4.1.2 – Individual Economic Decision Making

    92 – Consumer Behaviour

    Economists use theory of Margin
    • the margin in the change in a variable caused by an increase of unit of another variable
    o for e.g. the marginal cost of an ice cream is the additional cost of making one additional ice cream.
    o I.e. the cost of final ice cream produced
    • Marginal cost can be calculated by finding difference between total cost at new output level and total cost of
    producing one unit less than that.
    o The total cost of producing 100 ice creams is £100 and total cost of producing 101 ice creams is £102
    o So marginal cost of producing 101 ice cream is £102-£100 = £2
    Economic Agents are Utility Maximisers
    • Producers, consumers and workers want to maximise utility
    • Different economic agents have different ways of maximising utility e.g. consumer might maximise happiness
    while producer might maximise profit
    • Traditional economists argue that to maximise utility economic agents must act rationally

    You Need to Understand How Consumers Act Rationally
    • To understand how Consumers act rationally you must know about marginal utility, total utility and law of
    diminishing utility
    o Marginal utility – benefit gained from consuming one more additional item
    o Total utility – overall benefit gained from consuming a good
    o Law of diminishing utility – for each additional unit of good consumed, marginal utility gained decreases
    ▪ For e.g. each additional biscuit eaten gives consumer less satisfaction from previous one
    Different Economic Agents Have Different Economic Agents – Aspects of Behavioural Economics

    Behavioural economics Challenges Traditional Economic Theory
    • Key assumptions in traditional economic theory
    o Economic agents are utility maximises
    o Economic agents are rational
    • Behavioural Economic agents challenge impacts of social,
    psychological & emotional factors on decision making
    • So, they do use traditional Economic theory but improve upon it making it more relevant to real world
    Rationality is Used to Explain Actions of Economic Agents
    1. Its assumed that a rational individual will attempt to maximise their utility, by comparing costs and benefits of
    alternatives, then choose an option to maximise net utility (profit).
    2. Traditional economics assumes everyone has perfect information. But in real life economic agents don’t
    3. Asymmetric information also prevents rationality, as one party has more information than the other
    4. As a result, behavioural economists believe rationality alone can’t be used to predict consumer behaviour
    Theres Many Reasons why Consumers Don’t Act Rationally
    • Behavioural economists argue theres lot of restrictions on people’s ability to make rational decisions
    o Time available to make a decision is limited
    o Not all information is available, and the information that’s available may be incorrect
    o People can’t process and evaluate the vast amounts of data involved in making a decision
    o People might not be very good at calculating the costs of alternatives (computation weakness)
    • Limits of decision making are known as Bounded Rationality. so, people tend to satisfice rather than make a
    rational decision maximising utility
    Behavioural Economists Argue Individuals have Bounded Self control
    • A rational individual is assumed to have self-control and will only act to maximise utility
    • However behavioural economists argue individuals have limits on self-control e.g. smoking as it’s an addiction
    Biases Stop Individuals Acting in An Economically Rational Way
    • Behavioural economists believe individuals are influenced by biases affecting decision making. E.g.

    Fairness affects decision making – in traditional economic theory, a rational individual may give money to
    charity as they gain utility from it (e.g.) makes them feel good. However behavioural economists say they can do
    it as a sense of fairness rather than act out of self interest. E.g. a firm paying employee above market wage as its
    fair. Behavioural Economics and Economic Policies

    Choice architecture is where an individual’s choice is influenced by
    adapting the way the choice is presented this can be done in several ways:
    o Default choice – people more likely to choose default option, encouraging people to act in a certain way
    o Framing – the way the information is presented can influence a decision e.g. £1 a day vs £7 a week
    o Nudging – some alternatives are easier to choose than others without removing freedom of choice
    o Restricted choice – occurs when peoples choices are restricted
    o Mandated choice – where people have to make a decision (choice of organ donation)


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