Econ 101: Chapter 9
What is capital?
The total value of assets owned by an individual or firm-physical assests plus financial assets
What does it mean to have unrealistic expectations of the future?
Being overly optimistic about your future behavior Strategies that keep a person on the straight-and-narrow over time are often their root, ways to deal with the problem of unrealistic expectations about ones future behavior
What is an implicit cost?
It does not require an outlay of money; it is measures by the value, in dollar terms, of benefits that are foregone Ex: The implicit cost of the year spent in school includes the income you would have earned if you had taken the job instead
What are the three reasons why a person may prefer a worse economic payoff?
Concerness about fiarness Bounded Rationality Risk Aversion
What does it mean to count dollars unequally?
Ex: when you tend to spend more with a credit card then when you do with cash you engage in mental accounting
What are the two parts of opportunity cost?
Explicit cost Implicit cost Opportunity cost = Explicit Cost + Implicit Cost
What are concerns about fairness?
In social situations, people often care about fairness as well as their economic payoff to themselves Ex: Tipping a waitress isn't a law, but people do it because they have a concern for fairness
With small quantities, what is the rule for choosing the optimal quantity?
Increase the quantity as long as the marginal benefit from one more unit is greater than the marginal cost, but stop before the marginal benefit becomes less than the marginal cost
What is a sunk cost?
It is a cost that has already been incurred and is nonrecoverable. A sunk cost should be ignored in decisions about future actions because they have no influence on their actual costs and benefits
What is accounting profit?
It is equal to revenue minus explicit cost
What is Economic profit?
It is equal to revenue minus the opportunity cost of resources used. It is usually less than accounting profit In general it is less than accounting profit because there are almost always implicit costs in addition to explicit costs Economic profit should be used to get the best possible economic outcome
What is decreasing marginal cost due to?
It is often due to learning effects in production Ex: assembly line, when starting out workers make a lot of mistakes, but as they get better and have worked on the assembly line and gained more experience, they start to make less mistakes and this generates a lower marginal cost
What is Loss Aversion
It is over sensitivity to loss, leading to unwillingness to recognize a loss and move on It helps to explain why sunk costs are so hard to ignore: ignoring a sunk cost means recognizing that the money you spend is unrecoverable and therefore lost
What is the marginal benefit?
It is the additional benefit derived from producing one more unit of a good or service
What is mental accounting?
It is the habit of mentally assigning dollars to different accounts so that some dollars are worth more than others Ex: splurging after receiving an inheritance overspending at sales
What is the implicit cost of capital?
It is the opportunity cost of the use of ones own capital-the income earned if the capital had been employed in its next best alternative use
What is the optimal quantity?
It is the quantity that generates the highest possible total profit it is the quantity at which the marginal benefit is greater than or equal to marginal cost It is the quantity at which the marginal benefit and marginal cost curves intersect
What is status quo bias?
It is the tendency to avoid making a decision and sticking with the status quo People usually exhibit status quo bias when given many options, people find it harder to make a decision
What is Risk aversion?
It is the willingness to sacrifice some economic payoff in order to avoid a potential loss People will give up some potential gain in order to avoid it
What does a downward sloping marginal cost curve mean?
It means that the marginal cost is decreasing
What does an upward sloping marginal cost curve mean?
It means that the marginal cost is increasing
What is a marginal benefit curve?
It shows how the benefit from producing one more unit depends on the quantity that has already been produced
What is the marginal cost curve?
It shows how the cost of producing one more unit depends on the quantity that has already been produced The marginal cost curve is upward sloping
What is overconfidence?
Its when we tend to think that we know more than we actually do Overconfidence persuades people that they are in better financial shape then they actually are It can lead to bad investment and spending habits
How do you calculate marginal benefit?
Marginal benefit = (change in total benefit) / (change in total output)
How do you calculate marginal cost?
Marginal cost = (change in total cost) / (change in total output)
What are the six mistakes that make people irrational?
Misperceiving opportunity costs Being overconfident Having unrealistic expectations about future behavior Counting dollars unequally Being loss-averse Having a bias toward the status quo
Is it true that when marginal cost is falling, total cost is falling and vice versa?
No we cannot say that, but what we can say is that total cost increases whenever marginal cost is positive, regardless of whether marginal cost is increasing or decreasing
What does it mean to have misperceptions of opportunity costs?
People tend to ignore non monetary opportunity costs-opportunity costs that don't involve an outlay of cash People also have a hard time of what excatly constitutes an opportunity cost
What is marginal cost?
The cost of producing a good or service is the additional cost incurred by producing one more unit of that good or service
What is an explicit cost?
The cost that requires the outlay of money Ex: the cost of an additional year of school is the tuition
What does it mean to be irrational?
The decision maker chooses an option that leaves him or her worse off than choosing another available option
With large quantities, what is the rule for choosing the optimal quantity?
The optimal quantity is the quantity at which the marginal benefit is equal to the marginal cost
What do economists refer to when they say profit?
They are referring to economic profit
What is the best way to make an either-or decision?
Use the priniple of "either-or" decision making
What does it mean to be rational?
When a decision maker chooses the available option that leads to the outcome he or she most prefers However the outcome that you most prefer may not be the one that gives you the best economic payoff
What is a decreasing marginal cost?
When each additional unit costs less to produce that the previous one The marginal cost line is downward sloping
What is increasing marginal cost?
When each additional unit costs more to prooduce than the previous one
What is constant marginal cost?
When each additional unit costs the same amount to produce as the previous one Ex: plant nurseries, cost of growing one plant is the same as growing another plant regardless of how many have already been grown
What is a decreasing marginal benefit?
When each additional unit of an activity yields less benefit than the previous unit
What is the profit-maximizing principle of marginal analysis?
When faced with a profit-maximizing "how much" decision, the optimal quantity is the largest quantity at which the marginal benefit is greater than or equal to the marginal cost
What is the principle of "either-or" decision making?
When faced with an "either-or" choice between 2 activities, choose one with the most positive economic profit
When is the total benefit and total cost at a maximum?
When the marginal benefit and the marginal cost are equal
What is bounded rationality?
When you make a choice that is close to but not exactly the one that leads to the best possible economic outcome This can happen because the effort of finding the best payoff is too costly Ex: Shoppers when they $2.99 vs. $3.00, bounded rationality leads them to give more weight the the $2 part of the price, rather than the $.99 part