Behavioural economics 2

Standard Neoclassical Model of consumer choice assumptions

Well defined and stable preferences - Consumers clearly understand their preferences and remain consistent in their choices.

Perfect information - Consumers comprehensively understand and can view all available info

Utility maximisation - Consumers aim to obtain the highest possible utlity

The limitation of the standard neoclassical model of consumer choice

In the 1980-1990s, economists stumbled across the issue of anomaly choices, these are unexpected behaviours which were mainly researched in laboratories.

What makes anomaly choices more likely?

First time decisions: no experience

Complex decision: requires more thought

Many choice: lots of alternatives

Small incentives: Not worth looking into

Time: little time to decide

What is bounded rationality?

When individuals want to preserve cognitive resources so resort to using mental shortcuts (heurisitics) which take less cognitive effort.

What is behavioural economics?

The incorporation of psychological factors into economic models giving potential reasons as to why agents behave a certain way.

Departs from the three assumptions:

• Nonfixed and unstable preferences - Preferences don’t remain fixed and open to change

• Imperfect information and processing - Information available not processed comprehensively

• Bounded rationality - Consumers sometimes do not maximise utility due to using mental shortcuts, to prevent cognitive effort.

What is top position effect?

Where an individual presented with sequence of choice is inclined to pick the first item in the sequence.

Standard theory suggests that the individual would rational and process the information perfectly while aiming to maximise utility. However, in real life this is not the case.

What is choice overload?

Where the addition of choices within a sequence of choices makes it more likely that a suboptimal choice is chosen.

What is leftmost digit bias?

The disproportionate focus on the leftmost digit compared to the rest of the numbers, meaning the interpretation is skewed.

What is the decoy effect?

When an additional option influences an already existing choice decision between two options, where the additional choice would never have been considered.

What is the default effect?

Where an individual is inclined to pick the default option even with alternatives that maximise utility.

Loss aversion, framing and endowment effects

Loss aversion - Where individuals perceive the negative effects of loss more than the positive equivalent gains.

Framing effect - Individuals perception differs depending on how information is presented.

Endowment effect - Individuals placing higher value on things they own compared to what its actually worth.