ECO2003F EDU Workshop 3.pptx

# If a typical consumer demands more of a good because

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If a typical consumer demands more of a good because more people are buying it, we refer to this as a positive externality. The Bandwagon effect D20 Adidas Superstars 200 The market demand curve is constructed by joining the points D20 D40 D60 D80 D100 with the corresponding quantities 20 40 60 80 and 100. Price D40 D60 D80 D100 40 80 100 20 60 100 The market demand curve is more elastic than the other Demand curves

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If a typical consumer demands more of a good because more people are buying it, we refer to this as a positive externality. The Bandwagon effect D20 Adidas Superstars 200 When the price drops from 200 to 100 on D40, With no bandwagon effect, the quantity only increases to 48 We call this the pure price effect Price D40 D60 D80 D100 40 80 100 20 60 100 48 But as more people buy it, it becomes fashionable, and more people want it The increase from 48 to 80 is called the bandwagon effect
Choice under Uncertainty: (all decisions have some element of risk involved as we do not always have all the required information or if we do have the required information we don’t deem it important to include in our decision making or we include useless information and is essentially a gamble) Probability and expected value: Lets consider 3 cases of the same game, tossing a coin (outcome is Heads or Tails). Option C looks so attractive, but why don’t we take it?? We choose the option with the highest expected UTILITY, NOT the highest expected VALUE More on this to follow Expected value (weighted average of the outcomes)

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Von Neumann Morgenstein expected utility Model We choose the option with the highest expected utility and not the highest expected value Initial wealth is important, why? Consider getting a R100, does it as much to you as it does to a billionaire? Expected utility (expected value of utility over all outcomes Expected Utility model Risk averse vs. Risk Seeking vs. Risk Neutral Assume Snoop has R10 000 Lets call initial wealth M 0 M 0 = 10 000 Lets say Snoop was offered the following gamble: If Snoop gambles and wins he can win R2000, if he loses, he can lose R10 Win: 10 000 + 2000 = 12 000 Utility would be U(12000) Lost: 10 000 – 10 = 9990 Utility would be U(9990) General terms: EU = 0.5[U(M+2000)] + 0.5[U(M-10)] If you refuse gamble, U is M 0 , Therefore U(M 0 ) Expected utility (expected value of utility over all outcomes Von Neumann Model says “accept gamble if EU is larger than U(M 0 )
Von Neumann Morgenstein expected utility Model Expected utility (expected value of utility over all outcomes Von Neumann Model says “accept gamble if EU is larger than U(M 0 ) What is a fair gamble? Assume Dr. Dre has R100, therefore M 0 =100 Assume Utility is given U=U(M) EV =0.5(100+75) + 0.5(100-75) EV =0.5(175) + 0.5(25) = 100 This is a fair gamble Only accept if EU >U(M 0 ) Compare points of winning vs. losing Expected value (weighted average of the outcomes)

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Von Neumann Morgenstein expected utility Model Expected utility (expected value of utility over all outcomes Von Neumann Model says “accept gamble if EU is larger than U(M 0 ) What is a fair gamble?
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