ECON130 Ch 9 Decision Making by Individuals and Firms

marginal cost

cost of doing more of an activity; the additional cost of producing a good or service incurred by producing one more unit of that good or service

sunk cost

cost that has already been incurred and is nonrecoverable. A sunk cost should be ignored in decisions about future actions.

marginal benefit curve

shows how the benefit from producing one more unit depends on the quantity that has already been produced

marginal cost curve

shows how the cost of producing one more unit depends on that quantity that has already been produced

implicit cost of capital

the opportunity cost of the use of one's own capital- the income earned if the capital had been employed in its next best alternative use

optimal quantity

the quantity that generates the highest possible total profit

Status quo bias

the tendency to avoid making a decision and sticking with the status quo 1. find it hard to make a decision 2. due to loss aversion and fear of regret

capital

the total value of assets owned by an individual or firm- physical assets plus financial assets.

decreasing marginal cost

when each additional unit costs less to produce than the previous one

increasing marginal cost

when each additional unit costs more to produce than the previous one

constant marginal cost

when each additional unit costs the same to produce as the previous one

decreasing marginal benefit

when each additional unit yields less benefit than the previous unit

principle of "either-or" decision making

when faced with an "either-or" choice between two activities, choose the one with he positive economic profit

Risk Aversion

willingness to sacrifice some economic payoff in order to avoid a potential loss

Overconfidence

1. "finish thesis more time than they think" 2. think are in better financial shape than they actually are-->lead to bad investment and large spending decision without doing research on pros and cons 3. remember their successes and forget their failures

Misperceptions of opportunity costs

1. ignore nonmonetary costs (implicit costs) 2. count sunk costs in decision making

Counting dollars unequally

1. mental accounting- habit of assigning dollars to different accounts so that some dollars are more worth than others 2. credit card overuse (value dollars in wallet more than dollars on credit card balance) 3. overspending at sales 4. buying something that seemed like a bargain at that time but later regretted

Unrealistic expectations about future behavior

1. optimistic about your future behavior (e.g. tomorrow you'll study)

Three principal reasons why people might prefer a worse economic payoff:

Concerns About Fairness Bounded Rationality Risk Aversion

marginal analysis

comparing the benefit of doing more of an activity with the cost of doing more of that activity

Concerns About Fairness

Ex. Leave a tip (gift-giving: if you care about another person's welfare, it's rational for you to lower your own economic payoff in order to give that person a gift)

irrational behavior- six mistakes

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

With large quantities on "how much" decision, the rule for choosing the optimal quantity is:

The optimal quantity is the quantity at which marginal benefit is equal to marginal cost

Total opportunity cost equals:

Total opportunity cost= Total explicit+Total implicit cost

profit-maximizing principle of marginal analysis

When making a profit-maximizing "how much" decision, the optimal quantity is the largest quantity at which the marginal benefit is greater than or equal to marginal cost

behavioral economics

a branch of economics that combines economic modeling with insights from human psychology

explicit cost

a cost that requires an outlay of money For example, the explicit cost of the additional year of schooling includes tuition (constant)

irrational behavior

choosing an option that leaves them worse off than other available options

irrational

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

rational

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

implicit cost

does not require outlay of money; it is measured by the value, in dollar terms, of benefits that are forgone For example, the implicit cost of the year spent in school includes the income you would have earned if you had taken a job instead (changing)

incur

economic loss

economic profit

equal to revenue minus the opportunity cost of resources used. It is usually less than the accounting profit Revenue-Opportunity cost(explicit-implicit cost)

accounting profit

equals revenue minus explicit cost

With small quantities on "how much" decision, the rule for choosing the optimal quantity is:

increase the quantity as long as marginal benefit from one more unit is greater than the marginal cost, cut stop before the marginal benefit becomes less than the marginal cost

Bounded Rationality

makes a choice that is close to but not exactly the one that leads to the best possible economic outcome "good enough" decision

Loss aversion

oversensitivity to loss, leading to unwillingness to recognize a loss and move on

marginal benefit

the additional benefit of a good or service derived from producing one more unit of that good or service

marginal benefit

the benefit of doing more of an activity