Pol 51 lecture 3

Pol 51 lecture 3 - Uncertainty and Mistakes We know that we...

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Pol 51, lecture 3 I should understand when formal theory will be useful and how it works. Formal Theory – we have very clear assumptions and logical deductions (a more mathematical building from assumptions) from those assumptions. Helpful in generating predictions about the real world. You’re not trying to create a logical structure in the abstract (we’re not philosophers), but be able to use logic to create testable hypotheses. Utility: Utility is what economists use to measure “happiness”. Utility is the sum of all benefits minus the sum of all costs from that action. Not everything can be measured in utility. We assume that people choose an action that maximizes their utility. But we don’t know everything about the situation (prices, benefits, ect) so we talk about maximizing expected utility. Expected value = probability*value
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Unformatted text preview: Uncertainty and Mistakes: We know that we all make mistakes which can change response/action. In equilibrium, I know you make mistake, so I change my strategy to benefit from your mistake. Then we allow for each other to make mistakes, which may seem totally crazy, but that’s what makes the world work. If we assume that people never make mistakes and all actions are rational, there are actions that you take personally. If everything was intentional, you will hate the world. But if people make mistakes, you will let it go. You also don’t know what my preferences are and vice versa. Not know what’s in your best interest, vice versa. I may not even know what’s in my best interest. Hotelling, a prime example of where equilibrium is INEFFECIENT! They place their stores in areas of their best interest, not society’s....
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