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

This guide follows the AQA AS and A-level Economics specification (version 1.3, 29 June 2022) for the A-level, first taught from September 2015. It covers the sub-section called Individual economic decision making, which the AQA website numbers 3.1.2 (the A-level text in the combined PDF carries the number 4.1.2). Its four parts, 3.1.2.1 to 3.1.2.4, are taught in order. Every country, firm and number below is invented, for illustration only.

Use it with the revision notes and the practice questions. The course hub is AQA A-level Economics, the printable checklist tracks progress, and the free 10-minute diagnostics show weak spots. For wider context, see the overview of this part of the course.

Outcomes at a glance

Section	Outcome
3.1.2.1 Consumer behaviour	Rational decision making and incentives; total and marginal utility; diminishing marginal utility, which supports a downward-sloping demand curve; utility maximisation; the importance of the margin
3.1.2.2 Imperfect information	Why information matters for decisions; asymmetric information; how imperfect information stops agents deciding rationally and can cause market failure
3.1.2.3 Behavioural economic theory	Bounded rationality and bounded self-control; biases (rules of thumb, anchoring, availability, social norms); altruism and fairness
3.1.2.4 Behavioural economics and policy	Choice architecture and framing; nudges; default, restricted and mandated choice

The specification does not require the equi-marginal principle, so it is left out.

3.1.2.1 Consumer behaviour

Rational decisions and incentives

Traditional theory assumes a rational economic agent who weighs the costs and benefits of each option, uses the information available, and picks the option giving the greatest satisfaction. Satisfaction is called utility. Consumers aim to maximise utility.

An incentive is a reward or penalty that changes the costs or benefits of a choice. A rise in price, a bonus, a subsidy or a fine all alter the balance, so a rational agent changes behaviour. If a bus fare rises, some people walk.

Total and marginal utility

Total utility (TU) is the satisfaction from consuming a given quantity. Marginal utility (MU) is the extra satisfaction from consuming one more unit, which equals the difference between successive values of TU.

The hypothesis of diminishing marginal utility says that as someone consumes more of a good in a given time, each extra unit adds less satisfaction than the one before. TU keeps rising while MU is positive, reaches a maximum when MU is zero, and falls if MU becomes negative.

Worked example. Country A is invented. A consumer measures her satisfaction from cups of coffee in a day in pence she would pay.

Cups	TU	MU
1	100	100
2	180	80
3	240	60
4	280	40
5	300	20
6	300	0
7	270	-30

MU is TU minus the previous TU: 180 - 100 = 80, 240 - 180 = 60, and so on. MU falls at every step, so the hypothesis holds. TU peaks at 300 at five or six cups.

Utility maximisation and demand

If a rational consumer chooses freely and the good costs nothing, she keeps consuming until MU reaches zero, so utility is maximised at six cups (or five, since the sixth adds nothing). With a price, she buys another unit only if its MU, in money terms, is at least the price.

Price (pence)	Cups bought	Reason
70	2	Third cup adds 60, below 70
50	3	Fourth cup adds 40, below 50
30	4	Fifth cup adds 20, below 30
10	5	Sixth cup adds 0, below 10

Price falls from 70 to 10 and quantity rises from 2 to 5. This is the link to demand: because each extra unit is worth less to the buyer, she will take more only at a lower price, so the demand curve slopes downward.

The importance of the margin

Rational choices are made at the margin: compare the extra benefit of one more unit with its extra cost, ignoring sunk costs. Continue while marginal benefit (MB) exceeds marginal cost (MC), and stop where they meet.

Worked example. A small bakery (invented) can bake up to four extra batches. Each costs 40 in ingredients and energy.

Batch	MB (extra revenue)	MC	MB - MC
1	90	40	+50
2	70	40	+30
3	50	40	+10
4	30	40	-10

The baker makes three batches. Extra profit is 50 + 30 + 10 = 90. A fourth would lower it by 10. The oven bought last year for 500 is a sunk cost and is irrelevant at the margin.

3.1.2.2 Imperfect information

Rational decisions need good information about price, quality, risks and alternatives. When information is incomplete, inaccurate or uneven, agents cannot decide rationally and the market may fail to allocate resources efficiently.

Asymmetric information

Asymmetric information exists when one party knows more than the other. A seller knows more about a used car than the buyer, and a patient knows more about their health than the insurer. The less informed party cannot judge quality, so poor choices follow.

Worked example. In Country B (invented) a market sells used scooters. Half are good and half poor. Buyers value a good one at 1,200 and a poor one at 600. Owners of good ones will sell for no less than 1,000, and owners of poor ones for no less than 500. Buyers cannot tell them apart.

1. Expected value to a buyer: 0.5 x 1,200 + 0.5 x 600 = 900.
2. A good-scooter owner wants at least 1,000, so will not sell at 900.
3. Good scooters leave the market, so only poor ones are sold.
4. Buyers realise this, so they expect poor ones, value them at 600, and the price falls towards 600.

Trades that benefit both sides never happen: buyers value a good scooter at 1,200 and owners would accept 1,000. That is market failure caused by asymmetric information. Warranties and inspections help.

Imperfect information and consumers

Consumers can also misjudge the benefits or costs of what they buy. If they overestimate the benefit, they buy too much; this matters for harmful goods.

Worked example. The table compares perceived and true marginal benefit of a health supplement. Price (and MC) is 6 per unit.

Unit	Perceived MB	True MB
1	15	11
2	13	9
3	11	7
4	9	5
5	7	3
6	5	1

Consumers buy while perceived MB exceeds 6: five units. The efficient quantity is where true MB exceeds 6: three units. Units 4 and 5 are over-consumed. Welfare loss is the gap between price and true benefit on those units: (6 - 5) + (6 - 3) = 4.

Information failure can also cause under-consumption: someone unaware of the benefits of training will buy too little.

3.1.2.3 Aspects of behavioural economic theory

Behavioural economists question the assumption that people are rational utility maximisers. They use evidence on real choices to explain biased decisions.

Bounded rationality and bounded self-control

Bounded rationality means that the information, time and thinking capacity people have are all limited, so the fully rational choice is out of reach. They settle for a good enough option rather than the best.

Bounded self-control means people know what is best for them in the long run but fail to act on it, because they overvalue the present. A person intends to save but spends.

An invented example: a person prefers 100 today to 110 in a week, yet prefers 110 in 53 weeks to 100 in 52 weeks. The waiting time and amounts are the same, yet the choice flips. The same one-week wait is judged differently depending on whether it starts now, which shows the pull of the present and weak self-control.

Biases in decision making

• Rules of thumb are simple shortcuts that save effort, such as always tipping 10% or choosing the middle-priced item.
• Anchoring is relying too heavily on the first number seen. A jacket marked “was 80, now 50” feels cheap because 80 is the anchor: the saving is (80 - 50) / 80 = 37.5%. If the jacket had never sold above 60, the true saving would be 10 / 60, about 17%.
• Availability is judging how likely an event is by how easily examples come to mind. After widely reported floods, people overestimate flood risk and over-insure.
• Social norms are the unwritten rules about how people behave. People follow what others do. In an invented trial, 2,000 households received letters comparing their energy use with neighbours. Use fell 2.5% from 600 units a year, so 15 units each and 30,000 units in total.

Altruism and fairness

Traditional theory assumes self-interest. In practice people give to charity and care about fairness.

Worked example. In an invented ultimatum game, a proposer splits 100 and the responder can accept or reject. A rejection gives both nothing. A purely self-interested responder accepts any positive offer, even 1. In experiments, low offers are often rejected, for example an offer of 20 (20% of the pot). The responder gives up 20 to punish what they see as unfair. Their utility depends on fairness as well as their own income, which contradicts the standard assumption.

3.1.2.4 Behavioural economics and policy

Governments and firms can use these insights to influence decisions without removing choice.

Choice architecture and framing

Choice architecture is the way choices are presented: the order, the layout, the defaults and the description. Framing is how the same facts are worded. “Meat that is 90% fat free” and “meat that is 10% fat” are identical facts, since 1 - 0.10 = 0.90, yet the first wording can make the product seem more appealing. Bounded rationality makes people respond to the frame.

Nudges

A nudge moves people to a better choice by changing how it is presented, not by forbidding anything or altering prices much.

Default, restricted and mandated choice

• Default choice: the option applied unless the person acts. Employees automatically enrolled in a pension, with the right to leave, is an opt-out default.
• Restricted choice: the number or type of options is limited, such as a menu with fewer high-sugar items.
• Mandated choice: people must decide, for example by answering a yes-or-no question on organ donation when applying for a licence.

Worked example. A firm in Country C has 5,000 staff. With opt-in, 40% join a pension scheme. With opt-out, 85% stay in. Average contribution is 4% of a salary of 30,000, which is 1,200.

1. Opt-in: 0.40 x 5,000 = 2,000 members.
2. Opt-out: 0.85 x 5,000 = 4,250 members.
3. Extra members: 2,250. Extra saving: 2,250 x 1,200 = 2,700,000 a year.

Inertia explains the effect: few people act to change a default.

Evaluating nudges

Strengths: low cost, keeps freedom, may work where information fails. Compare with a tax. If a drink’s price rises 10% and price elasticity of demand is -0.3, quantity falls 3%. A default portion size reducing sales by 6% (invented) would then beat the tax, at less cost to consumers’ incomes.

Limits: effects can fade, vary between people, are hard to measure, and raise worries about who decides what is better. Nudges may be too weak for large externalities, where taxes or regulation may be needed.

Common errors

• Writing that marginal utility is total utility divided by units.
• Saying demand slopes down only because of income, ignoring the falling value of each extra unit.
• Including sunk costs in a marginal decision.
• Treating asymmetric and imperfect information as identical: asymmetry is one party knowing more.
• Calling a nudge a ban or a tax.
• Confusing bounded rationality (limited ability to choose well) with bounded self-control (failing to act on the choice).
• Giving a bias example without naming it.

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).