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Decision-making under certainty

 - What kind of decision-making model exist for "Classical economics" and "Behavioral Economics"

Classical economics -> rational (choice) model

Behavioral Economics -> behavioral model & procedurally rational model

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Decision-making under certainty

 - Model of decision-making in classical economics:

  1. Describe the "rational (choice) model"
  2. Which six attributes of homo economics belongs to rational (choice) model? 

Classical economics accepts that the homo oeconomicus is not a realistic depiction of human behavior but is used as a simplifying assumption in economic models (models have to simplify reality)

  • Fixed preferences
  • Completely rational behavior
  • Complete market transparency and foresight
  • Immediate reaction to new information
  • Utility maximization
  • Unlimited self-control
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Decision-making under certainty

 - Describe the "behavioral model" of decision-making in behavioral economics:

 

  • Describes behavior based on observations («what»)
  • No assumptions about motivation that might cause the behavior («why»)

Description of behavior that deviates (abweichen) from rational behavior

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Decision-making under certainty

 - What are advantages and limitations of the "behavioral model" of decision-making in behavioral economics:

Advantages of the model:

  • based in observations
  • Is usually precise for the type of situations in which the observations were made

Limitations of the model:

  • Misinterpretation possible because no assumptions are made about the motivation («why») as they are not observable; this also makes it difficult to generalize any conclusions made about the decision-making

 

Limitations of the model

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Decision-making under certainty

 - Describe the "procedurally rational model" of behavioral economics

people act with limited rationality = «bounded rationality»

More realistic model of problem solving, because humans have:

  • Limited information available
  • Limited information-processing capacity
  • Limited time available

 

Principle: Investing a reasonable amount of resources in the decisionmaking
process to achieve a satisfying result -> rule of thumb: You can get headphones from about
10 CHF. If I spend 70 CHF, I should get a pretty decent model.

-> a reasonable amount of resources is invested in the decision-making process to achieve a satisfying result

-> it is neither advisable nor possible to maximize utility -> (1) not all information is available, (2) trade-off between invested time and gained ut

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Decision-making under certainty

 - What are the advantages of the "procedurally rational model" of behavioral economics

  • Is not based on the assumption of that individuals are perfectly rational decision-makers
  • Good predictions of human behavior across different situations
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Decision-making under certainty

 - What are the advantages of classical economics and behavioral economics?

to explain, predict and influence human decision making in the economic context

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Decision-making under certainty

 - Which role plays the "utility" from the classical economics and behavioral economics perspective?

Concept of «utility» plays an important role in economic decision-making Utility according to economic theory:


= Total satisfaction received from consuming a good or service

  • Assumption: consumers strive to maximize their utility
  • Utility directly influences the demand, and therefore price, of a good or service