Ch 2 consumer theory basics

Some readers will object that kahnemans is an overly

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Unformatted text preview: rhaps least persuasive in his treatment of the business world. Noting that even top performers in business —also sports—tend eventually to revert to the mean, he attributes success largely to luck. This confuses events that may not be predictable with those that are determined by chance. A high -achieving retail store, to cite one of his examples, is not lucky —it is well-situated. And if its sales later decline, that is not necessarily a sign that its prior success was random. Business has a self correcting cycle that fosters mean reversion. Success attracts competitors. Some readers will object that Kahneman’s is an overly Cartesian world, barren of h uman intuition. He recommends using formulae even for predicting the future value of wines. Thinking, Fast and Slow is nonetheless rife with lessons on how to overcome bias in daily life. Kahneman advises that you “recognize the signs that you are in a cog nitive minefield, slow down, and ask for reinforcement from System 2.” The next time a relative pops off about the stock market or President Obama, I will wonder: Doe s he or she know? Or is this just their reflexive self? I will never think about thinking quite the same. It’s a monumental achievement. See also: Bias, Blindness, and How We Truly Think: Part 1, Part 2, Part 3, Part 4 __________________________________________________________________________________________________________ 4. Representing Rational Preferences by a “Utility” Function For mathematical models of consumer choice we need a mathematical equation which represents a consumer’s preferences over all bundles in her consumption set. In ECO 204, we assume that rational preferences can always be represented by a mathematical equation known as a “utility function”: ( ) defined over ⏟ {( ) } A utility function assigns a “utility number” to each bundle in the consumption set. This utility number is not the level of “satisfaction” nor does it in any way quantify the felicity from a bundle. Instead of being a cardinal measure of “felicity” it is an ordinal measure of preference rankings telling us how the consumer has ranked or ordered bundles. For example, suppose Ajax prefers listening to Damian Lazarus over Lee Burridge: 10 ECO 204 CHAPTER 2 Modeling Consumer Choice and Behavior:...
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