Economics Exam 2 Review Chapters 7 8 9 10 11 12 13 14 15 Chapter 7 Consumer Behavior Utility a measure of the amount of satisfaction a person derives from something Revealed Preference the idea that people s preferences can be determined by observing their choices and behavior Utility Function a formula for calculating the total utility that a particular person derives from consuming a combination of goods and services Bundle a unique combination of goods that a person could choose to consume Marginal Utility the change in total utility that comes from consuming one additional unit of a good or service Diminishing Marginal Utility the principle that the additional utility gained from consuming successive units of a good or service tends to be smaller than the utility gained from the previous unit Budget Constraint a line that is composed of all the possible combinations of goods and services that a consumer can buy with her or his income Changes in Income Changes in Price The entire budget line shifts out but slope remains the same Normal Goods demand increases as income increases steak Inferior Goods demand decreases as income increases ramen Income effect the change in consumption that results from increased effective wealth due to lower prices causes budged line to rotate outward Substitution effect the change in consumption that results fro a change in the relative price of goods opportunity cost changed Frames of Reference Utility based on what others around you have salary example Altruism a motive for action in which a person s utility increases simply because someone else s utility increases Reciprocity responding to another s action with a similar action Chapter 8 Behavioral Economics Behavioral Economics a field of economics that draws on insights from psychology to expand models of individual decision making Time inconsistency when we change our minds about what we want simply because of the but Commitment Device an arrangement entered into by an individual with the aim of helping timing of the decision saying you will want an apple next week picking cake when the time comes fulfill a plan for future behavior that would otherwise be difficult Sunk Cost a cost that has already been incurred and cannot be refunded or recovered People are usually prone to undervaluing opportunity costs when they are nonmonetary time Implicit cost of ownership people value things more once they possess them Ex keeping a 200 bike in your garage even though you wouldn t bay 200 to Fungible easily exchangeable or substitutable buy it People can create mental categories for money to reduce temptation People are more likely to spend money recklessly if they have recently gained it Chapter 9 Game Theory Strategic Thinking Game a situation involving at least two people that requires those involved to think strategically Game Theory the study of how people behave strategically under different circumstances Behaving Strategically acting to achieve a goal by anticipating the interplay between your own and others decisions Strategies the plans of action that players follow to achieve their goals Payoffs the rewards that come from particular actions Rules limits on the actions you can take to achieve a goal Prisoner s Dilemma a game of strategy in which two people make rational choices that lead to a less than ideal result for both Dominant Strategy a strategy that is the best one for a player to follow no matter what strategy other players choose Nash Equilibrium equilibrium reached when all players choose the best strategy they can given the choices of all other players Commitment Strategy an agreement to submit to a penalty in the future for defecting from a given strategy When is competition better for society than collusion It forces firms to be innovative and become more efficient Repeated Game a game that is played more than once Players no longer need commitment strategies to reach a mutually beneficial equilibrium Tit for Tat a strategy in which a player in a repeated game takes the same action that his or her opponent did in the preceding round Sequential Games when players move sequentially rather than simultaneously Backward induction the process of analyzing a problem in reverse starting with the last choice the second to last choice and so on to determine the optimal strategy First mover advantage benefit enjoyed by the player who chooses first and as a result gets a higher payoff than those who follow Ultimatum Game one player makes an offer and the other player has the simple choice of whether to accept or reject Chapter 10 Information Complete Information state of being fully informed about the choices that relevant economic actors face Information Asymmetry a condition in which one person knows more than other Adverse Selection a state that occurs when buyers and sellers have different information about the quality of a good or the riskiness of a situation results in failure to sides had the Principal a person who entrusts someone with a task Agent a person who carries outa task on someone else s behalf Moral Hazard the tendency for people to behave in a riskier way or to renege on contracts when complete transactions that would have been possible if both same information they do not face the full consequences of their action Adverse selection relates to unobserved characteristics of people or goods and occurs before the parties have entered into an agreement Moral hazard is about actions and occurs after the parties have voluntarily entered into an agreement Screening taking action to reveal private information about someone else Signaling taking action to reveal one s own private information A good reputation can be viewed as a special form of signaling Statistical Discrimination distinguishing between choices by generalizing based on observable Government can help to solve information asymmetry problem by providing the missing info to the less informed party or by requiring the more informed party to reveal the information characteristics in order to fill in missing information Chapter 11 Time and Uncertainty People prefer immediate benefits and delayed costs Money is worth more to us now than in the future Interest Rates the price of borrowing money for a specified period of time expressed as a percentage per dollar borrowed and per unit of time Value of a loan with interest X x 1 r Compounding the process of accumulation that results from the additional interest paid on
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