ECON HL CONTENT

Rational economic decision making: Individuals are assumed to act in their best self interest, trying to maximise the satisfaction they expect to receive from their economic decisions.

Biases that affect consumer choices are:

  • Rule of thumb: Simple guidelines based on experience and common sense, simplifying complicated decisions. (e.g, “A cup of fruit salad is about the size of two fists)”)

  • Anchoring: The use of irrelevant information to make decisions, which often occurs due to its being the first piece of information that the consumer happened to come across (e.g., wanting to buy something but it is $100 and then you see it again in another store for $50, so you buy it, only to see it later in another shop for $25)

  • Framing: How choices are presented to decision makers (e.g., people will be more lenient to buy milk that says 80% lean, rather than 20% fat)

Nudge theory is trying to influence people to behave in the socially desirable ways, but without imposing any constraints on their behaviour , and by maintaining freedom of choice.

Profit maximisation involves determining the level of output that the firm should produce to make profit as large as possible.

ASYMMETRICAL INFORMATION

  • Asymmetric information is when one party has more information about a good or a service than other in an economic exchange (like a doctor knowing more about a patient’s medical condition than the patient themselves).

  • Adverse selection occurs when the better-informed party uses an asymmetrical balance of information to take advantage of another party before an exchange or agreement has taken place (like someone who is a reckless driver going to take out car insurance. The insurer doesn’t know about their customer’s risk level.)

adverse selection can lead to market failure

  • Moral hazard: Occurs after a deal has been made between two parties that have asymmetrical information, and one party changes their behaviour as a result (like before car insurance, you were parking your car in a garage but after, you decide to park on the streets since you aren’t the one paying if any damages were to happen to the car).

MR = ∆TR/∆Q

AR = TR/Q (P = AR)