Key Idea: Topic 2.4 challenges the idea that people always act rationally. It introduces behavioural economics — biases, heuristics, and nudge theory that explain why real decisions differ from the rational model.
✅ Core definitions
- Rational consumer
- Maximises utility (satisfaction) with perfect information and consistent preferences.
- Rational producer
- Maximises profit (MR = MC).
- Bounded rationality
- People have limited information, time, and processing power — they satisfice rather than optimise (Herbert Simon).
- Nudge
- A change in the choice environment that steers behaviour without removing options (Thaler & Sunstein).
🧠 Key cognitive biases
- Anchoring — over-relying on the first piece of information ('was £100, now £60')
- Framing — decisions change based on how options are presented (gain vs loss framing)
- Status quo bias — preference for the current situation (inertia)
- Loss aversion — losses feel roughly twice as painful as equivalent gains
- Herding — following the crowd rather than thinking independently
💡 Nudge theory
- Defaults — opt-out pension enrolment → participation jumps from ~40% to ~90%
- Simplification — traffic-light food labels make healthy choices easier
- Social norms — '9 out of 10 neighbours pay tax on time' increases compliance
- Salience — plain cigarette packaging makes health warnings more noticeable
⚖️ Evaluation of nudges
✅ Strengths: Low cost to implement. Preserves freedom of choice. Can be very effective (defaults).
❌ Weaknesses: Paternalistic (who decides what's best?). Limited effect on strong preferences. Ethical concerns (manipulation?).
Nudges work best for low-stakes, habitual decisions (food, savings). They are less effective for major purchases or addictive goods.