ASPECTS OF BEHAVIOURAL ECONOMIC THEORY: AQA Economics Specification Topic 4.1

Topic 4.1 - Individuals, firms, markets and market failure

Snapshot of the AQA syllabus topic area we’ll be covering in this post.

ASPECTS OF BEHAVIOURAL ECONOMIC THEORY: Individual economic decision making

AQA students must understand the following content [taken from the syllabus]

• Bounded rationality and bounded self-control.

• Biases in decision making: rules of thumb, anchoring, availability and social norms.

• The importance of altruism and perceptions of fairness.

INFORMATION YOU NEED TO KNOW

Introduction:

Traditional economic models frequently involve the assumption that people are rational and only act in their own best interests. However, behavioural economics offers a novel viewpoint by acknowledging that cognitive constraints, biases, and social factors have an impact on human decision-making. This article explores the fascinating field of behavioural economic theory, delving into ideas like bounded self-control, bounded rationality, decision-making biases, the importance of altruism, and perceptions of justice.

1) Bounded Rationality and Bounded Self-Control:

According to the theory of bounded rationality, people have cognitive constraints that prohibit them from acting totally rationally. Due to information overload or low processing power, people frequently rely on streamlined decision-making techniques rather than having boundless cognitive abilities. Individuals occasionally make "good enough" decisions rather than those that are fully optimal, according to bounded rationality.

Bounded self-control, on the other hand, acknowledges that people often have trouble exercising self-control and resisting short-term temptations, even when such temptations run counter to their long-term objectives. This propensity to favour instant gratification before long-term wellbeing can result in impulsive actions like overspending or unhealthy habits.

2) Biases in Decision Making:

a) Rules of Thumb: Rules of thumb are mental shortcuts that people use to make decision-making easier. They are also known as heuristics. These heuristics might cause biases because people might rely on stereotypes or previous experiences instead of carefully examining all the information.

b) Anchoring: When people base their judgements or estimates significantly on the first piece of information they come across, it is known as anchoring bias. The initial anchor acts as a point of reference and can affect decisions made later, frequently resulting in systemic biases.

c) Availability Bias: The availability bias describes people's propensity to base assessments or decisions on easily accessible or memorable information. Even if they may not be indicative of the larger situation, more salient or vivid events or pieces of information are given disproportionate weight.

d) Social Norms: Social norms have a big impact on how we make decisions. People frequently follow social norms, aligning their actions with what is seen appropriate or expected within a specific social group. Because of this, people may prioritise conformity over their own preferences or logical analyses, which can result in biases in decision-making.

3) The Importance of Altruism and Perceptions of Fairness:

According to behavioural economics, people are not only motivated by their own interests. Altruism, or care for the welfare of others, can have a big influence on how we make decisions. Even if it has a negative impact on them personally, people can make decisions that are good for society or for other people. Various economic interactions, such as charitable giving and socially conscious consumer behaviour, depend heavily on altruism.

Decision-making is also influenced by one's perception of fairness. People naturally want to interact with others in a way that is fair and equitable. Decision-making can be influenced and negatively affected by unfairness or injustice. Distributive justice and procedural fairness are two ideas that have an impact on people's willingness to collaborate, exhibit reciprocal behaviour, and make choices that are consistent with their sense of fairness.

Conclusion:

Traditional economic models' foundation of pure rationality is called into question by behavioural economic theory, which sheds light on the complexities of human decision-making. While bounded self-control acknowledges the difficulties people have in exercising self-control over their behaviours, bounded rationality acknowledges the limitations of the mind. Economic decisions are also influenced by decision-making biases that depend on rules of thumb, anchoring, availability bias, and social norms. Additionally, the significance of altruism and perceptions of fairness emphasise the significance of social and ethical factors in decision-making. For governments, organisations, and individuals to negotiate the complexity of economic decision-making and develop a more nuanced and realistic understanding of human behaviour in the field of economics, it is essential to understand these behavioural aspects.