Study notes - 14:25:00 Chapter1: 1. o ShouldIdoactivityx...

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Study Notes Chapters 1-3 03/10/2010 14:25:00 Chapter 1: Thinking like an Economist 1.1 The cost-benefit approach to decisions All opportunities have economic question o Should I do activity x? Could be go see a movie, eat another waffle at a buffet Economists ask the question what is the cost of doing each activity o Comparing the cost and benefits General formula o If B(x) > C(x), do x, otherwise do not Money is not always the cost represented B(x) is the max dollar amount you would pay to do activity x o Often hypothetical C(x) is the value of all things you must give up in order to do activity x o Also does not just include money Example: should I reprogram my stereo o Sitting in comfy chair listening to music, realize the next two tracks are  ones you dislike o Economic question: do you get up from your comfy chair to change the  CD o Decision either stay put and wait it out or go change it o B(x)= not having to listening to the tracks you dislike o C(x)= moving from the chair
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o Must determine which is more important to you B(x) or C(x) o Can use monetary framework If someone offered one cent to change the song you may not be  inclined to change it If someone offered you $1000 you would definitely get up Must determine the minimum value that you would get up for The price that changes B(x) > C(x) to B(x) < C(x) is called the  reservation price Works in reverse as well How much you would be willing to pay someone to  do it for you o 1.2 a note on the role of economic theory nobody will consciousnessly do the entire stereo test to determine there  reservation price o economists criticized for this theory 2 responses to this criticism o (1) economists by no means assume people make these calculations  regularly make the theory useful by assuming people act as if they did  make these calculations expressed by Nobel Prize winner Milton Friedman uses expert pool players as an example argues that pool players don’t use actual physics to line  up and choose each shot assume that they do take into account all calculations hardly any pro pool players take all factors into account  or have any knowledge of the actual physics judge the theory not based on how accurate it is but how  well it predicts behavior
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most economists believe that through trial and error we develop  these rules o (2) economists make unrealistic assumptions is to concede that actual  behaviour does often differ from the predictions of economic models
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