AQA A-level Economics: Rational choice, information problems and nudges (7136) – Revision Notes

These notes condense the AQA AS and A-level Economics specification (version 1.3, 29 June 2022), A-level sub-section Individual economic decision making, which the AQA website numbers 3.1.2 and the combined PDF numbers 4.1.2. They cover 3.1.2.1 to 3.1.2.4. For full explanations, read the study guide, then test yourself with the practice questions. The hub is AQA A-level Economics, the printable checklist records progress, and the free 10-minute diagnostics find gaps. All figures are invented.

Key terms

Term	Meaning
Rational agent	Weighs costs and benefits, uses available information, aims to maximise utility
Incentive	A reward or penalty that changes the cost or benefit of a choice
Utility	Satisfaction from consumption
Total utility (TU)	Total satisfaction from all units consumed
Marginal utility (MU)	Added satisfaction from an extra unit
Diminishing MU	Each extra unit in a period adds less utility than the last
Margin	The decision about one more (or one fewer) unit
Asymmetric information	One party knows more than the other
Bounded rationality	Limited information, time and thinking ability
Bounded self-control	Failing to act in line with long-run interests
Nudge	Steering choices without banning options or changing incentives much
Choice architecture	How choices are presented and ordered
Framing	How the same facts are worded

3.1.2.1 Consumer behaviour

Method: from a TU table to MU and demand.

1. MU = TU now minus TU before.
2. Check that MU falls: that is diminishing marginal utility.
3. TU peaks where MU = 0.
4. With a price, buy another unit only while its MU in money terms is at least the price.
5. Different prices give different quantities: that traces a downward-sloping demand curve.

Worked reminder. A tea drinker in an invented town has TU of 60, 110, 150, 180, 200, 210 for 1 to 6 cups.

• MU: 60, 50, 40, 30, 20, 10. It falls steadily, so MU is diminishing.
• If one cup of tea costs 35 pence equivalent, she buys 3 cups (MU 40 is above 35; MU 30 is below).
• If the price falls to 15, she buys 5 cups (MU 20 is above 15; MU 10 is below).
• Lower price, more bought: the demand curve slopes down.

The specification links diminishing marginal utility to the downward slope of demand but does not require the equi-marginal principle.

The margin.

Rule	Detail
Do more while	MB is greater than MC
Stop where	MB = MC, or the next unit has MB below MC
Ignore	Sunk costs, which cannot be recovered whatever you choose
Count	Only extra costs and extra benefits caused by the decision

A café owner has paid 500 for a coffee machine (sunk). Opening one more evening hour costs 30 in wages and energy. If the extra hour brings in 45, open it: 45 - 30 = +15. The 500 does not change this.

Rational choice and incentives. Rational choice assumes self-interested people comparing costs and benefits. Incentives change those costs and benefits, so behaviour changes. Subsidies lower costs, taxes raise them, bonuses raise rewards.

Evaluation of the rational model. It is simple and may be a reasonable guide when stakes are high and choices are repeated. It fails when information is poor, decisions are quick or emotions matter. That is the starting point for behavioural economics.

3.1.2.2 Imperfect information

Chain of reasoning: asymmetric information to market failure.

1. One party (often the seller) knows quality or risk better.
2. The other party cannot tell good from poor.
3. Buyers pay only an average price.
4. Owners of good items refuse to sell at that price and leave.
5. The average quality offered falls, and so does the price buyers will pay.
6. Beneficial trades are lost: market failure.

Checked reminder. In an invented market for second-hand tablets, one in four is good. A buyer values a good one at 800 and a poor one at 400. Expected value: 0.25 x 800 + 0.75 x 400 = 500. A good-tablet owner wanting 650 will not sell at 500, so only poor ones remain, worth 400.

Imperfect information for consumers.

• Overestimating benefits leads to over-consumption, for example of harmful goods.
• Underestimating benefits leads to under-consumption, for example of training.
• Result: consumers choose where perceived MB differs from true MB, and welfare is lost.
• Welfare loss on a unit equals the gap between price and true MB, for units bought beyond the efficient quantity.

Ways to reduce the problem. Guarantees, ratings, inspections, compulsory disclosure, information campaigns and regulation of advice.

Evaluation. Some information problems are solved privately by reputation and branding. Information campaigns are costly and may be ignored. Regulation may add cost for small firms.

3.1.2.3 Aspects of behavioural economic theory

Idea	One-line explanation	Short example
Bounded rationality	Limits on information and thinking, so choose “good enough”	Booking the first acceptable hotel found
Bounded self-control	Overvalue the present	Spending money meant for savings
Rule of thumb	Simple shortcut	Always buying the middle-priced item
Anchoring	First figure seen sets the reference point	Original price 150, now 105: a 30% saving seems large
Availability	Easy-to-recall events seem more likely	Fear of flying after news coverage
Social norms	Copying what others do or approve of	Using less water after a comparison with neighbours
Altruism	Caring about others’ welfare	Giving to charity
Fairness	Rejecting outcomes seen as unjust	Refusing a tiny share in a split game

Must-know distinctions.

• Bounded rationality is about ability to decide; bounded self-control is about carrying out the decision.
• Rule of thumb is a shortcut method; anchoring is a bias caused by a specific starting number.
• Altruism is giving without return; fairness concerns are about the process or split.

Chain: why behaviour differs from the model. Real people have limited information and thinking capacity, use shortcuts, are swayed by context, care about others and delay beneficial actions. Their decisions may not maximise their own utility.

Evaluation. Behavioural findings explain many real choices, but experimental results may not hold outside the laboratory. The standard model is still useful as a baseline.

3.1.2.4 Behavioural economics and policy

Tool	What it does	Example
Choice architecture	Designs how options are presented	Healthy food placed first in a canteen
Framing	Changes wording of identical facts	“95% fat free” instead of “5% fat” (1 - 0.05 = 0.95)
Nudge	Steers without banning or large price changes	A reminder text before an appointment
Default choice	Applies unless the person opts out	Automatic enrolment in a savings scheme
Restricted choice	Limits the options	A vending machine stocking only low-sugar drinks
Mandated choice	Requires an active decision	A form that cannot be submitted without ticking yes or no

Worked reminder: default effect. A company in an invented country has 3,000 staff. Under opt-in, 30% enrol in a wellness plan (900). Under opt-out, 80% stay in (2,400). Extra participants: 2,400 - 900 = 1,500.

Evaluating a nudge: points to weigh.

• Cost: usually cheap compared with subsidies and campaigns.
• Freedom: keeps choice, though restricted choice limits it more.
• Effect size: can be small or fade; large externalities may need taxes or regulation.
• Fairness and trust: who decides what is “better”, and is it transparent?
• Evidence: results vary by group, so pilot first.
• Conclusion: judge by size of the problem, cost, and speed of effect.

Quick self-test

1. Define marginal utility.
2. TU for 1 to 5 units is 50, 90, 120, 140, 150. Find MU for each unit.
3. State the hypothesis of diminishing marginal utility.
4. A firm has paid a non-refundable 1,000 deposit for a venue. The next hire of equipment costs 200 and brings 260. Should it go ahead?
5. Why does asymmetric information cause good-quality goods to leave a market?
6. Distinguish bounded rationality from bounded self-control.
7. A shop shows “was 150, now 105”. Calculate the percentage saving and name the bias it exploits.
8. Give one example of availability bias.
9. Distinguish default choice from mandated choice.
10. Under opt-in 20% of 2,000 customers join a scheme; under opt-out 75% stay. How many more are in?

Answers

1. The additional satisfaction gained from one extra unit.
2. 50, 40, 30, 20, 10.
3. As more is consumed in a given time, each extra unit adds less satisfaction than the previous one.
4. Yes. The deposit is sunk. Marginal benefit 260 exceeds marginal cost 200, a gain of 60.
5. Buyers cannot tell quality, so offer an average price; owners of good items will not accept it and leave, lowering average quality.
6. Bounded rationality: limited information or thinking ability. Bounded self-control: knowing the best choice but not acting on it.
7. (150 - 105) / 150 = 30%. Anchoring on the original price.
8. Overestimating the risk of a dramatic event because it was widely reported recently.
9. A default applies unless you opt out and requires no action; mandated choice forces you to make an active decision.
10. Opt-in 0.20 x 2,000 = 400; opt-out 0.75 x 2,000 = 1,500; difference 1,100.

Where marks are usually lost

• Dividing TU by the number of units instead of finding the change in TU.
• Letting a sunk cost affect a marginal decision.
• Describing diminishing marginal utility as a fall in total utility.
• Saying “asymmetric information” without stating who knows more.
• Stating a bias without applying it to the context given.
• Treating a nudge as compulsion, or a tax as a nudge.
• Describing a policy but giving no evaluation of its cost, size of effect or fairness.
• Using one-sided conclusions, such as “nudges always work”.
• Mixing up default and mandated choice.

Official syllabus

AQA AS and A-level Economics specification, version 1.3 (29 June 2022), published by AQA: the A-level sub-section Individual economic decision making, 3.1.2 on the AQA website (4.1.2 in the combined PDF).