Topic 2 - Economic Decision making Flashcards
(11 cards)
Explain the law of diminishing utility…
As a person increases the consumption of a good, there is a decline in the marginal utility derived from consuming each extra good and therefore we say the utility of each good starts to diminish.
What does Adam smiths water and diamond paradox state.
Often practical goods we use in everyday life (such as water) have much lower value than scarce goods which have barely any use (such as diamonds) due to its scarcity.
He said that “practical goods we use daily have large value in use but small value in exchange.”
This is due to waters scarcity compared to diamonds scarcity. Because of waters lack of scarcity, people drink water till the point where one extra sip of water has extremely low marginal utility. However, due to diamonds scarcity adding one more diamond to someone’s collection has much more marginal utility (unless they are in a life or death situation where they are dying from thirst. )
Explain the assumption of maximising behaviour by ecnomic agents
(Assumption of rational consumers/producer decisions )
Each rational economic agent is aiming to maximise either their satisfaction/utility or profit
What does the problem of imperfect information cause
Imperfect information can often cause market failures due to consumers not maxing decisions to maximise their satisfaction and welfare.
What is asymmetric information?
When one party to a market transaction possesses less information relevant to the exchange than the other party.
This could mean that the party with less information is not maximising their welfare/satisfaction through the exchange.
What is meant by behavioural economics
Applies physchological insights into human behaviour when making economic decisions.
What is meant by bounded rationality
The final decisions that consumers make are limited in rationality by factors of:
- how long they take to make the decision
- the amount of choice they have
- the information they have
What is bounded self control?
In some economic decisions, consumers may have enough information to know the decision is irrational yet their bounded self control allows them to make this decision anyway.
What is a cognitive bias and explain the cognitive biases.
Cognitive bias is a systematic error that affects the decisions people make.
*Price anchoring *- forcing consumers to choose the “middle option” by presenting a high priced alternative to them and therefore making the middle option seem reasonabl priced even though it may not be.
Availability bias - when consumers base their decisions on vivid/memorable examples instead of actual probabilities (e.g : inflation fears due to constant talks in the media.)
Framing - how firms present information to you (90% survival rate OR 10% mortality rate - same figured different presentation)
Choice architecture - strategically placing different products in specific areas in order to bring more attention to them. E.g - cheaper products near the tills can bring more sales as consumers are more willing to buy them once they are already planning on spending money in the shop. OR products with highest profit margins are presented near the entrance of the shop in hope to grab people’s attentionto buying products that produce the most profit for the firm.
Social Norms - patterns of behaviour which affect where consumers invest in due to being deemed “acceptable”.
Herd Behaviour- following trends that are popular with other people.
What is the rule of thumb?
Thinking shortcuts or informed guesses which individuals use in order to save time and effort.
E.g - diversify ur portfolio rather than investing in one stock
A quick piece of information that lacks full knwoledge on the topic but is still relatively good advice that can be used when making quick decisions
What is altruism?
Concern for the wellbeing of others and not expecting anything back
