ECON 201, Chapter 7

Does the Endowment Effect Hold Only for New Traders?

Experienced traders are less likely than new traders to be prone to the endowment effect.

Should the Government Provide the Necessities of Life for Free?

If necessities were provided by the government at a price of zero (although not at zero taxes) then, according to marginal utility theory, individuals would consume them until the marginal utility of consuming were zero. But, if some resources were taken from producing these low-utility goods and redirected toward the production of goods with higher marginal utility, total utility would rise. Therefore, the government should not provide the necessities of life for free.

Neuroeconomics

Neuroeconomics is a branch of behavioral economics. In neuroeconomics, the brain is studied with tools such as magnetic resonance imaging (MRI) to see what is happening when people make choices, have certain thoughts, try to solve certain problems, and so on. Using magnetic resonance imaging, the limbic and analytical systems of the brain are studied when people are faced with some choices.

Coffee Mugs and the Endowment Effect

The endowment effect is the outcome that occurs when people place a higher value on something simply because they own it. Economist David Friedman attributes it to an evolutionary instinct that made possible a system of property rights in a world where property rights otherwise would not have existed. Experiments have shown that experience makes one less prone to the endowment effect.

Equating Marginal Utilities per Dollar

The marginal utility gained per dollar of purchase price is used to compare the additional utility gained from one good to the additional utility gained from some other good. The condition for consumer equilibrium is: MUA/PA = MUB/PB = MUC/PC = ... = MUZ/PZ

The Solution to the Diamond-Water Paradox

The solution to the diamond-water paradox comes from the fact that prices, value in exchange, are most often determined by marginal utility, rather than total utility. Goods have both total utility and marginal utility. Water, something necessary for life, has a high degree of total utility. However, since it is in plentiful supply, and we consume it in large quantities, the marginal utility afforded by one more glass is usually fairly low. On the other hand, diamonds, which have no real life-sustaining qualities, have a fairly low total utility. However, since they are available in very limited supply, and we consume them in small quantities, one more diamond would likely have a high marginal utility.

Is $1 Always $1?

Traditionally, economists have argued that any one dollar has the same value to a person as any different dollar, regardless of where it comes from or what it is earmarked for. But experiments have shown that people "compartmentalize" money into different categories, and then treat it differently.

Are People Willing to Reduce Others' Incomes?

Traditionally, economists have argued that no one will spend his own money to make someone worse off, but experiments have shown that 62% of people will indeed do that. One possible explanation for this is that people receive utility from relative wealth such as rank and status as well as absolute wealth.

Framing

Tversky and Kahneman have shown that the way a problem is framed can influence the choices one makes. The way a problem is framed can lead to a reversal of preferences. Even when there is no difference between options, how the options are framed matters to the outcome; framing matters to how people choose.

Maximizing Utility and the Law of Demand

Utility maximization is consistent with the law of demand.

The Millionaire and the Pauper: What the Law Says and Doesn't Say

We must be careful not to fall into the trap of making interpersonal utility comparisons, assuming that we know someone else's preferences on the basis of knowing our own. So, for example, we cannot tell whether an additional dollar of income is worth more to a poor man or a rich man, because we don't know those individuals' preferences with any degree of accuracy.

Behavioral economists

argue that some human behavior does not fit neatly into the traditional economic framework.

A util

is an an artificial construct that is used to measure utility

Marginal utility

is the additional utility gained from consuming an additional unit of a good.

Total utility

is the total satisfaction you receive from consuming a particular quantity of a good

To say that a good gives you utility

is to say that it satisfies some want or desire, or that it gives you satisfaction.

The diamond-water paradox

pointed to the fact that often things that have the greatest value in use have a relatively low price, and vice versa

The law of diminishing marginal utility

states that for a given period of time, the marginal utility gained from consuming equal successive units of a good will decline as the amount consumed increases. Individuals will choose to consume the goods that provide them with the greatest satisfaction first. After that, they will choose goods that provide them with relatively less satisfaction.