1.2.10

• The assumption of rational behaviour

  The assumption of rationality has dominated standard economic thinking and orthodox theory for decades. Some of the key assumptions behind rational behaviour:

  • Agents choose independently of one another
  • An agent has fixed and stable tastes and preferences
  • An agent gathers complete information on all alternatives
  • An agent always makes an optimal choice with given preferences
• Economic agents

  • Have limited capacity to calculate all costs and benefits
  • Are influenced by their own social networks
  • Often act reciprocally rather than in pure self interest
  • Lack self-interest and seek immediate satisfaction
  • Are loss averse (losses matter more than gains)
  • Make different choices in cold and hot emotional states
  • Often fall back on simple rules of thumb when choosing
  • Satisfice rather than maximise
  • Have a strong default to maintain the status quo
• Social norms

  Our day-to-day behaviour in markets is often strongly influenced by prevailing social norms or serial customs. Examples of social norms:

  • Changing the social stigma of drink-driving and speeding
  • Observing white lines in car parks
  • Queuing behaviour in shops
  • Impact on behaviour of smoking bans in all public places
  • Making seat-belts compulsory - these created conventions which then became self-sustaining
• Habitual behaviour

  • Most people carry on behaving as they have always done
  • Repeat choices / purchases often become automatic default choices don't involve mental effort
  • To get people to change their behaviour may require compelling incentives or introducing a form of mandated choice
• Herd behaviour

  We are herd animals and we often make decisions based on who is around us plus the choices they make. Examples:

  • Choosing items off a menu in a restaurant
  • Herd behaviour in financial markets
  • Binge drinkers going on holiday with each other