WHAT IS IRRATIONAL BEHAVIOUR?

• Irrational behaviour is when people make systematic and persistent

deviations from rational choice.
• This can take a lot of forms, but some examples include:
• Emotional decision-making, where people make choices based on
feelings rather than logical analysis.
• Herd mentality, where people follow the crowd without thinking
critically about their own preferences.
• Risk-averse or risk-seeking behaviour, where people make choices
based on their emotional reactions to risk rather than a rational
assessment of the probabilities.

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 QUESTIONING THE ASSUMPTION OF RATIONALITY

We have a limited Social networks Emotion often

ability to calculate influence choices overtakes logic

Altruism can overtake We often have a desire People often stick to

pure self-interest for instant rewards default choices

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 EXPLAINING DEPARTURES FROM RATIONAL CHOICE
• According to behavioural economists, economic agents:
1. Have a limited capacity to calculate all costs and benefits
2. Are often influenced by their own social networks
3. Often act reciprocally instead of pure self interest
4. Lack self control and seek immediate satisfaction
5. They are loss averse (which means that losses matter more than gains)
6. They make different choices in cold & emotional states
7. Often fall back on simple rules of thumb when choosing
8. Have a strong default to maintain the status quo

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 WHAT IS LOSS AVERSION?

• Loss aversion is the idea that people are more sensitive to losses than to
equivalent gains.
• In other words, people are more motivated to avoid a loss than they are to
acquire a similar gain.
• For example, if you give someone $20, they might be relatively unmoved,
but if you take away $20 from them, they’ll likely be upset.
• This is why we see things like "buy one, get one free" promotions - people
are more likely to buy something when it feels like they're avoiding a loss,
even if the overall cost is the same.

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 WHAT IS ANCHORING BIAS AND WHY DOES IT MATTER?

• Anchoring bias is when people tend to focus on an initial piece of information (the
"anchor"), and then base their decisions around that anchor, even if it's not the most
relevant or important piece of information.
• This causes them to feel like they're losing out if they stray from the initial anchor.
• Bargain hunting: People often compare a sale price to the original price of an item,
and think they're getting a great deal, even if the sale price isn't really that great. The
original price acts as an anchor that influences their perception of the sale price.
• Negotiation: When negotiating a price or salary, people often anchor on the first
number mentioned, making it difficult to negotiate a lower price or higher salary.

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 WHAT IS FRAMING BIAS AND WHY DOES IT MATTER?

• Framing bias is the idea that the way information is presented can influence
people's decisions and judgments. Here are some common examples:
• The "dread risk" framing: Presenting a risk in terms of "how many people will die"
rather than "how many people will be saved" can lead to different decisions.
• The "choice architecture" framing: Arranging options in a specific order or
highlighting certain options can influence what people choose.
• The "decoy" effect: Offering a less attractive option alongside two more desirable
options can make one of the desirable options seem even more attractive.
• The "scarcity" effect: Highlighting limited availability can create a sense of
urgency and drive people to act quickly.

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 WHY IS HABITUAL BEHAVIOUR IMPORTANT?

Most of use choose the same Our menu choices are A default opt-in (or auto
breakfast! predictable enrollment) such as for
pensions and organ
donations can have a
powerful effect

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 WHY IS HABITUAL BEHAVIOUR IMPORTANT?

• People often develop habits around purchasing and consuming certain

products and services, which can influence demand.
• For example, if people habitually purchase coffee from a certain chain, that
company's sales and profits will be higher as a result.
• Habits can be powerful forces in the economy because they can be difficult
to break and can influence behaviour in a predictable and consistent way.
• Habits can be seen as a type of "automatic" or "unconscious" decision-
making, where people act out of habit rather than consciously evaluating
their options and making a rational choice.

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 EXAMPLES OF COGNITIVE BIASES

• Confirmation bias: the tendency to seek out and remember information that
confirms our existing beliefs and ignore information that contradicts them.
• Anchoring bias: the tendency to rely too heavily on the first piece of
information we receive when deciding.
• Availability bias: the tendency to give more weight to information that is easily
accessible in our memory.
• Overconfidence bias: Tendency to be overconfident in our own abilities and
knowledge
• Sunk cost fallacy: the tendency to continue investing in something because of
the resources we've already invested, even if it's not a good idea

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 WHAT IS BOUNDED RATIONALITY?

Having choice does not always Pensions are complex products Search costs make it harder to
help consumers make decisions that many don’t understand find the best price in a market

Bounded rationality is the idea People are not perfect decision-

that people don't always make makers and that their choices can
perfectly rational decisions. They be shaped by a variety of factors
may be influenced by cognitive beyond pure logic and reason.
biases, emotions, social norms, People make decisions that are
and limited information or time to completely rational from the
make decisions. Using rules of thumb might decision-maker's perspective.
replace pure rationality

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 BOUNDED RATIONALITY

• Bounded rationality is a concept that acknowledges that people's decision-

making is limited by cognitive biases, incomplete information, and other
constraints.
• It means that people don't always act rationally in the traditional sense.
• They may be influenced by emotions, social pressures, or limited cognitive
resources.
• Most everyday decisions are made under conditions of bounded rationality
• Herbert Simon developed the theory of bounded rationality in the 1950s
and 60s

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 CONSUMER WEAKNESS AT COMPUTATION

• Weakness in computation refers to the idea that consumers often don't

have the time, knowledge, or inclination to make optimal economic
decisions. This can be due to several factors, such as limited cognitive
resources, information overload, and bounded rationality.
• For example, people may not have the time to fully compare and evaluate
all the options available to them when making a purchase, so they may rely
on shortcuts like brand loyalty or price as a proxy for quality.
• They may also be influenced by marketing tactics, like framing and social
proof, which can further distort their decision-making process.

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 BOUNDED RATIONALITY AND BOUNDED SELF CONTROL

• These are related but distinct concepts!

• Bounded rationality refers to the idea that people have limited cognitive
abilities and may make suboptimal decisions due to these limitations.
• Bounded self-control, on the other hand, is the idea that people may have
difficulty controlling their own impulses and behaviours, even when they know
it’s in their best interest to do so.
• So, while bounded rationality is about the limitations of our cognitive abilities,
bounded self-control is more about our emotional and motivational limitations
• Bounded self-control can be a big factor in why people struggle to stick to a
healthy diet or exercise regimen, even when they know it’s good for them

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 WHAT ARE HEURISTICS – WHY DO THEY MATTER?

• Heuristics are mental shortcuts that many people use in their day-do-day lives
to simplify complex decisions.
• For example, people may use a heuristic like "buy the cheapest option" or
"choose the most popular brand" rather than doing a complex analysis of cost,
quality, and other factors.
• Heuristics save time and cognitive effort, but they can also lead to suboptimal
decisions. For example, someone who always buys the cheapest option may
end up with lower quality products that don't meet their needs.
• Heuristics help people cut through the noise and make decisions quickly, even
if they're not always perfect.

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 THE IMPORTANCE OF DEFAULT CHOICES

• Default choices are the options that are automatically selected unless a person
actively chooses something different.
• They're often used in things like workplace retirement plans, car and home insurance
policies, and financial investment portfolios.
• And they matter because research has shown that people are often more likely to stick
with the default option, even if it's not necessarily the best choice for them.
• For example, if a retirement plan automatically enrolls people with a contribution rate
of 3% of their salary, many will stick with that rate even if they could afford to
contribute more and benefit from a higher rate of return in the long run.
• Nudging people towards a different default option - known as "choice architecture" or
"libertarian paternalism" - can be a powerful way to influence behaviour.

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 THE IMPORTANCE OF SOCIAL NORMS

Respecting social distancing Maintaining social norms

Not smoking in public places
during the pandemic when queuing

A social norm is a rule or Social norms are constantly

expectation of behaviour evolving over time. For
within a group or culture. example, gender norms
It's like an unwritten rule have changed enormously
that guides how people Recycling litter and other over the years but this
behave in social situations. forms of waste varies by country.

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 THE IMPORTANCE OF SOCIAL NORMS

• Social norms are collectively held beliefs or customs about what kind of
behaviour is appropriate in each situation
• Examples of social norms:
• Changing the social stigma of drink-driving and speeding
• Queuing behaviour in shops and queuing to enter events
• Impact on behaviour of smoking bans in all public places
• Making seat-belts compulsory – this created conventions which then
became self-sustaining
• Maintaining social distancing and wearing a mask during the pandemic

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 ALTRUISM AND CONSUMER BEHAVIOUR

• Altruism is a term for the act of being selfless and doing something to benefit others, without
expecting anything in return. It can influence behaviour in several ways:
• Social norms: People are often motivated to be altruistic because they want to conform to
social norms and be seen as kind and generous.
• Empathy: When people feel empathy for others, they may be more likely to act altruistically to
help alleviate their suffering.
• Prosocial behaviour: a broad term that describes any action or behavior that benefits others
or society. It can include acts of kindness, cooperation, and generosity, as well as helping
behaviours like volunteering, donating to charity, or advocating for social causes.
• Reciprocity: Altruistic behavior can create a sense of reciprocity and encourage others to act in
a similar manner. It can foster a culture of cooperation and mutual support.

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 ALTRUISM AND THE ULTIMATUM GAME

• The ultimatum game is designed to study how people make decisions when there’s an element
of negotiation involved.
• One player (the proposer) is given a sum of money, let’s say $100, and they have to offer a
portion of it to another player (the responder).
• The responder then must decide whether to accept or reject the offer. If they accept, they get
the amount offered, and the proposer gets the remainder. If the responder rejects the offer,
neither player gets anything! This creates a dilemma for both players.
• The proposer wants to offer as little as possible, while still making an offer that the responder
will accept, and the responder must weigh the value of getting something against their
feelings of fairness and how much they feel they “deserve.”
• It turns out that people often reject offers that they perceive as unfair, even if it means they
walk away empty-handed.

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 LESSONS FROM THE ULTIMATUM GAME

• Researchers find that proposers tend to offer around 40-50% of the total sum,
and responders tend to reject offers that are lower than around 30%.
• People seem to have a strong sense of fairness and equity, even if it means
they miss out on some cash.
• Interestingly, there are cultural differences in how people play the game -
some cultures tend to make higher offers, and some cultures are more likely to
reject lower offers.
• This has led some researchers to argue that cultural norms and values play a
big role in how people make economic decisions!

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 IS VAPING RATIONAL BEHAVIOUR?

• From a rational perspective, some people may choose to

vape as an alternative to smoking cigarettes, as it is
believed to be less harmful to health. The expected
private costs are lower.
• Smoking Cessation: Vaping can be used as a tool to help
smokers quit smoking. A rational long-term approach.
• Cost-effective: Vaping can be a cost-effective (cheaper)
alternative to smoking – lower relative prices causes a
substitution effect
• Vaping is also considered a more socially acceptable
behaviour than smoking. Perhaps less social stigma for
individuals?

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 IS VAPING RATIONAL BEHAVIOUR?

• People may start vaping without knowing the long-

term effects on their health. (Information failure –
bounded rationality)
• Studies have suggested that vaping may have negative
health effects, such as increasing the risk of respiratory
illness, heart disease and addiction.
• Many vaping products on the market are not regulated
and some may contain harmful substances.
• Marketing & promotion: E-cigarette industry is heavily
marketed and promoted which can influence behaviour
/ choices

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 Traditional economic theory has the key assumptions that economic agents
1 are

* A Altruistic

* B Boundedly rational

* C Satisficers

* D Rational utility maximisers

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 2 What name is sometimes used to refer to a rational economic agent?

* A Ceteris paribus

* B Homo economicus

* C Adam Smith-ite

* D Homo sapien

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 3 Which ONE of the following BEST describes loss-averse behaviour?

* A A consumer who values losses more than gains

* B A consumer who values losses and gains equally

* C A consumer who values gains more than losses

* D A consumer who values gains disproportionately more than losses

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