Different assumptions – suspends the assumption of perfect rationality
Assumptions are based on empirical evidence or experimental evidence rather than a normative theory
Behavioural assumptions of microeconomics (conventional) Microeconomics rests on a set of assumptions about preferences. Preferences are complete, transitive, (well-ordered) monotone and stable. Consumer behaviour in structurally sound, competitive markets, reveals their true choice – in aggregate at least. We infer what people want from what they choose. King Island Brie Grange Hermitage
What if? King Island Brie Grange Hermitage Preferences are discontinuous
What if? King Island Brie Grange Hermitage Preferences are not stable
What if? Q P Jane’s demand curve (addiction) Our behaviour does not reflect our preferences? Demand curve Jane would like to have
What if? We are concerned with equity and not just self-interest?
Assumption – rational behaviour at high levels of aggregation Rational mean Behaviour clustered around “rational” mean
BE questions this assumption Rational mean Behaviour clustered around some other point -- biased Observed behaviour While aggregate behaviour often conforms to assumptions of rationality, there are often systematic departures from rationality, and these are not necessarily in consumers’ best interests.
And behaviour can be fickle Rational mean Behaviour moves in response to minor stimuli Observed behaviour
Decision-making In general, our decisions are made on the basis of limited search (not even bounded rationality) We are guided by heuristics (quick rules of thumb), which generally serve us well, but which sometimes lead to costly biases – i.e. away from our “rational” self-interest.
Some heuristics and biases Endowment Overconfidence Framing Availability Pseudocertainty Anchoring Choice overload Myopia Self-control and discounting distortions Herding and beauty contests Shifting preferences Few “new” findings in behavioural economics – most are known to competent salespeople and experienced finance experts. Contribution of behavioural economics is to systematize knowledge.
Fairness Ultimatum game Proposer – to propose division of a resource Acceptor – to accept or reject division
Ultimatum game Proposer – proposes division Acceptor – accepts or rejects Both benefit Neither benefits Acceptor actually bases decision on perception of fairness. Limitation of Pareto assumptions – overridden by strong social norms concerning fair dealing
Fairness Evidence that people: engage in acts of generosity that cannot be expected to be requited incur costs to punish those whose behaviour they disapprove of Self-interest overridden by strong norms of fairness. Consumers are not indifferent to conditions of supply An intervention in a market must be seen to be fair Actions to preserve or improve fairness may be individually costly but collectively beneficial.
Choice and Information Overload Evidence that past a level, consumers default or choose not to choose (they choose whatever or walk away creating dead weight loss) Behavioural eco – optimum level of choice Range of choice Consumer benefit Conventional economics – more choice is better
Framing Our decisions are influenced by the frame: “ This account is subject to a 3 percent penalty if not paid within 30 days” OR “Payment within 30 days will attract a 3 percent discount” Contains 8% fat 92% fat free OR
No Yes No Is the market sound? Are consumers enjoying the benefits of a competitive market? Decision Tree Demand-Side Market Analysis by Consumer Protection Regulators Is there information failure? Informational Instruments Are there behavioural biases affecting consumer decision-making and outcomes? Behavioural Instruments CHECKS TOOLS CONSUMER (Demand side) Other Instruments Are benefits of intervention likely to outweigh the costs of intervening to empower or protect Consumers? Are costs falling on vulnerable or disadvantaged groups? YES STRATEGIES for compensation or protection Yes NFA NFA = no further action No STRATEGIES for improving market for consumers Yes Yes