Behavioural Economics


Bounded rationality

Economic agents only have bounded rationality, according to behavioural economists.

They often do not get all the information they need to make an optimal decision.

Their ability to process information is limited.

They do not spend the time to process the information they do have.

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Bounded self-control

Economic agents have bounded self-control, according to behavioural economists.

Economic agents know what they should be doing but in practise do something different.

Lack of self-control leads economic agents to make decisions which do not maximise their benefits.

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Value is set by anchors which are used as a mental reference point when making decisions.

They help to establish a basic price in our mind which we are prepared to pay.

Some help to set a high basic price and other set a low baskic price. 

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Rules of thumb/ Heuristsics

This is a method to make decisions quickly and easily  

The method produces an outcome which is not perfect but is usually sufficient.

The errors which arise from rules of thumb are called cognitive biases.#

Rules of thumb are used as decsions are complex and time consuming if they are made rationally. 

For example, buying a multipack of beans because as a rule of thumb it is cheaper than buying six individual cans

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Economic agents do not have the information that is needed to make rational decisions therefore they use the information that they do have to make the decisions. 

The information we possess acts as a cognitive bias and it is what we rely upon to make decisions even though we know there is better information available if we were to look.

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Social Norms

Social norms are beliefs held by a group of people about how to behave.

Evidence suggests economic agents do not make independent choices, instead they make choices based on social norms. 

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The concern or welfare of others, the opposite of egotism.

Neo-classical economists would argue that altruism creates welfare for economic agents and is done to benefit themselves, for example giving to charity because it enhances their self-image.

Behavioural economics suggests altruism cannot be explained in terms of welfare.

Humans behave with more kindness and fairness than neo-classical economists believe.

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Choice architcture

This refers to how decisions are affected by the layout and the framing of the choice. 

Behavioural economics argue that the way the choice is framed affects the decision that is made. 

The set of bounded rationality that economic agents possess determines the choices they make, however depending on the way the decisions are framed they can be manipulated to make a different decision. 

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A nudge is a very small change to the choice architecture designed to change the behaviour of an economic agent. 

Nudges are meant to be cheap to implement and shift economic agents into making more positive decisions.

Nudges still offer a choice to the economic agent; e.g offering apples at the canteen to promote healthy eating rather than banning crisps. 

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Default choices

A choice that is automatically chosen unless the economic agent positively chooses otherwise. 

Evidence shows that default choices are taken more regularly than if the economic agent had the option to opt in. 

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Restricted choices

Restricted choices are when economic agents are only given a small amount of choices when they could have a large number. 

Studies show that too many decisions make out hard for economic agents to make a decision as there is too much information to process. 

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Mandated choice

This is when economic agents are forced to make a choice. 

This is meant to reduce a proportion of the number of economic agents not making a choice. 

e.g. dvla have forced everyone applying for a new licence to choose whether or not they want to be an organ donor.

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