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Econ Study Guide.docx

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ECN 481

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Econ Study Guide Chapter 3 (Values, Preferences, and Choice): The Standard Model: 1. Preferences – these are the rankings people have over a set of options or gambles that are based on attitudes and values related to the outcomes of these options. a. Strictly prefer one over the other b. Weakly prefer one over the other, or is indifferent c. Revealed preference, if a consumer chooses a particular bundle it is assumed that this bundle is preferred to another bundle if that other bundle was both available and affordable 2. Beliefs – these related to the probabilities with which people think various outcomes will occur, conditional on available information 3. Rationality – this involves all four components of the standard model, referring to the ways which people: a. Determine preferences based on attitudes and values i. Logic and probability ii. Coherent iii. Not based on immaterial or irrelevant factors iv. Not be incompatible with empirical observations b. Appropriately modify their beliefs in the light of new information c. Discount values of future outcomes d. Succeed in choosing optimal actions given their preferences and beliefs Indifference curves – represent different combinations of two goods between which the consumer is indifferent (yield the same total utility) Equilibrium – any optimal point of consumption will occur at a point of tangency between an indifference curve and the budget constraint line Marginal Rate of Substitution (MRS) – represents the amount of Y that a consumer is prepared to give up in order to get one more unit of X (consumption combination to reach equilibrium) Happiness is a three-act tragedy: 1. Based on a reference point comparing ones happiness to others 2. Compares previous happiness to current happiness 3. I hate to loss more than I love to win (loss aversion) Peak-End Rule: Maximum pain suffered at any point and the mean suffered during the last three minutes Expectation effects - Anticipatory utility: the disappointment, or lower utility, after the event y be more than offset by the higher utility associated with the anticipation of the event. • Predicted utility (before trip), residual utility (after trip) Addiction and abstention - Self-signaling: people infer happiness from their actions when they feel that they are doing something good that they wouldn’t usually be doing (running in the rain even though there is bad weather = willpower) Addiction: people who feel that they are addicted to something may feel better about themselves if they abstain from consuming that thing at all Endowment effects – Exchange asymmetry: utility is not independent of possession; people who have acquired a gift tend to value it higher than others. Loss-aversion: mug and pen observation Framing effects – Anchoring effect: people asked to rate their level of happiness, their responses have been influenced by a prior question regarding the number of dates they have had in a recent amount of time. • Social security numbers (arbitrary coherence) Preference reversal: situations where people favor optionAwhen a question or problem is posed or framed in one way but favor option B when a question or problem is posed or framed in a different way. • Eating habits affected by packaging, plate sizes, etc. Menu effects 1. The attraction effect ▯ decoy effect puts something to throw of the consumer like magazine subscriptions 2. Preference for the salient ▯ people simplify complex decisions by choosing a salient option (stocks that are in the news, even if it is bad news) 3. Choice avoidance (paradox of choice) -▯ consumers avoid more choice 4. The momentum effect ▯ initial purchase provides psychological impulse that enhances the purchase of a second, unrelated product. 5. The vicarious consumption effect ▯ adding a healthy item to a list of available options has the perverse effect of causing people to choose the less healthy food items than otherwise. 6. Confusion ▯ reflects cognitive failure; mistakes in voting Attention: people tend to simplify complex decisions by using heuristics; only process a subset of information available like shipping costs, information included in rankings, etc. Visceral factors: Combination of feelings that influence behaviors (narrow attention onto the satisfaction of the drive especially in short-sighted decisions) • Without conscious • Impulsivity • Confuse actual and desired value Types of utility: UTILITY FOR DECISION MAKING Experienced utility – also hedonic, means that experiences of pleasure should point out what we should do as well as what we ought to do • Remembered utility – measured using memory-based approached; retrospective evaluation of past experience (Peak-End) o Retrospective hedonic ending draws attention to its dangers • Moment-based approach – involved continuous monitoring of the subjects o Total utility – measure of objective happiness, under certain assumptions Decision utility – refers to the weight assigned to an outcome in decision and is revealed by peoples choices (standard model) • Simply pick the better option (which offers more money versus which would make more happy) • Prominence effect – when it comes to preference the most important attribute is weighted more heavily (more convenient rationale for choice) • Somatic-Marker Hypothesis – a somatic marker, or an unpleasant gut feeling when a bad outcome connected with a given response comes to mind (forces attention to negative outcomes like an alarm) Cardinal – measure involving an interval scale Ordinal (favored) – baskets of commodities are simply ranked according to preference Endowment and contrast effects: Endowment – direct contribution to ones happiness; good news and positive experiences enrich our lives and make us happier while bad news and negative experiences diminish our well-being Contrast – a positive experience makes us happy but also renders similar experience less exciting and the opposite • Treadmill effect – people become more affluent over time o Adaptation – one hand in cold water and one hand in hot water, ad then immerse both hands in the same luke-warm water they experience a weird sensation that both hands will take the change differently; lottery winners and paraplegics adjust quickly to situations  Satisfaction treadmill (aspiration affect) – graduate student who is constrained by her income, can afford better food when she gets a job, but her satisfaction resumes to previous level when she gets used to good food  Ratchet effect – people find it easier to adjust their aspirations upward rather than downwards (loss-aversion) Transaction utility – net value of the purchase in terms of benefit minus cost • Acquisition utility – this represents the value of the good obtained relative to the price, equivalent to the concept of consumer surplus • Transaction utility – corresponds to the perceived value of the deal, in other words the reference between the reference price and the price paid Policy Implications: Bonus packs and price discounts – virtuous or vice good? Most goods are virtuous, being good for us in the long run, and in this case bonus packs are more effective for promotion. For a vice good, price discounts are a better method. *Post purchase guilt Context dependence – high correlation between punitive awards and compensatory damages awarded ▯ when there is a large amount of financial harm compensatory damages tend to be high, leading to high punitive damages. In cases of personal injury punitive damages tend to be low, since compensatory damages are also low. (Anchoring effect) Contingent Valuation Method (CVM) – used as a means of eliciting the value the people place on public goods, including non-use goods such as the continued existence of rare species • State willingness to pay (STWP), political support, personal satisfaction for making contributions, importance of the problem as a public issue Crime and punishment Menu Effects Placebo Effects Chapter 5 (Risk and Uncertainty) Prospect Theory: 1. Editing: phase consists of a preliminary analysis of the offered prospects to yield a simpler representation a. Coding – people normally perceive options as gains or losses relative to some reference point, rather than as final states of wealth or welfare b. Combination (coalescing) – prospects can sometimes be simplified by combining probabilities associated with identical outcomes (100, 0.3, 100, 0.3) = (100, 0.6) c. Segregation – some prospects contain a riskless component that can be segregate from the risky component. d. Cancellation – this is in relation to the independence axiom; when different prospects share certain identical components, these components may be discarded or ignored. i. Isolation effect – people ignore the first stage whose outcomes are shared by both prospects, and consider the choice as being between a riskless gain of 3000 and the risky prospect (4000, 0.80) e. Simplification – prospects may be simplified by rounding either outcomes or probabilities. For instance the prospect (99, 0.51) would be rounded to 100. If they are improbable they are most likely to be ignored. f. Detection of dominance – some prospects may dominate others, meaning they may have elements in common, but other elements involve outcomes or probabilities that are always preferable 2. Evaluation – after the editing phase the decision maker must evaluate each of the edited prospects and choose the prospect with the highest value; the overall value of an edited prospect (V) is expersed in terms of two scales (v, and pi). The scale, v, assign to each outcome X a number v(x) which reflectsthe subjective value of that outcome. The second scale, pi, associate with each probability p a decision weight pi(p) which reflects the impact of p on the overall value of the prospect. • V = Reference points, loss aversion, diminishing marginal utility • Pi = Decision-weighting • Strictly positive, strictly negative, or regular Reference points – have something to compare the outcome to • Empirical evidence: o Happiness treadmill – more money doesn’t always mean happier (US) and something bad happening doesn’t necessarily mean ultimate sadness; people can bounce back quicker than we think  Expectations affect reference points (work efforts) • Neuroscientific foundation: o Dopaminergic reward prediction error (DRPE) difference between anticipated and obtained reward • Psychological foundation: o Homeostasis – various systems of the body have an optimal set point and deviations from this point trigger negative feedback processes that attempt to restore it o Allostatis – different type of feedback system whereby a variable is maintained within a healthy range, but at the same time is allowed to vary in response to environmental demands (heart rate, blood pressure and hormone levels) Loss-aversion – a loss is equal is not equal to a gain? • Psychological foundation: gains can improve our prospects of survival and reproduction, significant losses can take us completely out of the game o Promotion system – nurturance needs related to advancement, aspirations and accomplishment and is marked by a sensitivity to gains versus non- gains o Prevention system - more sensitive to negative than to positive shifts from the status quo; more concerned about falling below the previous status quo or reference point, a negative change or loss, than should promotion- focused persons. • Neuroscientific fo
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