MICRO: Rational decision making/behavioural economics

Question 1

What are the key assumptions in traditional economic theory?

Answer 1

• Economic agents are utility maximisers
• Economic agents are rational

Question 2

Why do behavioural economists challenge these traditional assumptions?

Answer 2

They’re unrealistic.

Question 3

What do behavioural economists do?

Answer 3

• Look at the impact of social, psychological and emotional factors on decision making to attempt to make more realistic predictions about an individual’s decisions.
• They don’t ignore traditional economic theory - they try to improve upon it and make it more relevant to the real world.

Question 4

What is assumed of a rational individual, using the concept of utility maximisation?

Answer 4

They will attempt to maximise their utility (‘homo economicus’)

Question 5

What does acting rationally require?

Answer 5

This requires all agents to have the info needed to be able to make correct choices between alternatives.

Question 6

What do traditional economists assume about the info everyone has?

Answer 6

They assume everyone has perfect info and the ability to use this info to make a rational decision.

Question 7

In real life, how much info would economic agents have?

Answer 7

They would have imperfect information - they won’t have all the info they need to make a rational decision and this leads to market failure.

Question 8

What is asymmetric info?

Answer 8

One party has more information than the other in a transaction.

Question 9

What are the reasons why consumers don’t act rationally?

Answer 9

• Limited decision making time
• Not all info is available, and available info could be wrong
• People may not be able to process and evaluate the vast amounts of data involved in making a decision, and they may not be very good at calculating costs of alternatives (this is known as weakness of computation)

Question 10

What are these limits on decision making called?