1.2.3 Aspects of Behavioural Economic Theory

Traditional Economic Theory vs Behavioural Economic Theory

Traditional economic theory: the assumption that individuals are rational decision makers who endeavour to maximise their utility.

• Consumers know exactly what they want and the decisions required to achieve their objectives.
• Consumers have as much time as needed to consider all information and possible options.
• Focus on logical facts and figures, rather than emotions or social factors, when making decisions.

Behavioural economic theory: the assumption that individuals are not always rational decision makers and that their decisions may be influenced by a range of psychological and social factors, which may lead to them making decisions that do not maximise their utility.

Factors Influencing Behavioural Economic Decisions

There are a number of factors that may influence an individual’s economic decisions, which may lead to them making irrational decisions.

Bounded Rationality

Bounded rationality: the idea that individuals are limited in their ability to make rational decisions due to a lack of information, time or ability to process information.

• Individuals may not have access to all the information needed to make a rational decision.
• Individuals may not have the time to consider all the information and possible options.
• Individuals may not have the ability to process all the information and make a rational decision.

Bounded Self Control

Bounded self control: the idea that individuals may not always act in their own best interests due to a lack of self control.

• Individuals may be influenced by short term temptations and make decisions that are not in their long term best interests e.g. impulsive spending on luxury goods rather than saving for the future.
• Individuals may be influenced by social pressures and make decisions that are not in their own best interests e.g. peer pressure to spend money on alcohol or drugs.

Biases

Anchoring bias: the idea that individuals may be influenced by the first piece of information they receive when making a decision, even if it is not relevant or accurate. e.g. a consumer may see a £100 product discounted to £80 and perceive it as a good deal, without checking the price at other stores.

Availability bias: the idea that individuals may be influenced by information that is readily available to them, rather than seeking out all the relevant information. e.g. deciding not to fly due to a recent plane crash, even though the risk of flying is statistically very low.

Framing bias: the idea that individuals may be influenced by the way information is presented to them, rather than the actual information itself. e.g. a consumer may be more likely to buy a product that is advertised as "90% fat free" rather than "10% fat".

Herding bias (social norms): the idea that individuals may be influenced by the decisions of others, rather than making their own independent decision. e.g. buying an Xbox because all your friends have one, even though you prefer the games available on a PlayStation.

Rule of Thumb: a general principle derived from practice or experience rather than theory. e.g. buying the same meal deal from a supermarket because it is the same as what you bought last week, rather than considering other options that may be better value for money.

Altruism

Altruism: the idea that individuals may make decisions that are not in their own best interests, but are intended to benefit others. e.g. donating to charity or volunteering.

This can lead to irrational decision-making, for example, buying the Big Issue magazine from a homeless person, even though the money could be better spent on food or other necessities. However, it can also lead to positive outcomes, such as increased social cohesion and a sense of community.