2.1 Utility

What is Behavioural Economics

A method of economical analysis the applies psychological insights into human behaviour to explain economic decision-making

What is rationality

A decision making process that is based on making choices that result in the optimal benefit or maximum utility for an individual

What is utility

Satisfaction / Economic welfare that a consumer gains from consuming a good/ service

What are the assumptions of rational behaviour

A consumer has fixed and consistent preferences

Consumers choose independently irrespective of someone else’s preferences

They gather all the information on all alternative choices

Make an optimal choice based off of this

What is bounded rationality

Refers to the idea that people make decisions within the limits of their cognitive abilities (Individuals have limited info and resources to make a decision so they make an educated guess / use heuristics to make a decision

What is bounded self control

Refers to the idea that people posses a limited willpower when making a decision

Resisting temptations for example

Describe the differences between system 1 and system 2 thinking

System 1 is fast and system 2 is slow

System 1 is conscious, 2 is conscious

System 1 is automatic, 2 takes effort

System 1 is everyday decisions, 2 is complex decisions

System 1 is prone to making wrong decisions while 2 reliable

What does marginal mean

What does marginal utility mean

Additional

Additional satisfaction from consuming one more unit

What is the marginal utility theory

The marginal utility theory examines the increase in satisfaction consumers gain from the last unit of a good

What is the point of satiation

When marginal utility = 0 (any more units consumed will decrease utility)

What is the utility maximisation theory

That individuals and organisations seek to attain the highest level of utility/ satisfaction from their economic decisions

A consumer will consume a good up until marginal utility is equal to price/ cost for the consumer.

What are the utility maximisation constraints

Limited income- consumers cannot purchase all the goods they need to maximise utility

Limited time available

Irrational behaviour - Buying goods and later regretting it

Loyalty - Loyalty to local shops rather than buying from a supermarket but for cheaper

Sense of morality / religion - not eating meat, not eating avocado

Utility and price relationship diagram

What is consumer surplus

The additional amount over the price of which the consumer would be willing to pay for the good (highlighted in purple on diagram)

Give a comparison of how the marginal utility curve operates

The marginal utility is derived from the demand curve - a rise in fashion would lead to the marginal utility curve shifting to the right

If marginal benefit exceeds marginal cost / marginal cost exceeds marginal benefit what the effect on total utility

Total utility is increased/ Total utility is decreased

What is Adam Smith’s “The Paradox of Value”

Though water is more useful than diamonds in terms of survival but diamonds commands a higher price in the market

What is asymmetric information

A form of imperfect information

One side of the deal knows more than the other - usually the seller but it can be either

Example: Someone sells an antique but it’s actually from 1237 buyer knows this and gets it at a lower price

What is a merit good

A positive consumption externality

What is a demerit good

A negative consumption externality

What is the rule of thumb - heuristic

Consumers follow rule of thumb to make satisficing decisions