AQA 1.2: Individual Economic Decision Making 1.2.3 Aspects of behavioural economic theory How many African countries are members of the United Nations? Is it more or less than 105? What figure do you think? Write down your answer individually. AQA 1.2: Individual Economic Decision Making

1.2.3 What you need to know Bounded rationality and bounded self-control Biases in decision making: rules of thumb, anchoring, availability and social norms The importance of altruism and perceptions of fairness Students should appreciate that behavioural economists question the assumption of traditional economic theory that individuals are rational decision makers who endeavour to maximise their utility. They should understand some of the reasons why an individual’s economic decisions may be biased

Behavioural economics Behavioural economics looks at the psychological reasons behind why people make decisions Bounded rationality suggests that when people make decisions they are limited by: The information available to them Their intellectual limitations The time available to make decisions Bounded self-control suggests that individuals have limited control over their decision-making and therefore make decisions that are not in their best interests By recognising that people have limited control when making decisions we can adopt strategies that can help individuals improve their own welfare and therefore the welfare of society as a whole Daniel Kahneman on behavioural economics. http://thebrainbank.scienceblog.com/2014/09/14/nudge-how-science-is-being-used-to-influence-our-behaviour/

Consideration of the influence of other people‘s behaviour Social norms are the rules of behaviour that are considered acceptable within a social group People who don’t follow social norms are often not accepted within the group Therefore, individuals will attempt to ‘fit in’ with the crowd by following social norms This might even mean that consumption of a good or service leads to marginal disutility Nudge theory is an attempt to manipulate social norms through positive reinforcement in a non-coercive manner How are universities using nudge theory to change social norms? What is meant by the term marginal disutility? http://www.bbc.co.uk/news/education-27589939 To what extent are your decisions influenced by other people?

Consumer weakness at computation . Often, people struggle with day to day computation, the ability to make correct decisions based on the information available to them Individuals make judgements based on mental short cuts when uncertainty exists and when it is too difficult to compute the available information An heuristic is a simple rule of thumb (a general rule followed by an economic agent when making decisions) that individuals use to make a judgement when undertaking decision-making They normally focus on one aspect of a problem rather than looking at all the information available Therefore, decision-making is flawed

Consumer weakness at computation Tversky and Kahneman named three heuristics that can lead to irrational behaviour by individuals: Availability – making judgements based on, particularly vivid, events we can remember rather than the information at hand e.g. we might fear flying due to excessive media coverage but the likelihood of a plane crash is negligible Representativeness – categorising based on past information rather than on the information at hand e.g. a gambler might make a bet because they believe that they are in a run of good luck Anchoring and adjustment – using an arbitrary starting number to estimate a different number. The starting number is the anchor and we tend to adjust an answer to be close to the anchor e.g. Is the population of Brazil higher or lower than 100m? What is the population of Brazil? Often people will give a figure close to 100m Daniel Kahneman: We are beautiful devices. http://www.worldometers.info/world-population/brazil-population/ http://www.theguardian.com/science/2011/nov/14/daniel-kahneman-psychologist What is the population of Brazil?

The importance of altruism and perceptions of fairness Traditional economic theory is based on the fact that people are self-interested and their behaviour reflects this Altruism occurs when economic agents help others at their own expense and believe in fairness in society These contradictory ideas can be used to better understand economic models Often, people give to others in order to feel good about themselves. Thus there is an element of self-interest However, we also see selfless acts where people do not consider their own interests and act to benefit a group This is often seen in the case of family but can also be seen within the workplace and society as a whole This biases economic agents decision making, meaning it is more difficult to make assumptions about rationality

Self evaluate Analyse whether you have been influenced by any of these ? Social norms Nudge theory Computation Availability Representativeness Anchoring Altruism