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Market analysis- 220 > chapter 7 book: Uncertainty and Consumer Behavior > Flashcards

chapter 7 book: Uncertainty and Consumer Behavior Flashcards

1
Q

Probability

A

likelihood that a given outcome will occur

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2
Q

probabilities for all possible events must add up to what?

A

probabilities for all possible events must add up to 1

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3
Q

Subjective probability

A

the perception that an outcome will occur

may be based on a person’s judgment or experience, but not necessarily on the frequency with which a particular outcome has actually occurred in the past

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4
Q

objective interpretation of probability relies on?

A

relies on the frequency with which certain events tend to occur

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5
Q

what can cause subjective probabilities to vary among individuals?

A

Either different information or different abilities to process the same information

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6
Q

two important measures that help us describe and compare risky choices

A

expected value (mean)

variability of the possible outcomes

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7
Q

expected value (mean) associated with an uncertain situation

A

a weighted average of the payoffs or values associated with all possible outcomes

The probabilities of each outcome are used as weights

measures the central tendency

basically, just the mean

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8
Q

central tendency

A

the payoff or value that we would expect on average

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9
Q

payoff

A

Value associated with a possible outcome

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10
Q

variability of the possible outcomes

A

extent to which the possible outcomes of an uncertain situation differ

the thing with standard deviation and everything of the sort

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11
Q

how do we measure variability?

A

by recognizing that large differences between actual and expected payoffs (whether positive or negative) imply greater risk

these differences are called deviations

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12
Q

deviation

A

difference between expected payoff and actual payoff

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13
Q

why do deviation by themselves not provide a measure of variability?

A

Because they are sometimes positive and sometimes negative

average of the probability-weighted deviations is always 0

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14
Q

how do we solve the problem that deviations can be negative as well?

A

we square each deviation, yielding numbers that are always positive

We then measure variability by calculating the standard deviation

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15
Q

standard deviation

A

square root of the weighted average of the squares of the deviations of the payoffs associated with each outcome from their expected values

a measure of the amount of variation or dispersion of a set of values

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16
Q

what does a high standard deviation indicate?

A

a high standard deviation indicates that the values are spread out over a wider range

it means there is more risk

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17
Q

what does a low standard deviation indicate?

A

A low standard deviation indicates that the values tend to be close to the mean (also called the expected value)

it means there is lower risk

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18
Q

expected utility E(u)

A

Sum of the utilities associated with all possible outcomes, weighted by the probability that each outcome will occur

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19
Q

An individual who is risk averse

A

prefers a certain given income to a risky income with the same expected value

Such a per- son has a diminishing marginal utility of income

the most common attitude toward risk

losses are more important (in terms of the change in utility) than gains

risk-averse people prefer a smaller variability of outcomes

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20
Q

A person who is risk neutral

A

is indifferent between a certain income and an uncertain income with the same expected value

the marginal utility of income is constant for a risk-neutral person

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21
Q

an individual who is risk loving

A

prefers an uncertain income to a certain one, even if the expected value of the uncertain income is less than that of the certain income

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22
Q

the most common attitude toward risk

A

risk averse

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23
Q

the risk premium

A

the maximum amount of money that a risk-averse person will pay to avoid taking a risk

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24
Q

what does the magnitude of the risk premium depend on?

A

on the risky alternatives that the person faces

The greater the variability of income, the more the person would be willing to pay to avoid the risky situation (for risk averse individuals)

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25
Q

The extent of an individual’s risk aversion depends on what?

A

depends on the nature of the risk and on the person’s income

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26
Q

why are indifference curve in this chapter upward sloping?

A

because risk is undesirable

the greater the amount of risk, the greater the expected income needed to make the individual equally well off

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27
Q

for an individual who is highly risk averse, an increase in the standard deviation of income requires what?

A

a large increase in expected income

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28
Q

for an individual who is slightly risk averse, a large increase in the standard deviation of income requires what?

A

only a small increase in expected income

29
Q

three ways by which both consumers and businesses commonly reduce risks

A

diversification

insurance

obtaining more information about choices and payoffs

30
Q

diversification

A

allocating your resources to a variety of activities whose outcomes are not closely related

Risk can be minimized by diversification

31
Q

negatively correlated variables

A

tend to move in opposite directions

ex: whenever sales of one are strong, sales of the other are weak

32
Q

true or false

As long as you can allocate your resources toward a variety of activities whose outcomes are not closely related, you can eliminate some risk

A

true

33
Q

is diversification important for people who invest in the stock market?

A

ye bruv, very important

34
Q

mutual funds

A

organizations that pool funds of individual investors to buy a large num- ber of different stocks

this if whack af

only like 2% return each year

35
Q

stock prices are mostly positively or negatively correlated variables? why?

A

stock prices are to some extent positively correlated variables

They tend to move in the same direction in response to changes in economic conditions

36
Q

why would risk averse individuals enjoy insurance?

A

because it guarantees them the same utility (or income) no matter what happens

37
Q

law of large numbers

A

tells us that although single events may be random and largely unpredictable, the average outcome of many similar events can be predicted

38
Q

why does the law of large numbers apply to insurance companies?

A

because they know that when they sell a large number of poli- cies, they face relatively little risk

39
Q

actuarially fair insurance

A

When the insurance premium is equal to the expected payout

40
Q

why do insurance companies typi- cally charge premiums above expected losses?

A

because they must cover administrative costs and make some profit

41
Q

The value of complete information

A

the difference between the expected value of a choice when there is complete information and the expected value when information is incomplete

42
Q

asset

A

something that provides a flow of money or services to its owner

43
Q

capital gain

A

An increase in the value of an asset

44
Q

capital loss

A

A decrease in the value of an asset

45
Q

realized capital gain or loss

A

whenever you sell the asset and incurred gain or loss

46
Q

risky asset

A

provides a monetary flow that is at least in part random

the monetary flow is not known with certainty in advance

47
Q

riskless (or risk-free) asset

A

pays a monetary flow that is known with certainty

ex: Short-term U.S. government bonds—called Treasury bills

48
Q

The return on an asset

A

the total monetary flow it yields (including capital gains or losses) as a fraction of its price

49
Q

The real return on an asset

A

its simple (or nominal) return less the rate of inflation

50
Q

The expected return on an asset

A

the expected value of its return

the return that it should earn on average

51
Q

an asset’s actual return

A

In some years, may be much higher than its expected return and in some years much lower

Over a long period, however, the average return should be close to the expected return

52
Q

true or false

usually, the higher the expected return on an investment, the greater the risk involved

A

true bruv

53
Q

the budget line of an investor

equation and meaning?

A

Rp = Rf + ((Rm - Rf) / standard deviation m) * standard deviation p

it describes the trade-off between risk (standard deviation p) and expected return (Rp)

The equation says that the expected return on the portfolio Rp increases as the standard deviation of that return (tandard deviation p) increases

(Rm - Rf) / standard deviation m = slope of budget line = the price of risk

54
Q

the price of risk

A

Extra risk that an investor must incur to enjoy a higher expected return

the slope of the budget line

55
Q

buying stocks on a margin

A

a form of leverage

the investor must borrow money because she wants to invest more than 100 percent of her wealth in the stock market

the investor increases her expected return above that for the overall stock market, but at the cost of increased risk

she would borrow money from a brokerage firm in order to invest more than she actually owns in the stock market

56
Q

the Internet bubble

A

an increase in the prices of Internet stocks based not on the fundamentals of business profitability, but instead on the belief that the prices of those stocks would keep going up

applies for all bubbles

Bubbles are often the result of irrational behavior

57
Q

informational cascade

A

actions based on actions based on actions … , etc., driven by very limited fundamental information

58
Q

the basic theory of consumer demand is based on which three assumptions

A

(1) consumers have clear preferences for some goods over others
(2) consumers face budget constraints
(3) given their preferences, limited incomes, and the prices of different goods, consumers choose to buy combinations of goods that maximize their satisfaction (or utility)

59
Q

objective of behavioral economics

A

incorporating more realistic and detailed assumptions regarding human behavior to better understand consumer demand and firm decisions

60
Q

Adjustments to the standard model of consumer preferences and demand can be grouped into which three categories?

A

A tendency to value goods and services in part based on the setting one is in

a concern about the fairness of an economic transaction

the use of simple rules of thumb as a way to cut through complex economic decisions

61
Q

reference point

A

created by the setting the consumer is in at the moment

references might be at least partly based on this setting or reference point

the point from which the individual makes the consumption decision which can strongly affect the buying decision

62
Q

endowment effect

A

A well-known example of a reference point

the fact that individuals tend to value an item more when they happen to own it than when they do not

ex: the gap between the price that a person is willing to pay for a good and the price at which she is willing to sell the same good to someone else

63
Q

loss aversion

A

the tendency of individuals to prefer avoiding losses over acquiring gains

with experience (such as stock brokers) this disappears

64
Q

framing

A

also influences preferences

is another manifestation of reference points

a tendency to rely on the con- text in which a choice is described when making a decision

65
Q

all manifestation of reference points

A

endowment effect

loss aversion

framing

66
Q

what does the ultimatum game show?

A

shows how fairness can affect economic decisions

67
Q

anchoring

A

refers to the impact that a suggested (perhaps unrelated) piece of information may have on your final decision

68
Q

effects of rules of thumb

A

can introduce biases in decision making

help to save time and effort and result in only small biases

69
Q

the law of small numbers

A

tendency to overstate the probability that certain events will occur when faced with relatively little information from recent memory

ex: roulette player who bets on black after seeing red come up three times in a row

Market analysis- 220 (41 decks)

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