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Individual economic decision making (Consumer behaviour (Utility theory…
Individual economic decision making
Consumer behaviour
Maximisation occurs when an economic agent tries to obtain the most that they can from the economic activity that they undertake
this will differ dependent on the economic agent:
-Households or consumers wish to maximise their utility or personal satisfaction
-Firms wish to maximise their profits
-Government wish to maximise the welfare of the population
Economic objectives
have a variety of economic objectives
they meet these objectives by making use of factors of production available to them
Economic agents are: household, firms and government
The economic objectives of households might include: the maximisation of private benefit from consumption and the maximisation of private benefit from labour (supply of their labour)
Firms:
-Profit maximisation
-Profit satisficing - level below profit maximisation that satisfies the needs of the owners or managers
-Sales maximisation - gain market share
-Growth
Utility theory
it is concerned with the satisfaction that an individual derives from consuming a good or service
the unit of measurement for utility is called utils
Total utility is the aggregate amount of satisfaction an individual derives from consuming a good or service
Total utility diminishes or decreases over time
this occurs as an individual becomes more satisfied with the product
as consumption increases, total utility rises at first and then starts to diminish
Marginal utility is the amount of satisfaction an individual derives from consuming one extra unit of a good or service
change in utility/change in number of units consumed
As consumption increases, marginal utility diminishes giving us diminishing marginal utility
as price falls, consumers gain greater satisfaction from demanding the good
Utility maximisation
occurs where the last £ a consumer spends on each product yields the same amount of marginal utility
MUx/Px = Muy/Py
Margins
Individuals will only choose an option if the marginal benefit is greater than the marginal cost
this will improve their total utility
if the marginal cost is greater than the marginal benefit then total utility will actually fall
Imperfect information
without having full information about a product it is difficult for consumers and producers to make decisions regarding price and quality
Symmetric information is when all the relevant information is known by both parties
Perfect knowledge is a theoretical concept which occurs when all consumers in a market are fully aware of price, quantity available and other relevant information
Information failure is a type of market failure where consumers or producers have asymmetric information
This can lead to misallocation of resources as one party in a transaction has greater information than another
Markets are unable to operate efficiently if economic agents do not have perfect information
Economic agents are unable to undertake rational decision making unless they have the information required to make these decisions
Free markets are likely to misallocate resources
Behavioural economics theory
Looks at 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
Social norms are the rules of behaviour that are considered accepted within a social group
Nudge theory is an attempt to manipulate social norms through positive reinforcement in a non-coercive manner
People struggle with computation, the ability to make correct decisions based on the information available to them
An heuristic is a simple rule of thumb that individuals use to make a judgement undertaking decision making
Availability - make judgements based on events we can remember rather than the information at hand
Representativeness - categorising based on past information rather than on the information at hand
Anchoring and adjustment - using an arbitrary starting number to estimate a different number
Altruism occurs when economic agents help others at their own expense and believe in fairness in society
Choice architecture is the design of ways in which choices are presented to economic agents
Framing is the actual way in which choices are presented
Libertarian paternalism is the idea that economic agents can try to affect decisions made by other economic agents in order to improve their welfare
Default choices suggests that consumers display habitual behaviour by following the same routines
Economic agents might suffer from loss aversion making decisions based on avoiding loss rather than achieving gain
The paradox of choice suggests that sometimes individuals simply have too much choice, leaving them feeling overwhelmed
Restricted choice remedies this, offering less scope but allowing individuals to make more informed decisions
Mandated choice occurs when individuals are forced to make a decision