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IBDP Economics Higher Level 2.4

RATIONAL ECONOMIC DECISION-MAKING

- standard economic theory and models are based on the assumption that consumers
take part in rational economic decision making
- individuals are assumed to act in their best self-interest (maximise the
satisfaction/utility)
- consumers spend their money on purchases that maximise the satisfaction
- producers try to maximise the pro ts they make from their businesses

ASSUMPTION OF RATIONAL CONSUMER CHOICE

- Consumer rationality
- consumers make purchasing decision according to their tastes and preference
- the consumer is able to rank goods according to preferences
- preferences among alternative choices are consistent (if she prefers A to
B, and B to C, then she prefers A to C)
- The consumer always prefers more of a good to less.
- between competing alternatives, the one with more is preferred
- Perfect information
- consumers have at their disposal perfect information about all alternatives to
create no uncertainty (unrealistic)
- if someone where to consider options A and B and had to choose, then the
consumer would need to have all information on products A and B
- Utility maximisation
- utility: the satisfaction that consumers derive from consuming something
- consumer maximise their utility meaning they get as much satisfaction possible
by buying combinations of goods that result in the greatest utility for a given
price(s)
- based on the assumptions of rationality and perfect information
- related to the concept of marginal utility and law of diminishing returns.

BIASES
- Rules of thumb
- guideline based on experience and common sense
- simplify complicated decisions that would have to be based on complex
consideration or every possible choice
- Anchoring
- use of irrelevant information to make decisions (occurs due to it being the rs
piece of information that the consumer conceders)
- Short time decision making


















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IBDP Economics Higher Level 2.4

- Framing
- how choices are presented to decision makers (framed)
- example: 80% fat free milk and 20% fat milk
- example: discounts / environment / Language / etc
- information is the same, just framed differently
- Availability
- information that is most recently available which people tend to rely on more
heavily, thought there is no reason to expect that this information is more reliable
than others that were available earlier.
- people remember recent events and information than older ones
- Bounded Rationality
- developed by Herbert Simpson
- people fo not have an unlimited capacity to process information and that
searching for information needed to maximise utility is itself a costly process.
- Consumers are rational only within limits due to imperfect information
- Bounded self-control
- related to bounded rationality
- people in reality exercise self-control only within limits.
- they often do not have self-control that would be required of them to
make rational decisions
- examples: eat too much, drink too much, work too little
- Bounded Sel shness
- related to bounded sel shness
- people are sel sh only within limits and that the assumption. Of self-interested
behaviours underlying the maximisation principle cannot explain the numerous
accounts of sel shness to contribute to the public off.
- Imperfect information
- people have access to incomplete information.
- unable to maximise utility as they make choices based on faulty and incomplete
information

NUDGE THEORY
- a method designed to in uence consumer s choices in a predictable way without
offering nancial incentive or imposing sanctions and without limiting choice.
- in uence people to behave in a socially desirable ways with no constraints in
behaviour




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IBDP Economics Higher Level 2.4

- Examples of Nudges
- placement of products
- advertisements
- Noti cations
- Signs

CHOICE ARCHITECTURE
- The design of a particular ways or environments in which people make choices; based
on the idea that consumers make decisions in a particular context and that choices of
decision-makers are in uence by how options are presented to them
- Default choice
- Choice that is made by default , the option that results when on does
not do anything. (Made due to habit or lack of interest in taking
action.
- One way of inducting people to follow a particular course of action is
to provide it as a default choice.
- Restricted choice
- Choice that is limited by the government or other authority.
- People are subject to countless restriction of all kinds (examples:
speed limits, voting age, recycling, etc)
- Restriction such as these are necessary because people have too many
choices available, and due to their imperfect information, they make
poor choices
- Mandated choice
- Choice between alternatives that is made mandatory (compulsory) by
the government or other authority. (Required choice)

EVALUATING BEHAVIOURAL ECONOMICS AND ECONOMIC POLICY

- Potential advantages
- Relatively simple and low-cost way to in uence peoples behaviour
- Previously successful in multiple areas, showing multiple available
applications
- Offers consumers freedom of choice without forcing them to do anything or
preventing them
- May overcome the theories of consumer behaviour (inconsistencies and
irrationality)





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IBDP Economics Higher Level 2.4

- Potential Disadvantages
- Knowledge is not based on any understanding of human behaviour, and leads
to systematic and unifying theory in general applicability
- May not be valid over time or across different income groups, social groups
or cultures.
- Risks of manipulating consumers in a way that are not in their best interests
- May be used as substitutes for necessary but politically costly economic
policies
- Less effective that traditional economic policies (taxes, subsidies, etc)
- People may not be aware of its existence and is not really free choice
- Choices due to nudge theory may not re ect true preferences

RATIONAL PRODUCER BEHAVIOUR: PROFIT MAXIMISATION

- Determining the level of output that the rm must produce to make pro t as large as
possible
- Make the difference between revenues and costs as large as possible
- Pro t I equal to the total revenue earned by a rm, minus the total costs incurred by
the rm in the process of producing the output

CORPORATE SOCIAL RESPONSIBILITY: ETHICAL AND

ENVIRONMENTAL CONCERNS
- Self interested behaviour of rms often leaves to negative consequences for society
- The well being of rms is not consisted with the well being of society
- Engage in actions consumers would consider ethically unacceptable
- Causes rms to Increasingly recognise that the pursuit of self-interest causes
a negative image of the rm.
- May lead to government regulation of the rm intended to minimise the
negative consequences of the rms actions
- Market share
- Percentage of total sales in a market that is earned by a single rm
- High market share means that the rm is enjoying large sales and
indicated a products popularity
- Large companies often measure their performance in therms of their market
share in speci c countries.
- How well it is doing in relation to its competitors
- Constant market shares indicate that the revenues earned are growing at the
same rate as the overall market.
- To increase market share they can decrease the price, introduce new
products or advertise.
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IBDP Economics Higher Level 2.4

- growth maximisation
- Growth maximisation is attractive because:
- Growing rms can achieve economies of scale and lower average
costs, increase pro t
- Can diversify into production of different products and markets
- Greater market power and increased ability to in uence future
prices
- Reduces risks to effects of economics downturn or to be taken over
- Satisfying
- The large modern enterprise cannot be looked upon as a single entity with a
single maximising objective; but is composed of many separate groups within
the rm (with different objectives)
- Multiplicity of objectives does not allow rms to pursue any kind of
maximisation
- Firms must establish processes in which they make compromises and
reconcile con icts that arrive in agreements cause by the pursuit of many
objectives.
- De nition: the idea that rms try to achieve a satisfactory level of pro ts
together with satisfactory results for many more objectives rather than
optimal results for one objective.
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