Chapter 1: Book Outline Flashcards
Essence of economic way of thinking is to
understand how incentives and institutions affect people’s behavior.
When outcome is undesirable, ask these 3 questions:
- Who made the bad decision?
- Did they have the information they needed?
- Did they have the right incentives?
When it is identified who made decision, we can understand circumstances in which the decision was made and what objectives were.
Methodological Individualism
The doctrine that all social phenomena (Their structure and their change) are in principle explicable only in terms of individuals - their properties, goals and beliefs. (Jon Elster)
There is a _____ between individuals and institutions.
Feedback mechanisms
Institutions
collective action in control, liberation and expansion of individuals actions
Two key behavior assumptions
- The rationality assumption - incentives affect behavior (at the margin)
- The self interest assumption - people pursue their own self interest
Goal of Management
to change behavior you need to change what is in people’s self interest to pursue; Change incentives
Positive Analysis
refers to what is
Normative Analysis
Refers to what ought to be
Economists limit themselves to _____ about society.
making positive claims
When you move from positive to normative, _______
ethical and moral opinions are introduced
Managerial Individualism
Idea that all corporate phenomena emerge from the actions and interactions of individual employees who are making choices in response to expected additional costs and benefits as they perceive them
Incentives are not an objective fact but a
subjective interpretation
To understand public policy the decision maker is the
politician
To understand management, the decision maker is the
manager
To understand consumer theory focus on the
consumer
Consumer sovereignty
Implies that firms should bend over backwards to satisfy the whims of their customers. Means is that ina market economy, it is consumers who decide upon how resources are managed.
Value based compensation
paying for specific results achieved rather than hours worked
when focus is on value
it is output that matters, not inputs.
scarcity
is necessary but not sufficient condition to determine something’s value
Value is
subjective and stems from the alleviation of pressing needs
We satisfy _______.
our most pressing needs first. It is the alleviation of pressing needs that we ‘value’, not the commodities themselves.
Lesson for management is to lead on ____
benefits rather than features. Value of the product derives from the service being provided, not the product itself.
First Law of Demand
States that prices and quantity demanded are inversely related.
Law of Diminishing Marginal Utility
As consumption of goods increases, the satisfaction derived from consuming more of the good will eventually decline.
Utility
our subjectively determined benefits
Satiation
refers to the point at which marginal utility becomes zero and total utility stops increasing
DMU states that
the more you have of something, the less you value additional units.
Rate of DMU will
differ for different goods and we would expect DMU to be more pronounced for perishable or sickly good.
Consumer surplus
Demand curve slopes downward
defined as the difference between what you pay for a good or service and the maximum that you would have been willing to pay
Demand curves show the relationship between
price and quantity
Changes in price affect
quantity demanded
Examples of non-price factors that will cause a demand curve to shift include:
- Income
- The price of related goods
- The number of consumers
- Expectations about future prices
- Changes in preferences
If any of the above changes, original demand curve becomes outdated.
Substitution Effect:
We can switch consumption from other goods
If the price of a good falls it becomes cheaper relative to other goods, therefore we consume more of it.
We substitute or switch from relatively expensive to the relatively cheap.
Income Effect
We can afford more
More income may mean we wish to consume more of a good, but it may mean we wish to consume less.
Law of DMU tells us that
demand curves will always slope downwards.
Elasticity of an economic variable refers to its
responsiveness to changes
Price elasticity refers to the response of
quantity demanded to changes in price and reflects the slope of the demand curve.
How to calculate the price elasticity of demand
Divide the percentage change in quantity demanded by the percentage change in price. This will yield a negative number (due to first law of demand) and reflect the extent of responsiveness.
If elasticity is > 1
Changes in price lead to an even bigger change in quantity demanded; it is elastic
If elasticity is between 0 - 1
the change in price is proportionally bigger than the result in change in quantity demanded; it is inelastic
An elastic demand curve is
very flat; small changes in price lead to large changes in quantity demanded
An inelastic demand curve will be
very steep; even a large change in price has a small effect on quantity demanded
Factors that influence price elasticity
- Substitution
- Share of total budget
- Search costs
If a good is elastic
then demand is highly responsive to changes in price.
Do not raise prices for a
an elastic good
If a good is inelastic
then demand is going to be less responsive.
Raise prices for
inelastic goods because the additional revenue per item offsets the small fall in quantity demanded.
If income elasticity is greater than 1, the good is
superior
if income elasticity is negative, these goods are
inferior
Four behavior postulates
- People have preferences
- More of a good is preferred to less
- People are willing to substitute one good for another
- Marginal value falls as you consume more
