Economy Ch 3 Extended

Net benefit

the benefit of the choice (measured in dollars) minus the cost of the choice). Negative = car costs more than it's worth to you. Positive = better off buying rather than not buying it

Benefits

make life better now or in the future.

Common mistakes to rational decision making

1. Being swayed by the way a decision is framed 2. Letting sunk costs matter 3. Letting impatience lead to unfortunate decisions 4. Letting overconfidence lead to bad decisions 5. Sticking to the status quo when better alternatives exist 6. Focusing too much on fairness rather than happiness

self-interested

a person is this when they make decisions for his or her own benefit.

Marginal cost

the additional cost of doing something one more time

Common decision making mistake: Letting sunk costs matter

A _________ is a cost that is irrelevant to new decisions because it has already been paid Recognize that __________s are unrecoverable. They should not be counted among the costs of new options

How do budgets necessitate tradeoffs?

A budget is a certain amount of money available to spend. You can't go over it and it is limited therefore, you need to choose what to buy and what you won't

What does it mean to make a rational decision?

A rational decision will benefit the decision maker as much as possible (the benefits outweigh the costs).

How can the benefits of the same activity be different for different people?

Different people like and dislike different things therefore what might be considered to have a greater benefit than cost by one person might have a greater cost than benefit to another due to different likes and dislikes.

Mistake: Letting sunk costs matter

Desc: A _____________ is a cost that is irrelevant to new decisions because it has already been paid Recognize that ___________s are unrecoverable. They should not be counted among the costs of new options

Mistake: Letting impatience lead to unfortunate decisions

Desc: _________ can cause people to discount future benefits and costs too heavily and focus too much on immediate benefits and costs Pay appropriate attention to benefits and costs that will come in the future, even though they may seem a long way off

Mistake: Letting Overconfidence lead to bad decisions

Desc: _________ leads people to believe they know more about what will happen in the future than is possible given the information available. This leads to excessive risk taking Be realistic about the ability to predict future events and consider all the possible consequences of a choice.

Mistake: Sticking to the Status Quo Bias

Desc: _______________ is a tendency to avoid making changes even when a change is likely to be beneficial Actively consider options for change by considering their benefits and costs, and don't be afraid to try new things that seem likely to provide a net benefit

Mistake: Being swayed by the way a decision is framed

Desc: _________ing is the way a product or deal is presented. It can make options seem better than they really are Consider the costs and benefits of the decision, which most often have nothing to do with how they are _______ed

Why is marginal analysis useful?

It allows you to compare cost and benefit and determine which is greater for each step. This helps us make better decisions about what to do next.

Read the "Economics in Action" section on page 82. Why is it important to understand that the true cost of any decision is the opportunity cost?

It's important because true cost encompasses more than just money directly. Part of the opportunity cost is time that you could spend doing something else so the true cost is what you gave up which includes what you could have had. By going to college you may lose time but you would also lose the money that you could have made if you went straight into work.

Why might it be beneficial to study behavioral economics?

Learning about it can help you understand and avoid some of the most common mistakes people make

Common decision making mistake: Focusing too much on fairness rather than happiness

People sometimes punish others for unfair behavior, even if it makes the punisher worse off. Recognize that sometimes life is not fair. It's often in your interest to ignore fairness and base your decision on an evaluation of benefits and costs.

Mistake: Focusing too much on Fairness rather than happiness

People sometimes punish others for unfair behavior, even if it makes the punisher worse off. Recognize that sometimes life is not fair. It's often in your interest to ignore fairness and base your decision on an evaluation of benefits and costs.

How does the assumption that all people are self-interested relate to rational decision making?

People who are self interested do things for their own benefit (although yours interests may include seeing others succeed) while rational decision making means that you choose to do something if the benefits outweigh the costs. Generally rational decision makers are self interested and so you can generalize that a rational decision generally benefits the decision maker in some way.

What are sunk costs and how do they relate to decision-making?

Sunk costs are costs that have already been paid and can't be gotten back. They relate to decision making because they are a cost that should NOT be considered when making decisions since no matter what you do you have already lost them.

Describe the two types of decisions.

The first type: What to do. It's a choice between different options The second type: how much of something to do.

How should each type of decision be made?

What to buy: should be decided rationally using net benefit (measuring something by taking the benefit of the choice (in dollars) minus its cost) to provide a dollar measure of what is gained by that choice. You pick the one that has the most positive net benefit. How much to buy: should be decided with marginal benefit and cost. Take the next step if the marginal benefit is less than the marginal cost. If the marginal cost is greater then don't do it. If the same doesn't matter, pick whichever.

What would be the opportunity cost of any decision if you had unlimited amounts of time and money to spend?

Your Opportunity cost would be zero since you wouldn't have to give up anything

Common decision making mistake: Being swayed by the way a decision is framed

________ is the way a product or deal is presented. It can make options seem better than they really are. Consider the costs and benefits of the decision, which most often have nothing to do with how they are framed

Common decision making mistake: Sticking to the status quo when better alternatives exist.

__________ bias is a tendency to avoid making changes even when a change is likely to be beneficial Actively consider options for change by considering their benefits and costs, and don't be afraid to try new things that seem likely to provide a net benefit

Common decision making mistake: Letting overconfidence lead to bad decisions

__________ leads people to believe they know more about what will happen in the future than is possible given the information available. This leads to excessive risk taking Be realistic about the ability to predict future events and consider all the possible consequences of a choice.

Common decision making mistake: Letting impatience lead to unfortunate decisions

____________ can cause people to discount future benefits and costs too heavily and focus too much on immediate benefits and costs Pay appropriate attention to benefits and costs that will come in the future, even though they may seem a long way off

rational decision

benefits the decision maker as much as possible

Sunk Cost

costs that have been paid and cannot be recovered. NOT part of the opportunity cost since it has already been used.

Marginal Analysis

decide how much or many by comparing marginal cost and benefit at each step

Marginal benefit

the additional benefit of doing something one more time

Marginal

when we're looking a bit beyond where we are now (taking one more step)

Budget

when you have a certain amount of money available to spend