Midterm #2 Study Guide - Midterm#2 Chapters 7-15 Chapter 7 Consumer Behavior(155-174 Utility the value a person places on something o Comes from 2

Midterm #2 Study Guide - Midterm#2 Chapters 7-15 Chapter 7...

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Midterm #2: Chapters 7-15 Chapter 7: Consumer Behavior (155-174) Utility- the value a person places on something o Comes from 2 sources 1. Direct effect a product has on us 2. Other peoples’ reactions Revealed Preference- we can tell what maximizes peoples’ utility by observing their behavior Bundle- unique combination of goods and services that a person can choose from Diminishing Marginal Utility- each successive unit provides less utility than the last until marginal utility becomes negative (in some cases) o Total utility is maximized when marginal utility is equal to 0 Budget Constraint Changes in Income and Price o A change in Income will SHIFT the budget line o A change in Price will cause the curve to ROTATE Outward for decreased price Inward for increased price Income Effect- increased effective wealth due to lower prices Substitution Effect- change in consumption from a change in the relative prices of goods Veblen Goods- goods for which the quantity demanded is higher when prices are higher (ie. Luxury items; luxury watches/handbags) Altruism- a motive for action in which a person’s utility increases simply because someone else’s utility increases (selfless concern for the well-being of others) Reciprocity- responding to others’ actions with similar actions Substitution Effect o When the price of one good decreases, the marginal utility per dollar for another good does not change o When the price of one good increases, marginal utility of that good decreases, so people spend less on that good Chapter 8: Behavioral Economics (179-189)
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People often don’t act in rational ways Behavioral Economics- draws on insights from psychology to expand models of individual decision making o 3 Applications 1. Time Inconsistency When we change our minds about what we want, simply because of the timing of the decision (competing selves) Commitment Device- forcing yourself to fulfill future plans 2. Thinking Irrationally about Costs 2 common mistakes 1. Failing to ignore sunk costs (sunk cost fallacy) 2. Undervaluing opportunity costs People will often do this when one option is concrete; right in front of them Implicit Cost of Ownership- people value things more when they own them 3. Forgetting about Fungibility If something is Fungible- easily exchangeable or substitutable (ex. Money…a dollar) Chapter 9 : Game Theory and Strategic Thinking (193-212) One-Time Games and the Prisoners’ Dilemma
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o Prisoners’ Dilemma- a game of strategy in which two people make rational decisions that lead to a less-than-ideal result for both Decision Matrix YOU ACCOMPLIC E Confess Don’t Confess Confes s Don’t Confes s Dominant strategy is for both to confess o Nash Equilibrium- equilibrium reached when all players choose the best strategy they can given the choices of all other players Can have multiple Nash Equilibriums Promoting competition in the public interest Exxon Sunoc o Low Prices High Prices Low Price
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