Behavioural Economics
Rational consumer choice
Nature of rational consumer choice
➔ Behavioural economics offers a different view on consumer decision-making.
➔ Behavioural economics considers consumer behaviour by using human psychology
as part of the buyer decision-making process.
➔ It considers how factors other than utility maximisation affect whether
someone buys a good or not.
Behavioural Economics
Nature of biases(cognitive Biases)
➔ Biases are the factors that influence individuals in decision-making situations and take them away from
rational judgments.
➔ Biases are influenced by heuristics. Heuristics mean simplifying decision-making when individuals cannot
work out the option that will give them the greatest utility.
➔ Consumers use heuristics to make mental shortcuts in buying situations because it allows them to make
decisions in the time frame they are normally faced with.
➔ The rule of thumb allows individuals to make decisions based on imperfect information allowing them to
optimise their utility rather than maximise their utility.
Behavioural Economics
Anchoring bias
Anchoring bias is a reference point in an individual’s mind based on the first piece of information an individual
experiences and it strongly influences a decision they make.
Anchoring bias comes from a series of past experiences and it can even be formed in the mind of a consumer from their
first experience of buying a good.
For example, when Apple first launched the iPad it was reported that the company would set a price of $999, but the
actual launch price was $499. With a $999 'anchored' in the mind of potential consumers the $499 was a relatively
attractive price.
Behavioural Economics
Framing bias
Framing bias is how decisions made by individuals are affected by how choices are presented to them.
For example, consumers faced with a dessert in a supermarket would choose a product that says ‘80% fat-free’ rather
than ‘20% fat’ because they are attracted by the word 'free'.
Availability bias
Availability bias considers how individual decision-making is affected by information that comes easily into someone's
mind.
This information is often based on recent events and how the outcomes of these recent events affect our decision-
making.
For example, if someone goes to catch a bus and it is late they will believe the bus service is unreliable even if the bus
service is the most reliable in the area.
Behavioural Economics
Herd behaviour
The way that others behave can exert a powerful influence on our own choices. It can be very
gratifying and reading to be like others.
For example, changing clothing fashion. Producers are able to influence people to buy more clothes to
fit into the new style even when their own clothes are perfectly good (Bandwagon effect).
Status Quo/ Inertia Bias
Consumer prefer to maintain the status quo by doing nothing.
For example, mobile phone contracts
Behavioural Economics
Loss aversion Bias
Experiments shows that humans feel that losses are far more significant than gains.
Businesses can take advantage of this bias by creating a feeling of losing something if
don’t purchase a product.
For example, “Buy now before stocks run out!”
Hyperbolic discounting
Tendency of human to prefer short-term rewards over larger later rewards.
For example, procrastinating your Economics IA over night out evening.
Behavioural Economics
How can behavioural economics be used to help consumer make better
choices?
Choice architecture
Decisions are affected by the ways in which choices are presented to us.
For example, supermarkets —-----cash counters—---impulse buying—----tempted to buy those
products like chocolates/candies —--- --.
Default choice
For example, pre-set options—---default options—-----google search engine.
Mandated choice
People are required to make a choice by law in advance
For example, organ donation.
Behavioural Economics
How can people be encouraged to make better choices?
Nudge Theory
[Link]
menu-design-can-nudge-us-toward-better-choices/?sh=307fd75b52a1
[Link]
Helps in people making better decisions as contributed in people’s standard of living,
their health, their communities and environment.
For example, “Save More Tomorrow” in the US nudging people to save money for
retirement.
Criticism: government intervention is required—----assumption that consumer behave
rationally.
[Link]
Behavioural Economics
Sample questions
Describe two cognitive biases that influence consumers when
making consumption choices? (10 marks)
Using real-world examples, evaluate the effectiveness of nudge
theory in helping consumers to make better choices? (15 marks)
