Individual economic decision making

What is homo economius?

Economic human- described humans as rational and self interested capable of making complex calculations and decisions, having self control and unmoved by emotion and external factors. The assumption that humans are aiming to maximise utility.

What are humans in reality?

Humans are not always rational , capable of making optimum decisions, able to exert self control and are emotional and easily distracted. They can display altruism- are not always self centered.

How much are consumers willing to spend?

What’s utility?

They’re willing to spend the same amount or less money as the amount of utils (a measure of the satisfaction or economic welfare an individual gains from consuming a good or service) they will receive .

What is marginal utility?

The additional utility gained from consuming one more unit of a good.

What’s the hypothesis of diminishing marginal utility?

For a single consumer, the marginal utility derived from a good or service diminishes for each additional unit consumer.

What’s asymmetric information?

What can this cause?

Asymmetric- one party to a market transaction has more or less relevant information to the exchange than the other.

This can cause adverse selection e.g market of lemons (second hand cars), lower prices are offered. The market for lemons’- second hand cars, buyers don’t know the quality of the car before buying (asymmetric information) unlike the sellers, good and bad used cars must be sold at the same price, causing the majority of the cars in the market to be lemons.

What’s bounded rationality?

When making decisions, individuals rationality is bounded by the information they have, the limitations of their minds and the finite amount of time available in which to make decisions. We usually satisfied.

What’s bounded self control?

Individuals have limited self control and therefore do not always act rationally and in their self interest.

What are cognitive biases?

A systematic error in thinking that affects the decisions and judgments that people make.

Define social norms.

Informal rules that govern human behaviour.

What are nudges?

Factors which encourage people to act in a certain way.

Define anchoring.

Anchoring is a cognitive bias describing how humans tend to rely too heavily on one piece of information- often the first piece of information they have been provided with, which are used when making later decisions

What are rules of thumb?

Rules of thumb are thinking shortcuts which help us to save time and effort when making decisions.

Define loss aversion.

People tend to prefer avoiding looses to acquiring relevant gains

Define altruistic behaviour.

Selfless concerns for the well being of others.

Define heuristics.

Mental shortcuts or rules of thumb for decisions making to help people make a quick, satisfactory, but perhaps not perfect answer to a complex question.

What is confirmation bias?

The tendency to seek out and interpret information in a way that supports one's pre- existing beliefs, ignoring information that contradicts them.

What's availability bias?

Making decision based on information that is the most easily accessible/ recalled rather than finding all relevant information, leading the decisions which aren’t based on logical reasoning.

What's hindsight bias?

People tend to believe that they would have predicted the outcome of an event correctly after the outcome has occurred, despite them not having evidence or reasons.

What’s choice architecture?

Controls the way in which information/ choices are presented to consumers, which can nudge them into certain decisions.

What's the framing effect?

Choices or judgements are affected by how the information is presented/ framed.

What's the status quo bias?

Preferring the current state or default to avoid change or risk

What are nudges?

Guiding people to make a certain decision without reducing the number of options.

What's a mandated choice?

A decision has to be made bA decision by an individual is required, there is no default (a decision has to be actively made)

What's a restricted choice?

Limiting the number of options to simplify decision making.

What's a default choice?

The automatic option given to you which remains unless changed e.g opt out organ donation in the UK, automatic pension enrolment.

What is adverse selection?

How can adverse selection be overcome?

When a party acts in their own interest as they have more information e.g insurance company’s and market for lemons.

Solutions: buyers selection, codes of conduct (law), enforce a penalty, put tests in place, trackers, black boxes, excess, increase your premium.

What is a moral hazard?

When individuals are more likely to take risks if they will not near the full consequences of their actions.