ECON Exam (19-23)

The principle of diminishing marginal utility states that people don't enjoy consuming more of a good.

False - The principle of diminishing marginal utility states that the marginal utility that a person gets from each additional unit of a good decreases with each unit consumed after some point.

The prisoner's dilemma is a theoretical tool with little in the way of practical applications.

False - The prisoner's dilemma is useful in many real-world situations.

what does differentiate models are:

1. the building blocks that economists use in their models, and 2. the structure of formal models that economists fin acceptable

vickrey auction

a seat-bid auction where the highest bidder wins but pays the price bid by the next highest bidder. - ex: since you are not paying your bid, but rather the second highest bid, you could bid $500, and if the second highest bidder only bid $220, you would only pay $220.

The formal game theory model assumes that:

each player tries to anticipate the reaction of his or her rivals when making a decision. - The key assumption of game theory is interdependent choices.

we have a better sense of what is meant by opportunity cost of a forgone opportunity:

it is essentially the marginal utility per dollar you forgo from the consumption of the next-best alternative. - to say MUx/Px>MUy/Px is to say that the opportunity cost of not consuming good x is greater than the opportunity cost of not consuming good y. so you consume good x.

The consumption of an additional unit of a good provides additional satisfaction, which is called:

marginal utility.

(Chapt 21) supply and demand is not the glue that holds modern economics together, rather

modeling is the glue

What is the glue that holds modern economics together?

modeling is the glue

(models don' have to be mathematical: economists also use more informal verbal or...) heuristic models

models that are expressed informally in words.

A simultaneous game is one in which:

players make their moves and/or decisions at the same time.

the payoff matrix shows 3 elements of any game:

players, their possible strategies, and the pay offs

If the average utility of good A is 15 and the average utility of good B is 25, you should:

realize that you don't have enough information to answer the question. - Since you don't know the relevant marginal utilities or prices, you do not have enough information to answer the question.

Behavioral economics:

tests the underlying economic assumptions of economic models. - Behavioral economics conducts real-life experiments to see how people would actually behave rather than assuming a certain model of individual preferences.

marginal utility

the satisfaction one gets from consuming one additional unit of a product above and beyond what one has consumed up to that point. - ex: eating a whole pound of Beluga Caviar might give you 4,700 units of utility. Consuming the first 15oz may give you 4,697 units of utility. Consuming the last oz may give you an additional 3 units of utility. The 4,700 is total utility. the 3 is the marginal utility of eating the last ounce of caviar. - marginal utility tends to decrease as consumption of a good increases; marginal utility relates to changes in quantity.

A Nash equilibrium is:

the set of strategies such that no player can improve his or her position by changing his or her own action.

behavioral economics

the study of economic choice that is based on realistic psychological foundations

framing effects

the tendency of people to base their choices on how the choice is presented - people respond differently if the choice was presented in the negative rater than positive frame.

Endowement effect

the tendency of people to value an item that they posses more than they would value that item if they did not posses it. - the ownership increases the value of a good is even confirmed by brain scans that show increased brain activity associated w/ fear of loss when a good is acquired.

total utility

the total satisfaction one gets from consuming a product.

Which of the following games has a first-mover advantage?

tic-tac-toe - Only sequential games might have first-mover advantages. This eliminates the prisoner's dilemma; rock, paper, scissors; and the Vickrey auction.

Total utility refers to the:

total satisfaction one gets from the consumption of a product.

A rational consumer maximizes his or her:

total utility. - Consumers maximize total utility because the ultimate goal is to maximize total satisfaction or pleasure.

modern economists are a highly diverse group of social scientists:

what ties them together is their training in modeling an their shared view that incentives are important, and that their models have to capture the importance of incentives

backward induction

where you begin with a desired outcome, and then determine the decisions that will lead you to that outcome. - with sequential decisions, you continue backward induction until you arrive at the best strategy for your first move. -ex: tic tac to, work backwards from the desired outcome (winning the game) to the initial decision of where to place your x or o.

general utility maximizing rule

you are maximizing utility when the marginal utilities per dollar of the goods consumed are equal.

if MUx/Px=MUy/Py,

you're maximizing utility. -when you're maximizing utility, you're in equilibrium.

behavioral economists question the assumptions on which traditional economists' analysis of choice is based. Assumptions include:

1. decisions are costless 2. tastes are given 3. individuals maximize utility.

Principle of Diminishing marginal utility

As you consume more of a good, after some point, the marginal utility received from each additional unit of a good decreases with each additional unit consumed, other things equal. - it simply states that, as you consume more of the good, you enjoy the additional units less than you did the previous units.

The payoff matrix shows the outcome for only one player in a game situation.

False - A payoff matrix shows the outcome for each player in the game.

Game theory tells how to win at games of chance.

False - Game theory is about using reasoning when decisions are interdependent.

Joan is deciding where to spend her spring break. If she goes to Cancún, Mexico, the trip will give her 9,000 units of utility and will cost her $300. If she travels to Florida instead, the trip will give her 8,000 units of utility and will cost her only $200. Joan will do best going to:

Florida because her pleasure per dollar will be greater. - Individuals choose the good that has the highest marginal utility per dollar.

According to the principle of rational choice, a consumer should spend money on those goods which provide the most marginal utility per dollar.

True

Strategic reasoning applies to situations in which decisions are interdependent.

True

If marginal utility is declining but still positive, total utility is increasing.

True - Total utility is the sum of all marginal utilities up to that point. Since marginal utility is positive, total utility must be rising.

A strategy that is preferred by an individual regardless of an opponent's decision is called:

a dominant strategy.

non cooperative game

a game in which each player is out for him or herself and agreements are either not possible or not enforceable

cooperative game

a game in which players can form conditions and can enforce the will of the coalition on its members.- the possibility for cooperation is often greater when a game will be repeated.- the outcome of a repeated game can often be different from the outcome of a game played just once.

screening question

a question structured in such a way as to reveal strategic information about the person who answers. - devising such strategies and understanding the strategic interaction of individuals when they take into account the expected reaction of others are the essence of game theory.

Nash equilibrium

a set of strategies for each player in the game in which no player can improve his or her pay off by changing strategy unilaterally. - it's the predicted outcome of a non cooperative game if each player follows his best strategy and assumes that the other player are following their best strategies. this is a solution to the prisoner's dilemma.

model

a simplifies representation of the problem or question that captures the essential issues- and then work with that model and empirical evidence to understand the problem - the modeling approach is the modern economics approach.

mixed strategy

a strategy of choosing randomly among moves. - it makes sense to vary your choices randomly so that your opponent has no pattern on which to base his strategy.

dominant strategy

a strategy that is preferred by a player regardless of the opponents move.

Payoff matrix

a table that shows the outcome of every choice by every player, given the possible choices of all other players

Prisoner's Dilemma

a well-known two person game that demonstrates the difficulty of cooperative behavior in certain circumstances.

According to the law of diminishing marginal utility:

after some point, the rate of change in total utility declines. - According to the law of diminishing marginal utility, after some point marginal utility declines. This means that total utility rises at ever-slower rates. Total utility falls if marginal utility is negative.

inductive approach

an approach to understanding a problem or question in which understanding is developed empirically from statistically analyzing what is observed in the data - models based on inductive approach are developed by how well they fir the data.

status quo bias

an individuals actions are very much influenced by the current situation, even when that reasonably does not seem to be very important to the decisions.

Modern economists

are economists who are willing to use a wider range of models than did earlier economists - a major change is that modern economists use a much more inductive approach to modeling

building blocks

are the assumptions of a model. the structure of a model is the form it takes- verbal, graphical, or algebraic. - ex: you can assume that individuals are selfish, or that individuals care about other people; the models would be different in each instance. By structure, i mean the form of the model- for example, a model an be verbal, graphical (ex: supply/demand model), algebraic with simple equations (ex: q=4-2p), or algebraic with highly complex equations.

The principle of diminishing marginal utility states that:

as you consume more of a good, you enjoy the additional units less than you did the previous units.

If people generally believe that "you get what you pay for," it is reasonable for them to:

assume that an expensive item is of higher quality, creating the possibility of an upward-sloping demand curve. - This is one of the rules of thumb suggested by bounded rationality. Reliance on price for information can lead to upward-sloping demand curves since consumers may be more willing to purchase an item at higher prices.

Joseph Gallo poured two glasses of wine from the same bottle but put a more expensive price tag on one glass than on the other. He let people test both and asked them which they wanted, and most wanted the more expensive glass, not knowing that both had come from the same bottle. This result indicates that firms should:

be careful about lowering the price of their product, because consumers may assume that a lower price means lower quality. - If consumers follow the rule of thumb "you get what you pay for," they may react to a lower price by purchasing less of a good. This does not imply that firms should never lower price or always raise price but rather that they should be careful when considering a price cut because the result could be unexpected.

informal game theory is often called

behavioral game theory because it relies on empirical observation, not deductive logic alone, to determine the likely choices of individuals - it's empirically based.

if MUx/Px > MUy/Py,

choose to consume an additional unit of good x.

if MUx/Px < MUy/Py,

choose to consume an additional unit of good y.

cheep talk

communication that occurs before the game is played that carries no cost and is backed up only by trust, and not any enforceable agreement. - if standard theory assumptions hold, then cheap talk doesn't influence the results, but economists have found that cheap talk may work. In many experiments, cheap talk does influence the outcome of a game, especially in ones where players have significant difficulty figuring out there optimal strategy. - shows that, to some degree, people do have interdependent utility functions where each person cares about others as well as him or herself.

Given a set amount of money, goods A and B both give the same marginal utility but good A costs twice as much as good B. You should:

consume more of good B and less of good A. - Because both goods give the same marginal utility but good A costs twice as much, one should consume more of good B and less of good A. This will reduce the marginal utility of good B and increase the marginal utility of good A. We should alter consumption in this direction until the ratio of marginal utility to prices of the goods is equal.

early economists were much more likely to use a

deductive approach

In standard game theory, cheap talk:

doesn't affect the outcome of the game. - Cheap talk, because it is not enforceable, will not change the outcome of the game in standard game theory because the players have no trust in one another.

The principle of diminishing marginal utility states that marginal utility:

falls after some point. - The principle of diminishing marginal utility says that as you consume more of a good, after some point, you enjoy the additional units less than you did the previous units.

(chapt 20) Game Theory

formal economic reasoning applied to situations in which decisions are interdependent - game theory is the underlying model of of the social sciences - game theory developed to help us understand real-world problems and issues; it offers a new set of models which to approach economical issues. - Game theory models are more flexible than the standard economic models.

formal game theory predicts that any tic - tac - toe game will end in a tie because

formal game theory assumes all players (1) are fully forward looking, (2) always behave in a way that gives them the highest pay off and (3) expect all other players to behave in that same manner. players are "rational" - but formal fame theory only provides a prediction about the outcome of a game.

A different game theory must be developed for each different situation and for each different set of assumptions. (there are many models that often have multiple equilibrium solutions)- so hence, game theory is a

framework

Formal economic reasoning applied to situations in which decisions are interdependent is called:

game theory.

A Nash equilibrium assumes that a player follows his or her best strategy:

given that the other players follow their best strategy. - A Nash equilibrium refers to the set of strategies by all the players, not just one player's individual strategy.

"follow the leader" leads to focal point equilibrium

in which a set of goods is consumed, not because the goods are objectively performed to all other goods, but simply because, through luck, or advertising, they have become focal points to which people have gravitated. Once some people started consuming a good, others followed.

Game theory is designed to study situations in which each agent's decisions are:

interdependent. - Game theory is best applied to strategic thinking. This is when decisions are interdependent

Game theory:

is more flexible than the standard supply/demand model. - Game theory examines the assumptions behind the standard supply/demand model and is therefore more flexible.

The principle of rational choice says that you should

keep adjusting your spending within your budget if the marginal utility per dollar (MU/P) of two good differs. The only time you don' adjust is when there is no clear winner.

Marginal utility per cost=

marginal utility/ cost of utility - choose the activity that has the higher marginal utility per unit of cost or lower cost per unit of utility.

The prisoner's dilemma is a well-known game in which:

noncooperation is not the best joint action but is the best independent action. - In the prisoner's dilemma game, cooperation is beneficial for both prisoners but difficult to achieve. There are gains to both cooperative action and independent action. Individuals don't always act in their best joint interest.

the cost of decision making means that is is

only rational to be somewhat irrational- to do things without applying the principle of rational choice.

Joseph Gallo poured two glasses of wine from the same bottle but put a more expensive price tag on one glass than on the other. He let people test both and asked which they wanted; most wanted the more expensive glass, not knowing that both had come from the same bottle. This kind of experiment tells us that:

people probably want to drink wine for the sense of indulgence it gives them rather than for the taste. - This can be considered a case of conspicuous consumption and also indicates that people probably follow the rule of thumb "you get what you pay for."

models can be

physical or they can be virtual models embodied in computer simulations. - ex: computer stimulation models also can be interactive, where individuals become part of the model. For ex: the online virtual world, Second Life, can be thought of as a model of society, and its economy can provide insight for the real-world economy.

sequential games

players make decisions one after another, so one player responds to the known decisions of other players - ex: tic-tac-toe. the order makes a big difference - some games have a first-move advantage, like tic tac toe, and some have second mover advantage.

An assumption of economists' standard theory of choice is that:

preferences are given and are not shaped by society. - Many economists believe that people use "bounded rationality," which means basing decisions on rules of thumb. The model of rational choice assumes that it is costless to make decisions, but in the real world where people face hundreds of choices, they make many decisions with their minds on automatic pilot.

a number of economists have come to believe that, to make real-world decisions, most people use bounded rationality

rationality based on rule of thumb-rather than using the principle of rational choice. - one rule of thumb ex: "you get what you pay for.", meaning that something with a high price is better than something with a low price. we rely on price to convey information about quality, this can lead to upward sloping demand curves. *(advertising is designed to mine rule of thumbs) - another ex: "follow the leader." If you don't know what to do, do what you think smart people are doing.

to apply game theory to real-world problems, game theory must be accompanied by a combination of

reasoning, intuition, and empirical study about how people actually behave.

If two choices are the same but one is presented in a positive manner and one in a negative context, people:

respond differently because of the framing effect. - The framing effect indicates that people respond differently to the same set of choices depending on how the questions are presented.

The underlying psychological foundation of individual choice and economic reasoning is:

self-interest. - Economists' view of rational choice is based on their assumption that people do what they do because it is in their self-interest.

a change in taste makes the demand curve

shift.

Principle of Rational Choice

spend your money on those goods that give you the most marginal utility per dollar.

Taking explicit account of a rival's expected response to a decision you are making is called:

strategic decision making.

The theory of rational choice assumes that:

tastes are given.

the term, "rational", in economics means

that people prefer more to less and will make choices that give them as much satisfaction as possible. - the problem is, people face a budget constraint.

conspicuous consumption

the consumptions of goods not for ones direct pleasure, but simply to show off to others.

ultimatum game

the first person only gets the money if the other person accepts the offer. If the second person does not accept, they both get nothing.

The values in a payoff matrix show:

the gains and losses of decisions for each player given the decisions of other players.

In a standard sealed-bid auction, the person who bids:

the highest gets the object of the bid.

(chapt 19) Utility

the pleasure or satisfaction people get from doing or consuming something- and the price of doing or consuming that something.

(ultimatum game) what is the prediction from the standard economic model? And what is that really happens?

the prediction from the standard economic model is that the first person will keep most of the $10 and the second person will accept whatever amount is offered. But when people play this game, this isn't what happens. Instead, the first person offers something close to 50-50, which is almost always accepted. However, in instances where the first person offers only a small amount, the offer is generally rejected. People have a sense of fairness in their decisions.

substitution effect

the reduction in quantity demanded because relative price has risen. it tells us that when the relative price of a good goes up, the quantity of that good decreases, even if you're given more money to compensate you for the rise. -The change in the quantity demanded as the good that has become relatively cheaper is substituted for the good that has become relatively more expensive.

Income effect

the reduction in quantity demanded because the increase in price makes us poorer.

A screening question is structured:

to reveal strategic information about the person who answers.

Economists have been interested in the following interaction: A person is allowed to split a sum of money between himself and another person. The other person can then accept the split or reject it, in which case neither person gets anything. Economists call this interaction the:

ultimatum game. - Behavioral economists sometimes use an ultimatum game to investigate problems of utility maximization and perceptions of fairness.

according to the principle of rational choice, if there is diminishing marginal utility and the price of a good goes up,

we consume less of that good. Hence, the principle choice leads to laws of demand. - to satisfy our utility maximizing rule so that our choice will be rational, we must somehow raise the marginal utility we get from the good whose price has fallen. following the principle of diminishing marginal utility, we can increase marginal utility only by decreasing our consumption of the good whose price has risen. -when the price of a good goes up, consumption of that good will go down.

Utility maximizing rule

when the ratios of the marginal utility to price of the two goods are equal. -juggling your choices, adding a bit more of one and choosing a bit less of another.

simultaneous move games

where players make their decisions at the same time as other players w/o knowing what choices the other players have made. ex: prisoner's dilemma and rock paper scissors. - many simultaneous games don't have a single dominant strategy.

according to the principle of rational choice, if there is diminishing marginal utility and the price of supplying a good goes up,

you supply more of that good. ex: how much labor you should supply. - the benefit of utility you get from supplying work. ex: say that an exam is coming up and you haven't studied. This will likely raise the marginal utility of studying sufficiently, so you will choose to work less, if you have a choice. What will that change do to your supply curve of labor? - it will shift it in to the left.