1- Choice under uncertainty Flashcards
What does weak preference (≽) mean?
At least as good as
What are axioms?
Self-evident statements which cannot be proven
What is the axiom of transitivity?
If x≽y and y≽z then x≽z
What is the axiom of completeness?
Either x≽y or y≽x or both
When are weak preference relations defined as rational?
The weak preference relation is rational if it satisfies the Axioms of Transitivity and Completeness
What is the indifference preference relation?
x~y if and only if x≽y and y≽x
What are the 3 properties of the indifference preference relation?
- Reflexivity: x~x
- Symmetry: if x~y then y~x
- Transitivity: if x~y and y~z then x~z
What is the strict preference relation definition?
x≻y if and only if x≽y and not y≽x
What are the 3 properties of the strict preference relation?
- Irreflexivity: Not x≻x
- Anti-symmetry: if x≻y then not y≻x
- Transitivity: if x≻y and y≻z then x≻z
What are the 2 requirements of a rational choice?
- rational preference ordering
- choose the most preferred option under the set of alternatives
What is the representation theorem?
For finite domains, there exists a utility function u(·) that represents the weak preference relation ≽ if and only if ≽ is rational
What are explicit costs?
What you have to pay in dollars to get something
What are opportunity (implicit) costs?
The value of the next best option foregone
What is net (utility) surplus?
Utility of your choice minus opportunity cost
What is the opportunity cost proposition?
An alternative is a rational choice if and only if its utility is greater than its opportunity cost
What are sunk costs?
Costs that cannot be recovered once the decision is made
What is the sunk cost fallacy?
Failure to ignore sunk costs
What is the Independence of Irrelevant alternatives?
If x is chosen from menu {x,y} then y cannot be chosen from menu {x,y,z}
What is the decoy effect and how does it change preferences?
If you introduce a similar good which is absolutely dominated by your own good then you can shift the indifference curve slope in favour of your good
What is the compromise effect?
Consumers often prefer the middle option due to extremeness aversion so firms may offer extremely expensive or cheap products to manipulate clients
How are menu dependencies explained?
If you make a decision you have to justify your purchase so although you may be spending a lot, the belief it is a bargain justifies it
What is the willingness to accept (WTA)?
The minimum price to give up an object if in possession
What is the willingness to pay (WTP)?
The maximum price in order to obtain the object
What should the relationship between WTA & WTP be under rational preferences?
WTA=WTP i.e. endowment should not affect choice
What is the endowment effect?
Subjects often require more to give up an object than they would be willing to pay to get one: WTA > WTP
What is loss aversion?
The phenomenon that people dislike losses more than gains
What is the Anchor and adjustment heuristic?
Adjustments are frequently insufficient such that final judgements reflect the (possibly) arbitrary anchor
How do you construct a budget line? i.e. what is its equation
p1q1 + p2q2 = w
How do you find the Marginal rate of substitution?
Differentiate the budget line for it’s gradient
How do you calculate the value of gains and losses with a reference point value function?
Insert reference point and amount in gain scenario, and subtract for ELSE scenario, vice versa for loss
