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Lecture 18

ECON 2023 Lecture 18: ECON 8-4

3 Pages

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ECON 2023
Jeff Cooperstein

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Prospect Theory • Neoclassical economics: Consumer-choice situation only in good situations Behavioral economics: How people cope w. negative possibilities • - 3 facts how people deal w. goods & bads • 1) Judge good & bad things in relative term - As gains & losses relative to current situation (status quo) • 2) Diminishing marginal utility for both gains & losses • For gains: Each successive unit of gain=NOT feel as good as previous unit • For losses: Each successive unit of loss= NOT hurt as painfully as previous unit • 3) Loss aversion For losses & gains near status quo, losses= felt much more intensely than gains • - Loss > gain (impact) • Prospect theory - Pay attention to… • How consumers plan for & deal w. life’s ups & downs • Why they often appear narrow-minded & fail to “see big picture” - Daniel Kahneman - Awarded Nobel prize in economics w. powerful prospect theory Losses & Shrinking Packages - Business= be careful about increasing prices - Used to given price—> “Any increase= loss (to status quo price)” - Many business change product size (instead of price) - Consumer mentally fixate on price (<= not fully rational) - (Because price= characteristic in making purchasing decisions) - E.g.) Hershey’s chocolate bar Framing Effects & Advertising - Evaluate situations in terms of gains & losses - —> Decision-making= sensitive to mental frame • E.g. of frame changing purchase decisions • $100,000 salary per yr is happy?? - (Generally yes, but depends on your previous yr’s salary) • 10% up of your hourly salary happy?? - (what is others get 15% up?) • Prospect theory: - ⭐ Preferences= change drastically depending on whether contextual info defines situation gain/ loss
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