4.1.2- Individual Economic Decision Making
Consumer Behaviour
Traditional economic theory assumes that consumers act rationally and wish to maximise
their utility or consumption by correctly choosing how to spend their income
Rational producers wish to maximise their profits
Government wishes to improve the economic and social welfare of citizens
RATIONAL DECISIONS- The one which maximises someone's personal net benefit for
every £ spent
THE UTILITY THEORY
Utility- The satisfaction or happiness an individual derives from consuming a good or
service
Marginal Utility/Total Utility- Same as returns
Diminishing Marginal Utility- For a single consumer the marginal utility derived from a good
or service diminishes for each
additional unit consumed- lends general support to the idea of a downward
sloping demand curve
• When utility is maximised, the marginal utility is proportional to the income spent
◦ In order to maximise a desired objective, an economic agent must undertake the
activity involved up to a point where MARGINAL PRIVATE BENEFIT RECEIVED =
MARGINAL PRIVATE COST INCURRED
IMPERFECT INFORMATION
• Whilst it is often assumed that an individual has perfect information, in reality it is
imperfect
• Information failure occurs when people have inaccurate or incomplete information and
therefore make potentially sub-optimal decisions
• Causes of Information failure
◦ Lack of education/understanding about information
◦ Over-complication
◦ Myopia- ST
, ◦ Asymmetric information
◦ High cost/ time-consuming nature when gaining all of the information
• E.g. Uncertain quality of second hand products, high complexity of pension schemes etc.
• Could be a source of market failure as a good or service could be under consumed or
over-consumed as a result (Merit/Demerit good), leading to a misallocation of resources
and allocative inefficiency
ASYMMETRIC INFORMATION
When one party involved in a transaction has more or superior information than another
party
Adverse Selection- An undesired result due to the situation where there is asymmetric
information
Moral Hazard- When a party with superior information alters their behaviour resulting in
benefits to them while at the same time
increasing the costs and risks on people possessing less information
• Asymmetric information usually results in an imbalance of power between parties
involved in a transaction, affecting the outcome, resulting in allocative inefficiency
• E.g. Landlords vs Tenants, Sub-prime mortgages, Doctors have superior knowledge
about drugs and treatments, Used-car sellers
THE SYSTEMS ASSOCIATED WITH THINKING
System 1 Thinking:
- Vast majority of decisions happen without realising
- Thinking fast, automatic effortless
System 2 Thinking:
- Slow, deliberate, logical and rational
- Involving conscious thinking processes
- Tends to provide reason to back up our system 1 view
Consumer Behaviour
Traditional economic theory assumes that consumers act rationally and wish to maximise
their utility or consumption by correctly choosing how to spend their income
Rational producers wish to maximise their profits
Government wishes to improve the economic and social welfare of citizens
RATIONAL DECISIONS- The one which maximises someone's personal net benefit for
every £ spent
THE UTILITY THEORY
Utility- The satisfaction or happiness an individual derives from consuming a good or
service
Marginal Utility/Total Utility- Same as returns
Diminishing Marginal Utility- For a single consumer the marginal utility derived from a good
or service diminishes for each
additional unit consumed- lends general support to the idea of a downward
sloping demand curve
• When utility is maximised, the marginal utility is proportional to the income spent
◦ In order to maximise a desired objective, an economic agent must undertake the
activity involved up to a point where MARGINAL PRIVATE BENEFIT RECEIVED =
MARGINAL PRIVATE COST INCURRED
IMPERFECT INFORMATION
• Whilst it is often assumed that an individual has perfect information, in reality it is
imperfect
• Information failure occurs when people have inaccurate or incomplete information and
therefore make potentially sub-optimal decisions
• Causes of Information failure
◦ Lack of education/understanding about information
◦ Over-complication
◦ Myopia- ST
, ◦ Asymmetric information
◦ High cost/ time-consuming nature when gaining all of the information
• E.g. Uncertain quality of second hand products, high complexity of pension schemes etc.
• Could be a source of market failure as a good or service could be under consumed or
over-consumed as a result (Merit/Demerit good), leading to a misallocation of resources
and allocative inefficiency
ASYMMETRIC INFORMATION
When one party involved in a transaction has more or superior information than another
party
Adverse Selection- An undesired result due to the situation where there is asymmetric
information
Moral Hazard- When a party with superior information alters their behaviour resulting in
benefits to them while at the same time
increasing the costs and risks on people possessing less information
• Asymmetric information usually results in an imbalance of power between parties
involved in a transaction, affecting the outcome, resulting in allocative inefficiency
• E.g. Landlords vs Tenants, Sub-prime mortgages, Doctors have superior knowledge
about drugs and treatments, Used-car sellers
THE SYSTEMS ASSOCIATED WITH THINKING
System 1 Thinking:
- Vast majority of decisions happen without realising
- Thinking fast, automatic effortless
System 2 Thinking:
- Slow, deliberate, logical and rational
- Involving conscious thinking processes
- Tends to provide reason to back up our system 1 view
