Individual economic decision making

• What is rational economic decision making?

  Rational economic decision making is when consumers make choices by logically evaluating available alternatives, based on preferences and available information, to maximize their utility (satisfaction or happiness). Consumers are assumed to make decisions that are consistent with their best interests.
• What are economic incentives?

  Economic incentives are factors or stimuli that influence the choices and behaviors of individuals, such as:

  • Monetary incentives: Price signals, subsidies, etc.
  • Non-monetary incentives: Social norms, ethical considerations, and status.
• What is Total Utility (TU)?

  Total utility is the total amount of satisfaction or benefit a person gets from consuming a certain amount of a good or service. It increases as consumption rises but at a diminishing rate.
• What is Marginal Utility (MU)?

  Marginal utility is the additional satisfaction or benefit derived from consuming one more unit of a good or service. It typically decreases as more units are consumed, a principle known as diminishing marginal utility.
• What is the hypothesis of diminishing marginal utility?

  The hypothesis of diminishing marginal utility states that as a person consumes more units of a good or service, the additional satisfaction (marginal utility) from each successive unit decreases. This is why the demand curve for most goods slopes downwards.
• How does diminishing marginal utility relate to the demand curve?

  It explains why the demand curve is downward sloping: As individuals consume more of a good, the marginal utility from consuming additional units decreases, so they are willing to pay less for subsequent units.
• What is utility maximisation?

  Utility maximisation refers to the idea that consumers allocate their limited resources (income) among various goods and services in a way that maximizes their total utility, given their budget constraint.
• How do consumers achieve utility maximisation?

  Consumers adjust their expenditure so that the marginal utility per unit of currency spent is equal across all goods.

  • Formula: MUx/Px = MUy/Py = MUz/Pz where MU is marginal utility and PP is price.
• What does marginal analysis involve?

  Marginal analysis involves making decisions based on comparing marginal benefit (MB) and marginal cost (MC).

  • If MB > MC, individuals will continue consuming or producing.
  • If MC > MB, they will stop consuming or producing.
• How does marginal utility apply to everyday decisions?

  Individuals use marginal utility to determine whether the next unit of consumption provides enough satisfaction to justify the cost, adjusting their behavior accordingly.
• What is perfect information?

  Perfect information refers to having complete knowledge about products, prices, quality, and potential consequences, enabling rational decisions.
• What is imperfect information?

  Imperfect information occurs when consumers or firms lack complete information, leading to suboptimal or less informed decisions. This is common in real-world markets.
• What is asymmetric information?

  Asymmetric information occurs when one party in a transaction has more or better information than the other party. This imbalance can lead to market inefficiency and failure.
• How can asymmetric information cause adverse selection and moral hazard?

  • Adverse Selection: One party exploits their informational advantage, leading to poor outcomes (e.g., a buyer of a used car being unaware of defects).
  • Moral Hazard: One party takes on more risk because they do not bear the full cost (e.g., an insured person driving recklessly).
• What is bounded rationality?

  Bounded rationality suggests that individuals do not always make perfectly rational decisions due to cognitive limitations, lack of information, or time constraints. Consumers may make satisfactory decisions rather than optimal ones.
• What is bounded self-control?

  Bounded self-control refers to the idea that individuals often fail to act in their long-term best interests due to impulses, short-term desires, and lack of self-discipline (e.g., overspending on impulse purchases).
• What is a rule of thumb?

  A rule of thumb is a simplified decision-making strategy that people use when faced with complex choices. These shortcuts can lead to systematic errors, such as choosing based on familiarity instead of evaluating all options.
• What is the anchoring bias?

  The anchoring bias occurs when individuals rely too heavily on the first piece of information they receive (the anchor), influencing their subsequent decisions even if that initial information is irrelevant.
• What is the availability bias?

  The availability bias occurs when individuals base their decisions on the most readily available or recent information in their memory, rather than considering all relevant facts.
• How do social norms influence decision making?

  People are often influenced by social norms or peer behaviors, making them more likely to make decisions that align with societal expectations or trends, even if it’s not the optimal choice.
• What is altruism in behavioral economics?

  Altruism refers to individuals making decisions that benefit others, even at a personal cost. People often act out of a sense of generosity or concern for the welfare of others.
• How does fairness influence decision making?

  People often care about fairness and equity when making decisions, and may sacrifice personal utility to ensure that outcomes are perceived as fair or just. For example, individuals may choose to ensure their employees are paid fairly, even if it reduces their profits.
• What is choice architecture?

  Choice architecture refers to the way in which choices are presented to individuals, which can influence their decisions. By organizing options in a specific way, decision-makers can "nudge" individuals toward more beneficial choices.
• What is the framing effect?

  The framing effect occurs when individuals make different decisions depending on how options are presented, even if the options are essentially the same. For example, people are more likely to choose a product labeled as "90% fat-free" than one labeled as "10% fat."
• What are nudges in behavioral economics?

  Nudges are subtle interventions that steer people toward making decisions that are in their long-term best interest, without removing their freedom to choose. Examples include automatically enrolling employees in pension plans or setting healthier food options at the front of a line.
• How can default choices influence decision making?

  Default choices are pre-selected options that consumers must actively opt-out of. By making beneficial options the default, governments or organizations can encourage better decisions (e.g., defaulting individuals into organ donation unless they opt-out).
• What is restricted choice in behavioral economics?

  Restricted choice reduces the number of options available to individuals, simplifying the decision-making process. It can help reduce decision fatigue and improve outcomes by narrowing down options.
• What is mandated choice?

  Mandated choice requires individuals to make a decision, such as mandatory organ donation or retirement savings contributions. This removes the default "opt-out" option and forces individuals to actively choose.
• What is utility maximization in consumer behavior?

  Utility maximization is the process by which consumers make choices to maximize their satisfaction or utility, subject to their budget constraints. They choose a combination of goods and services that provides the highest total utility.
• Why is marginal utility important in utility maximization?

  Consumers allocate their budget to ensure that the marginal utility per dollar spent on each good or service is equal. This helps maximize their overall satisfaction given their income.
• What is the Law of Diminishing Marginal Utility?

  The Law of Diminishing Marginal Utility states that as a person consumes more units of a good or service, the additional satisfaction (or marginal utility) gained from each successive unit decreases.
• Why is marginal utility important in utility maximization?

  Consumers allocate their budget to ensure that the marginal utility per dollar spent on each good or service is equal. This helps maximize their overall satisfaction given their income.
• What is the Law of Diminishing Marginal Utility?

  The Law of Diminishing Marginal Utility states that as a person consumes more units of a good or service, the additional satisfaction (or marginal utility) gained from each successive unit decreases.
• How does this law explain consumer behavior?

  As marginal utility decreases with additional consumption, consumers are willing to pay less for each additional unit of the good. This is reflected in the downward-sloping demand curve.
• How does asymmetric information affect decision-making?

  Asymmetric information occurs when one party in a transaction has more or better information than the other. This leads to market inefficiencies, such as adverse selection (where buyers or sellers make poor choices due to incomplete or misleading information) and moral hazard (where one party takes excessive risks because they do not bear all the consequences).
• What is an example of asymmetric information in a used car market?

  In the used car market, sellers have more information about the car’s condition than buyers, leading to the risk of selling a “lemon” (defective car) at a price higher than its true value, which may drive out good cars from the market.
• What is bounded rationality?

  Bounded rationality suggests that while individuals aim to make rational decisions, their ability is limited by cognitive constraints, time limitations, and access to information. This leads them to make satisfactory rather than optimal decisions.
• What are the key features of bounded rationality?

  • Cognitive limits: Limited memory and processing ability.
  • Time constraints: Not enough time to evaluate all alternatives.
  • Limited information: Incomplete or difficult-to-interpret data.
• What is the anchoring effect in decision-making?

  The anchoring effect occurs when individuals rely too heavily on the first piece of information they encounter (the "anchor"), which then influences their subsequent decisions, even if the anchor is irrelevant.
• Can you provide an example of anchoring bias?

  If a person sees a jacket priced at $300 and then sees another at $200, they may perceive the second jacket as a good deal, even if $200 is still above their budget. The initial $300 price "anchors" their perception of value.