OxfordAQA International AS and A-level Economics: Rational and behavioural choice (9640) – Revision Notes

These notes condense sections 3.3.1.1 and 3.3.1.2 of the OxfordAQA International AS and A-level Economics specification (9640, version 1.2). Section 3.3 is extra International A2 content, beyond the International AS. For full explanations use the study guide, then test yourself with the practice questions. Other links: course hub, checklist, diagnostics and the demand and elasticity notes.

The objectives and growth of firms are separate statements and are not covered. Every figure is made up for illustration.

Key definitions

Term	Meaning
Utility	Satisfaction gained from consuming a good or service
Total utility (TU)	Overall satisfaction from the whole quantity consumed in a period
Marginal utility (MU)	Satisfaction gained from consuming one additional unit, found as the change in TU
Diminishing marginal utility	The more consumed in a period, the less satisfaction each additional unit brings
Utility maximisation	Choosing the option that gives the highest utility
Asymmetric information	Buyer and seller are not equally informed: one side knows more
Imperfect information	Information that is incomplete, inaccurate or hard to use
Bounded rationality	Limited information, time and ability to process it, so choices fall short of fully rational
Bounded self-control	Failing to act on what you know is best, often by overweighting the present
Nudge	A way of steering choice without banning options or greatly changing prices

The rational decision maker

Traditional theory assumes individuals are rational and aim to maximise utility.

Idea	Key points
TU and MU	MU = TU now minus TU before. TU rises while MU is positive, peaks at MU = 0, falls when MU is negative
Diminishing MU	The MU curve slopes downward. It is a hypothesis about typical behaviour
Free good	A utility maximiser consumes until MU reaches zero and no further
Priced good	Buy another unit only while its value to you is at least the price
Demand	Each extra unit is worth less, so more is bought only at a lower price: this supports a downward-sloping demand curve

You do not need the principle of equi-marginal utility, or to use it to explain the inverse link between price and quantity.

Method: from TU to MU and the best quantity

1. Subtract each TU from the next to get MU.
2. Check that MU falls, which confirms diminishing marginal utility.
3. Find the quantity where MU reaches zero, or TU is highest.
4. If there is a price, convert MU to money and buy while MU is at least the price.

Worked reminder. A consumer’s TU from ice creams in a day is 15, 27, 36, 42, 45. MU is 15, 12, 9, 6, 3. MU falls throughout, so diminishing marginal utility holds. TU is still rising at the fifth, so with free ice cream she would take at least five. If one util is worth 1 currency unit and the price is 7, she buys 3: the third is worth 9, the fourth only 6.

Sketch of the logic in words: the MU curve is a downward line, the quantity bought is where it falls to the price, and a lower price means a point further along it.

Information

Idea	Key points
Why it matters	Rational choice needs reliable information on price, quality, risk and alternatives
Imperfect information	Makes it hard for agents to decide rationally. It is a potential source of market failure
Asymmetric information	The better-informed party can gain at the other’s expense, or the market may shrink

Method: show how asymmetric information causes market failure

1. Identify which side has the better information, and on what.
2. Show the less-informed party must act on an average or a guess.
3. Show who gains or loses (the good type leaves, a poor deal is accepted).
4. Conclude that mutually beneficial trades do not happen, so resources are misallocated.

Worked reminder. A lender in Country C cannot tell safe borrowers from risky ones. Of 600 borrowers, 300 are safe (expected loss 20 each) and 300 risky (expected loss 100 each). The average expected loss is (20 + 100) ÷ 2 = 60, so every borrower is charged 60 for risk. Safe borrowers who would pay no more than 40 for the loan’s risk charge leave. The 300 risky borrowers remain, each costing 100 in expected loss but paying 60, so the lender loses 300 × (100 - 60) = 12,000. The charge must rise towards 100.

Behavioural economics

Behavioural economists question the assumption that individuals are rational utility maximisers. They show why decisions are biased.

Concept	Meaning	Quick example
Bounded rationality	Limits on information, time and processing	Comparing 40 phone plans by one headline price
Bounded self-control	Knowing the best action but not taking it	Planning to save but spending
Computational problems	Calculations too hard, so guesses are used	Mistaking compound interest for simple
Inertia	Staying with the current option	Keeping an old bank account
Rules of thumb	Simple shortcuts	Always buying the middle-priced item
Anchoring	Over-relying on a first number	A high “usual price” makes the sale price look low
Social norms	Unwritten rules followed because others do	Tipping a fixed share
Altruism	Utility from others’ wellbeing	Giving to charity
Fairness	Reactions to what seems fair	Boycotting a firm for a price rise in an emergency

Must-know distinctions

• Bounded rationality versus bounded self-control. The first is a limit on ability to choose well. The second is a failure to carry out the choice.
• Imperfect versus asymmetric information. Imperfect: either side may lack good information. Asymmetric: the two sides are unequally informed.
• Rule of thumb versus anchoring. A rule of thumb is a standing shortcut. Anchoring is being swayed by a particular figure seen just before.
• Inertia versus bounded self-control. Inertia is staying put through the effort of change. Bounded self-control is failing to follow a plan for the future.

Worked reminder (computational problem). A loan of 800 at 2% a month, compounding, repaid after 6 months. The mistaken view: 6 × 2% = 12%, so repay 896. The correct amount is 800 × 1.02⁶ = 900.93, which is 4.93 more.

Worked reminder (social norm). A town sends 5,000 households a letter saying most neighbours recycle. Recycling rises from 52% to 58% of households, from 2,600 to 2,900, which is 300 more.

Worked reminder (anchoring). A shop shows a coat as “was 200, now 130”. The saving looks like 35%, since 70 ÷ 200 = 0.35. If the coat was only ever sold for 140, the true saving is 10 ÷ 140, about 7%.

Firms, governments and nudges

Actor	Use of behavioural evidence
Firms	High “was” prices (anchoring), automatic renewal (inertia), pricing and wording that suit rules of thumb, messages built on norms
Governments	Nudges: default enrolment, social-norm messages, clearer information. Used alongside or instead of taxes, subsidies and rules

Evaluating a nudge: chain of reasoning. Identify the bias. Show how the nudge works on it. Estimate the effect and the cost. Compare with a tax or regulation. Judge using the size of the problem and the evidence.

• For: low cost, choice kept, can work where information fails.
• Against: may fade, vary between people, be hard to measure, and could be too weak for large externalities. Some people object that nudges manipulate.

Worked reminder. A city has 4,000 drivers. Under opt-in, 25% join a car-share scheme: 1,000. Under opt-out, 55% stay in: 2,200. That is 1,200 more. The nudge changes the default and not the price, so inertia does the work.

Quick self-test

1. Define marginal utility.
2. TU from a good is 20, 34, 44, 50, 52. Find MU for each unit.
3. At which quantity does a utility maximiser stop if the good is free and TU is 20, 34, 44, 50, 50?
4. Explain how diminishing marginal utility supports a downward-sloping demand curve.
5. Distinguish imperfect from asymmetric information.
6. Give one reason asymmetric information may cause market failure.
7. Distinguish bounded rationality from bounded self-control.
8. A loan of 1,000 at 3% a month compounds for 4 months. Find the amount to repay.
9. Name the bias: a diner thinks a 40 dish is cheap after seeing a 120 dish.
10. State two arguments against relying on nudges.

Answers

1. The gain in satisfaction from one additional unit, equal to the change in total utility.
2. 20, 14, 10, 6, 2.
3. Four units. TU stops rising after the fourth, so the fifth has MU of zero and adds nothing; four or five are equally good.
4. Each extra unit adds less satisfaction, so the buyer values it at less and takes more only at a lower price.
5. Imperfect: information is incomplete or inaccurate for anyone. Asymmetric: one party knows more than the other.
6. The less-informed side acts on an average, so good types leave and beneficial trades do not happen.
7. Bounded rationality: limited ability to choose the best. Bounded self-control: fails to act on the best choice.
8. 1,000 × 1.03⁴ = 1,125.51.
9. Anchoring.
10. Effects may fade or vary; they could be too weak for large externalities; they may be hard to measure.

Where marks are usually lost

• Writing total utility when the question asks for marginal utility.
• Calling diminishing marginal utility a certainty rather than a hypothesis.
• Mixing up bounded rationality and bounded self-control.
• Naming a bias without applying it to the case in the question.
• Describing asymmetric information without saying who is hurt and why.
• Treating a nudge as a ban, a tax or a subsidy.
• Evaluating nudges with a list and no judgement.
• Leaving a calculation without saying what the number means.

Official syllabus

Source: the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2, Oxford International AQA Examinations. Sections 3.3.1.1 and 3.3.1.2.