
What are the 2 heuristics?
1. Availability bias
2. Anchoring.
131
Example of availability bias?
UK - much media narrative about immigration - Ipsos polls found that UK residents think 24% of the population is immigrants - the real figure is 13%.
132
What is anchoring?
The tendency to make a decision by comparing the options to a limited frame of reference.
133
In decisions with three options, which option do humans disproportionately select?
The middle option.
## Footnote
Anchoring.
134
What are social norms?
Forms or patterns of behaviour considered acceptable by society or a subgrouping thereof.
135
What are nudges?
Factors which encourage people to think and act in particular ways.
136
How can imperfect information hamper social norms?
If people believe they are expected to do something.
137
What is a key feature of a sanction?
Breaking it leads to punishment.
138
When was Duflo's study?
2003.
139
How is Duflo's research linked to behavioural economics?
Combatted social norm of absenteeism.
140
What are the two most common heuristics that lead to bias?
Availability bias
Anchoring.
141
What does behavioural economics believe about having too many options?
Leads to suboptimal decision making. Search costs and bounded rationality.
142
Example of how behavioural insights can be used to improve honesty?
Signing the top of the page on forms leads to more accurate answers.
143
What is a key way to counter-evaluate paternalism?
Alternatives are all sanctions and hence have less choice, not more.
144
Why can nudges produce more allocatively efficient outcomes than the equivalent shove?
Those with very high elasticities of demand, who might genuinely need the product for some reason, continue to use it without a regressive effect on their income.
145
Is a tax a nudge?
No.
