Micro Econ Chapter 9

("either-or")

A choice between two alternatives choose the one with the positive economic profit

("how much?")

A more complex choice that requires us to choose at the margin

Decreasing marginal cost

Each additional unit costs less to produce than the previous one.

Increasing marginal cost:

Each additional unit costs more to produce than the previous one

Constant marginal cost:

Each additional unit costs the same to produce as the previous one.

Misperceptions of opportunity costs

If we don't understand all of the costs, we cannot make a rational choice.

Overconfidence

Nonprofessional investors who engage in speculative investing have significantly worse results than professional brokers because of their misguided faith in their ability to spot a winner

Concerns about fairness:

Providing for others sometimes trumps self-interest.

Marginal benefit:

The additional benefit derived from producing one more unit of that good or service.

Sunk cost:

a cost that has already been incurred and is not recoverable.

rational

decision maker always chooses the available option that leads to the outcome he or she most prefers.

irrational

decision maker chooses an option that leaves him or her worse off than choosing another available option.

implicit cost

does not require an outlay of money; it is measured by the value, in dollar terms, of benefits that are forgone (e.g., wages forgone because of being a full-time student).

explicit cost

is a cost that requires an outlay of money (cost of books).

optimal quantity

is the largest quantity at which the marginal benefit is greater than or equal to marginal cost

implicit cost of capital

is the opportunity cost of the use of one's own capital

Capital

is the total value of assets owned by an individual or firm—

Economic profit

is usually less than accounting profit. shows a more complete picture of costs. helps businesses and individuals make better-informed decisions. is the measure economists prefer.

All of the following are considered implicit costs except: paying rent on an existing building. interest that could have been earned from the savings account if the money were not used on the existing business. the wages the entrepreneur could have earned if he or she chose to pursue a career in corporate America. forgone entrepreneurial income.

paying rent on an existing building.

Marginal cost

the additional cost incurred by producing one more unit of that good or service.

Counting dollars unequally/Mental accounting

the habit of mentally assigning dollars to different accounts so that some dollars are worth more than others.

Status quo bias

the tendency to avoid making a decision altogether.

Sandy owns a firm with annual revenue of $1 million. Wages, rent, and other costs are $900,000. Suppose that instead of being an entrepreneur, Sandy could get a job with an annual salary of $250,000. Assume that a job would be as satisfying to Sandy as being an entrepreneur. Calculate Sandy's economic profit. $100,000 $50,000 $0 -$150,000

-$150,000

implicit costs formula

= depreciation + other implicit costs

Accounting profit formula

= revenue - explicit cost

Economic profit Formula

= revenue - explicit cost - implicit cost.

Unrealistic expectations about future behavior

Most of us are overly optimistic about our future behavior and level of discipline.

Types of Cost Example: Babysitting fees Preschool expenses Earnings from paid work contributed by an employer to a retirement account Doctor visits, medical expenses Costs of decorating child's room Lost training opportunities at work Unearned Social Security credits Forgone promotions Salary lost by not working Expenses for baby's room Loss of experience at work Depreciation of work skills Food and clothing for the child Loss of pension and 401k benefits Awards and kudos for excellence doing a paid job

Implicit: Unearned Social Security credits Forgone promotions Salary lost by not working Loss of experience at work Depreciation of work skills Loss of pension and 401k benefits Awards and kudos for excellence doing a paid job Earnings from paid work contributed by an employer to a retirement account Lost training opportunities at work Explicit: Expenses for baby's room Food and clothing for the child Babysitting fees Preschool expenses Doctor visits, medical expenses Costs of decorating child's room

Bounded rationality—"good enough":

Making a choice that is close to (but not exactly) the highest possible profit MAY MAKE SENSE because the effort of finding the best payoff is too costly.

six established decision-making mistakes.

Misperceptions of opportunity costs Overconfidence Unrealistic expectations about future behavior Counting dollars unequally/Mental accounting Loss aversion Status quo bias

Economic Profit Example: If you quit your job as a lion tamer ($45,000/year income) to open a tanning studio ($45,000/year left over after costs are paid), what is your economic profit?

We would say it's zero: You are earning just enough to cover your costs, including your forgone lion-taming wages. You are doing just as well in your new job as your last one. If you hadn't considered your implicit costs, your analysis would suffer.

Risk aversion:

Willingness to sacrifice some economic payoff in order to avoid a potential loss IS FAIRLY COMMON.

"Either-or" example: What if, instead of just two options, there are three or more? Does the principle of "either-or" decision making still apply?

Yes. Any choice between three or more options can always be boiled down to a series of choices between two alternatives.

Loss aversion

an oversensitivity to loss that leads to unwillingness to recognize a loss and move on.