Economics (HL Micro)

Rational Consumer Choice Assumptions

• consumer rationality

• perfect information

• utility maximisation

Consumer Rationality

• rational consumers have clear preferences for goods and services that are stable over time and transitive

Non-Satiation Assumption

• the consumer prefers more of a good to less

Perfect Information

• consumers have perfect information about the good and all other alternatives

• includes knowledge of all possible products, qualities, and prices

Utility Maximisation

• rational consumers have analytical skills which allow them to determine which goods they prefer and to effectively compare their possible choices in terms of costs and satisfaction

• consumers maximise their utility

  • done through buying the combination of goods and services that results in the greatest amount of utility fro the given amount of money spent

Biases

• refers to systematic deviations from rational choice decision-making

  • rule of thumb

  • anchoring

  • framing

  • availability

Rule of Thumb

• a simple guideline based on experience and common sense, simplifying complicated decisions

  • can help consumers make good decisions and save time, but can be inaccurate and lead to irrational decisions at times

Anchoring

• the use of irrelevant information to make decisions, which occurs due reliance on the first piece of information the consumer comes across

Framing

• deals with how choices are presented to decisions makers

  • eg. 80% lean vs. 20% fat

  • eg. jeans in a luxury store vs. jeans in a thrift store

Avaliability

• refers to information that is most recently available, which people tend to rely on more heavily, though there is no reason to expect that the information is any more reliable than information available at an earlier time

  • people remember recent events more readily

Realistic Consumer Behaviour

• bounded rationality

• bounded self-control

• bounded selfishness

• imperfect information

Bounded Rationality

• the idea that consumers are rational only within limits

Bounded Self-Control

• the idea that people in reality exercise self-control only within certain limits, lacking the self-control required o them to make rational decisions

Bounded Selfishness

• the idea that people are only selfish within limits

Imperfect Information

• consumers cannot have access to all information about goods and all alternatives

Producer Surplus

• the positive difference between the price that producers receive from selling a good and the minimum price they are willing and able to sell at

Consumer Surplus

• the positive difference between the amount that a consumer is willing and able to pay for a good and the amount they actually pay

Allocative Efficiency

• the socially optimal outcome where resources are maximised

• MB = MC

Behavioural Economics

• a sub-discipline of economics that relies on elements of cognitive psychology to better understand decision. making by economic agents

• it challenges the assumption that economic agents (consumers or firm) will always make rational choices with the aim of maximising utility with respect to some objective

Choice Architecture

• the design of environments based on the idea that the layout, sequencing, and range of choices available affects the decisions made by consumers

Default Choice

• When a choice is made by default, meaning that is the choice that automatically selected when one does not do anything

  • person needs to actively opt-out

  • eg. countries with “opt-out” for organ donation

Restricted Choice

• when the choice of a consumer is restricted by a government or authority

Mandated Choice

• choices made by consumers who are required to state whether or not they wish to take part in an activity

Nudge Theory

• nudges (prompts, bias) are used to influence the choices made by consumers to improve the well-being of people and society

Profit Maximisation

• a possible objective of firms that involves producing the level of output where profits are the greatest, where total revenue minus total cost is greatest, or where marginal revenue = marginal cost

Corporate Social Responsibility

• a corporate goal adopted by many firms that aims to create and maintain an ethical and environmentally responsible image

Market Share

• the percentage of total sales in a market accounted for by one firm

Satisficing

• a business or firm objective to achieve a satisfactory outcome with respect to one or several objectives, rather than to pursue any one objective at the possible expense of others by optimising

  • a mix of the words “satisfy” and “suffice”

Growth

• the growth of a firm can be measured by indicators such as the number of employees, market share, value of assets, revenues, and profits

Fixed Costs

• expenses that do not vary with the level of output

Variable Costs

• expenses that increase as production increases and decrease as production decreases

  • raw materials

  • energy consumption

  • labour (when paid by the hour or based on output)

Total Costs

• the sum of all costs incurred by a company to produce a certain level of output.

• fixed costs + variable costs

Average Costs

• total costs of production divided by the total quantity of output produced

Marginal Costs

• the extra or additional cost of producing one more unit of output

The Law of Diminishing Marginal Returns

• When additional variable factors of production are employed to fixed factors, the marginal returns will eventually decrease

• this occurs in the short run, as at least one of the FOPs are fixed

Perfect Competition Characteristics

• many small firms

• homogenous products (perfect substitution

  • demand for one firm perfectly price inelastic

• no market power

• firms are price takers

• no barriers to entry or exit

• consumers and producers have perfect information

• perfect factor mobility

Marginal Revenue (MR)

• The extra or additional revenue that arises for a firm when it sells one more unit of output.

Marginal Costs

• The extra or additional costs that arise for a firm when it sells one more unit of output.

MR > MC

• the firm can increase profit by increasing production because each additional unit produced adds more to revenue than it adds to costs

MR < MC

• the firm is losing money on each additional unit produced so it should decrease production

MR = MC

• the firm is at the point where producing one more unit neither increases nor decreases profit

• this is the point of maximum profit

Why do consumers have bounded rationality?

• insufficient information

• costliness of obtaining information

• limitations of the human mind to process large amounts of information

Three types of choice architecture

• restricted choice

• default choice

• mandated choice