Economic A Level 2

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AQA A Level Economics Your notes
2. Individual Economic Decision Making

Contents
Consumer Behaviour
Imperfect Information
Behavioural Economics
Using Behavioural Economics
Page 1 of 21
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Consumer Behaviour
Your notes
Rational Economics & Incentives
Individual economic decision-making is influenced by
Rationality
Incentives
Marginal utility
When analysing markets, a range of assumptions are made about the rationality of economic
agents involved in the transactions
In classical economic theory, the word 'rational' means that economic agents are able to
consider the outcome of their choices and recognise the net benefits of each one. Rational
agents are incentivised to select the choice which presents the highest benefits
Consumers are assumed to act rationally. They do this by maximising their utility
Producers are assumed to act rationally. They do this by selling goods and services in a way
that maximises their profits
Workers are assumed to act rationally. They do this by balancing welfare at work with
consideration of both pay and benefits
Governments are assumed to act rationally. They do this by placing the interests of the
people they serve first in order to maximise their welfare
In many ways, the assumption of rational decision-making is flawed. For example, consumers are
often more influenced by emotional purchasing decisions than a rational computation of net
benefits
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Exam Tip
Your notes
In your examinations, the essay questions test your ability to think critically. The command term
for these questions are evaluate, justify, assess and to what extent
One way in which you can demonstrate critical thinking is to challenge the underlying
assumptions of economic theory. The idea of rational decision making is one such assumption.
Do consumers act rationally when they make impulse purchases? Do workers act rationally when
they accept terrible working conditions for mediocre pay? Do governments actually maximise
public welfare or do they implement policies that mainly benefit their core voter base?
Irrationality distorts markets and produces fundamentally different outcomes than what would
be achieved if all economic agents acted rationally.
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Utility Theory
Utility is the satisfaction gained from consumption Your notes
Marginal utility is the additional utility (satisfaction) gained from the consumption of an
additional product
The utility gained from consuming the first unit is usually higher than the utility gained from
consuming the next unit
For example, a hungry consumer gains high utility from eating their first hamburger. They are
still hungry and purchase a second hamburger but gain less satisfaction from eating it than
they did from the first hamburger
To calculate total utility, the marginal utility of each unit consumed is added together
This means that total utility keeps increasing even while marginal utility is decreasing
The Law of Diminishing Marginal Utility states that as additional products are consumed, the
utility gained from the next unit is lower than the utility gained from the previous unit
The Law of Diminishing Marginal Utility helps to explain why the demand curve is downward
sloping
When the first unit is purchased, the utility is high and consumers are willing to pay a high
price
When subsequent units are purchased, each one offers less utility and the willingness of the
consumer to pay the initial price decreases
Lowering the price makes it a more attractive proposition for the consumer to keep
consuming additional units
This is one reason why firms offer discounts such as '50% off the second item'
A consumer achieves utility maximisation when they spend their limited income in such a way that
they will achieve the most satisfaction from their money
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The Influence of Marginal Analysis on Choices

A rational consumer seeks to maximise satisfaction with their limited income Your notes
When deciding at the margin, they weigh whether to consume a little more or a little less of
something
This involves considering the additional happiness or utility gained from each extra unit
(marginal benefit) and the extra money spent (marginal cost)
Consumers continue to consume until the extra happiness from each unit equals the extra
cost, which is making decisions at the margin
Every choice involves a balance between benefits and costs, taking into account each additional
unit consumed
Thinking at the margin is not exclusive to consumers but is also fundamental for firms and
governments
It guides decisions on how to allocate scarce resources by evaluating the marginal benefit and
marginal cost of an additional unit
By comparing the best decisions to their costs, the aim is to achieve optimal choices
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Imperfect Information
Your notes
Asymmetric Information
One of the assumptions of free markets is that there is a perfect flow of information
This would include information on pricing, the availability of substitutes, the truthfulness of
the product claims, etc
Information gaps exist in nearly all free markets and distort market outcomes, resulting in market
failure
Perfect information in the market means that buyers and sellers have exactly the same level
of information about the good or service. This is called symmetric information
In many markets, buyers and sellers have different levels of information. This is called
asymmetric information. For example, there is asymmetric information in the used car
market: sellers know more about the vehicle than the buyers
Asymmetric information distorts socially optimal prices and quantities in markets, resulting in
over or under-provision of goods or services
For example, goods/services with dangerous side effects would be sold in lower quantities
if buyers were aware of these effects (consider the VW emissions scandal). Fewer factors of
production should be allocated towards producing these
Similarly, goods and services with extra benefits would be sold in higher quantities if buyers
were aware of them. More factors of production should be allocated towards producing
these
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Behavioural Economics
Your notes
An introduction to Behavioural Economics
Behavioural economists question the assumption of traditional economic theory that
individuals are rational decision-makers who endeavour to maximise their utility
It argues that many economic decisions made by an individual are biassed
Behavioural economics is a field of study that combines elements of psychology and

economics to understand how people make decisions and behave in economic contexts
Diagram: Traditional Versus Behavioural Economics
Behavioural economics contrasts traditional economics as it challenge the view that economic agents
behave rationally
Behavioural economics recognises that human decision-making is influenced by cognitive

biases, emotions, social, and other psychological factors that can lead to deviations from
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rational behaviour
The assumptions of traditional economics regarding decision-making do not hold Your notes
The following limitations mean individuals are unlikely to always make rational decisions
Bounded rationality
Bounded self-control
Biases
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Bounded Rationality & Self Control

Bounded Rationality Theory Your notes
This theory argues that people make decisions without gathering all the necessary information
to make a rational decision within a given time period
Individuals may not understand the technical jargon linked to selecting insurance or
pensions
The theory assumes rational decision-making is limited because of

An individual's thinking capacity
Availability of information
Lack of time available to gather all of the information and make a judgement
Too much choice can also cause people to make irrational decisions
E.g. When making choices about purchasing particular products in the supermarket, there may
be too much choice, making it difficult to make a decision
Bounded Self-Control
The theory of bounded self-control suggests that individuals have a limited capacity to regulate
their behaviour and make decisions in the face of conflicting desires or impulses
It recognises that self-control is not an unlimited resource that can be exercised endlessly
without consequences
Humans are social beings influenced by family, friends, and social settings. This often results in
decision-making which conforms to social norms but does not result in the maximisation of
consumer utility
Bounded self-control leads to decision-making based on emotions, which may not yield the
best outcome
E.g People may indulge in impulsive spending, purchasing goods they did not originally intend
to buy
Businesses use marketing to capitalise on the lack of bounded self-control of individuals when
appealing to their target audience to maximise sales
E.g. Supermarkets place a range of items at the checkout register to encourage impulse
purchases
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The Influence of Biases on Decision Making

Biases influence how we process information when making decisions and these influence the Your notes
process of rational decision-making
Examples of bias include common sense, intuition, emotions and personal and social norms
Types of Bias
Type of Bias Explanation
Rule of thumb This is when individuals make choices based on their default choice based
on experience
E.g. Individuals may also order the same piz z a anytime they order from
Piz z a Hut, However, the best choice may be to buy the new tasty option,
which is available at 50% discount
Anchoring and Anchoring bias occurs when individuals rely too heavily on an initial piece of
framing information (the "anchor") when making subsequent judgements or
decisions
E.g. When buying a used car, the seller may initially suggest a price of
$10,000. Even if you know the market value is lower, the anchor of
$10,000 might still influence your perception and as a result, the
consumer ends up paying a higher price than intended
Framing refers to how the presentation or wording of information can

significantly influence people's choices or judgements
The same information can be framed in different ways, leading to
different outcomes
E.g Consumers are more likely to purchase a product that states ‘80%
fat free’ than ‘20% fat’
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Your notes
Availability bias Occurs when people rely on immediate examples or information that comes
to mind easily when making judgments or decisions
It leads individuals to overestimate the likelihood or importance of
events or situations based on how readily available they are in their
memory
Availability bias is influenced by personal experiences, vividness of the

information, media exposure, and emotional impact
E.g. People use alternative modes of transport when there is a plane
crash, even though the probability of a crash happening is very low
Social norms These are the informal rules that govern behaviour in groups and societies
E.g Consumers buy expensive goods to display wealth or social status
rather than for practical reasons
The perception is that owning luxury goods equates to success and
status
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The Influence of Altruism & Perception on Rational Choice

Traditional economics assumes that people always act in their own self interest Your notes
Yet many charitable economic decisions have no economic benefit for the decision-maker
Altruism and perception can be major drivers in the non-rational decision-making process
Altruism is the idea that behaviour benefits a group at the expense of the person performing it
E.g. Giving charitable donations or volunteering
This explains why individuals make decisions that do not always align with maximising their own
personal benefits and is in contrast to what rational self-interest theory would suggest
Altruistic decision-making can be influenced by

The pressure to conform to social norms
E.g Following ethical and conscious shopping trends may nudge consumers towards
sustainable options
The perception of fairness and what individuals and societies deem to be right or wrong
Individuals may be more concerned with more equitable outcomes for society than
their own self-interest
E.g Some people buy the Big Issue even though they never read it, as they choose to
support the individuals selling the Big Issue
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Using Behavioural Economics

Your notes
Choice Architecture
Choice architecture refers to the intentional design of how choices are presented so as to to
influence decision making
E.g. Salad bar placement at the beginning of buffets to encourage people to put fruit and
vegetables on their plate
Supermarkets place more profitable products at eye level on the shelves
Choice architecture aims to simplify the decision making process

E.g. Restaurants present information about food options in a particular format to encourage
individuals to make a particular choice - often bundling items together
E.g. Tesco replaced confectionary usually found at the checkout till with healthier options
so as to encourage people to make better food choices
Types of Choice Architecture
Type of Choice How does it work?
Default Choice Occurs when an individual is automatically signed up to a particular

choice
This reduces choice as it means a decision is already made even if no
action has been taken
Research has shown that individuals rarely change from the default
choice
E.g. Driver licence agencies select 'organ donation' as the default
choice when offering driver's new licences
When signing up for an online service, the default choice for receiving
promotional emails may be set to "opt-in,"
Restricted Choice It occurs when the choices available to individuals are limited, which helps
individuals make more rational decisions
E.g. In a cafeteria, if unhealthy food options like sugary drinks are
removed and replaced with healthier choices like water, consumers
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will be more likely to purchase them
Mandated Choices Mandated choices require individuals to make a specific decision or take Your notes
a particular action by imposing a requirement or obligation
Mandated choices can be used to ensure compliance with regulations
or societal norms, making it necessary for individuals to make certain
decisions
E.g. Some countries mandate car insurance, which requires all vehicle
owners to make an active decision to choose and purchase car
insurance rather than leaving it as an optional choice
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An Evaluation of Choice Architecture

Choice Architecture is a powerful tool which can be used both for the benefit of firms and Your notes
society, but it can also be abused
The Advantages and Disadvantages of Choice Architecture
Advantages Disadvantages
Influences Behaviour Manipulation

Choice architecture can be used to nudge It can be seen as a form of manipulation as
individuals towards making choices that it attempts to influence people's
are in their best interest or align with decisions without their explicit consent,
desired outcomes which may infringe on the principle of free
choice
Simplifies Decision-Making Ethical Concerns

Well-designed choice architecture can Individuals may not be aware that their
simplify complex decisions by providing choices are being influenced, or they may
clear and understandable options not fully understand the consequences of
their decisions due to the way choices are
presented
Improved Outcomes Potential for Bias

Effective choice architecture can lead to Choice architecture is susceptible to
improved outcomes such as encourage biases inherent in the design process and
healthier eating habits and combatting may be used by companies to increase
issues like obesity profits
Enhance Decision Quality Unintended Consequences

By structuring choices carefully, it can Changes in the presentation of choices
provide guidance, reduce biases, and can have unforeseen effects and the
increase the likelihood of individuals outcomes may not align with the original
making choices they would consider to be goals
better
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Nudge Theory
Nudge theory is the practice of influencing choices that economic agents make, using small Your notes
prompts to influence their behaviour
Richard Thaler coined the phrase ‘nudge theory’ and argued that firms should use nudges in a
responsible way to guide and influence decision-making
Examples of nudges
Diagram: Nudge Theory at SME
Save My Exams choice architecture nudges users to select the £5 a month option
The choice architecture above ‘nudges’ individuals towards selecting the monthly plan above the
other plans available
Diagram: London Underground
Page 16 of 21
Your notes
Source: Transport for London
The baby on board badge is supplied by Transport for London to expectant mothers to wear
when using public transport
Other commuters should see the badge and accommodate for the expectant mother by
giving their seat to her
Dr David Halpern, from the UK Behavioural Insights team suggested the following EAST
framework to nudge decision making
Easy: Simplify or make it straight forward
Attractive: Gain people's attention, e.g through personalised messages, encourage people
not to miss out on opportunities
Social: Individuals are influenced by what other people do rather than rules and regulations
Timely: identify when people are most responsive
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An Evaluation of Nudge Theory

Consumer nudges are designed to guide people towards certain decisions or actions while Your notes
still allowing them to have freedom of choice
These interventions are typically based on behavioural economics principles and aim to
nudge individuals towards decisions that are considered beneficial for themselves and
society as a whole
Consumer nudges should be designed with transparency, respect for individual autonomy, and
clear societal benefits in mind
Ethical considerations should be taken into account to ensure that interventions are not
manipulative or coercive
Diagram: The Advantages & Disadvantages of Nudge theory
The advantages and disadvantages of using nudge to influence behaviour
The advantages
Cost effective
Relatively low-cost compared to other marketing measures
Preserves freedom of choice

Steers individuals towards certain choices while still allowing them to retain their freedom of
choice
Improved public health

Nudges can be used effectively to encourage healthier behaviours such as exercising, eating
nutritious food, or quitting smoking
Better decision making
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Helps individuals make better decisions by simplifying complex information, providing

reminders, or structuring choices
Your notes
Environmental sustainability
By influencing individual choices in a subtle way, firms/governments can contribute to
broader environmental goals without imposing strict regulations
The disadvantages
Ethical concerns
Some critics argue that nudges can be manipulative, as they rely on influencing behaviour
without individuals being fully aware of the intervention
This raises ethical concerns about autonomy, consent, and the potential for abuse by
governments
Lack of transparency
Nudges often operate behind the scenes, making it difficult for individuals to understand
or question the influences shaping their choices
Unintended consequences
As citiz ens become used to firms and government's use of nudges, they may well begin
looking for it and actively work against them, e.g. In the UK, more people now look for
automatic inclusion in organ donor databases and quickly select the non-default option
Variable success rates

Nudges may not be equally effective for all individuals due to differences in cognitive biases,
cultural backgrounds, or personal circumstances
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Examples of UK Government Nudge Theory in Action

Nudge theory helps governments and other agencies shape economic decision-making Your notes
Examples of UK government nudge theory in action include
Workplace pension schemes
Health checks
Labels on food packaging
Evaluating the UK Governments Use of Nudge
Description Cost Benefits to

Nudge Benefits to Society
Consumers
Workplace Employers enrol Administrative Encourages Reduces reliance

pension eligible workers costs for retirement savings on state
schemes automatically employers to among workers pensions
into pension implement the Ensures financial Reduces future
schemes unless scheme security in old age financial strain on
they choose to government
opt-out welfare systems
Health Preventive health Cost of Early detection of Reduced future

checks checks offered funding the diseases that can health care
for those aged healthcare be treated costs
40–74 professionals Nudges to A healthier and
who carry out patients to more
the tests manage own productive
healthcare and society
wellbeing
Labels on Traffic light Cost of Improved health Improved public

food labelling on food designing and of individuals as health of society
packaging packaging to printing labels they can make Reduced long
indicate nutrient more informed term cost of
value health care
Page 20 of 21
choices about
food
Your notes
Page 21 of 21

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AQA A Level Economics Your notes

2. Individual Economic Decision Making

The Influence of Marginal Analysis on Choices

Behavioural economics is a field of study that combines elements of psychology and

Behavioural economics recognises that human decision-making is influenced by cognitive

Bounded Rationality & Self Control

The theory assumes rational decision-making is limited because of

The Influence of Biases on Decision Making

Type of Bias Explanation

Framing refers to how the presentation or wording of information can

Availability bias is influenced by personal experiences, vividness of the

The Influence of Altruism & Perception on Rational Choice

Altruistic decision-making can be influenced by

Using Behavioural Economics

Choice architecture aims to simplify the decision making process

Type of Choice How does it work?

Default Choice Occurs when an individual is automatically signed up to a particular

will be more likely to purchase them

An Evaluation of Choice Architecture

The Advantages and Disadvantages of Choice Architecture

Influences Behaviour Manipulation

Simplifies Decision-Making Ethical Concerns

Improved Outcomes Potential for Bias

Enhance Decision Quality Unintended Consequences

Diagram: London Underground

Source: Transport for London

An Evaluation of Nudge Theory

The advantages and disadvantages of using nudge to influence behaviour

Preserves freedom of choice

Improved public health

Better decision making

Helps individuals make better decisions by simplifying complex information, providing

Variable success rates

Examples of UK Government Nudge Theory in Action

Description Cost Benefits to

Workplace Employers enrol Administrative Encourages Reduces reliance

Health Preventive health Cost of Early detection of Reduced future

Labels on Traffic light Cost of Improved health Improved public

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