individuals and rational decision-making Flashcards
psychology in economics
- psychological (motivation, perception, learning, beliefs, values, confidence)
- value: how much you’re willing to pay
- personal (age, life-cycle stage, economic circumstances, lifestyle)
- social
- cultural
malsow’s hierarchy of needs
- difference between wants and needs
- theory of motivation: individual behaviour (human motivation)
- understanding what people need and how people’s needs are an important part of effective management
behavioural economics
- seek to explain why people make certain decisions about how much to pay for a good/service
- assumes that individuals always make decisions that provide them with the highest amount of personal satisfaction
rational decision-making theory
- ideally: self-control, unmoved by emotions, logic, objectivity, analysis
- reality: people are emotional and easily distracted (psychological factors and emotions influence individuals)
rational consumer
considered to be the person making rational consumption decisions
- opportunity cost and budget constraints
the determinants of price: price
- the amount of money that has to be paid to acquire a given product
- the amount people are willing to pay for a product represents its value, price is also a measure of value
the determinants of price: value
- value is the measurement of the benefit derived from a good/service
- the max price or amount of money that someone is willing to pay for a good/service
theories of value: cost-of-production analysis
- modern value theory began with adam smith, explaining pricing primarily on the basis of the cost of production
- considers only part of the relevant problem (demand)
theories of value: theory of utility
- the analysis of demand was made possible by the theory of utility (H. H. Gossen)
- modern value theory (Alfred Marshall, 1920) considered prices to be determined simultaneously by cost and demand considerations, with demand and supply of various commodities affecting one another
- two sides to the analysis of price and value: the supply and demand
the classical economic theory of consumer choices
assumes that people attempt to maximize their total satisfaction (utility) subject to budget constraint
- want-satisfying power of goods/services
- purely subjective
with tastes and preferences
- the utility that individuals receive from consuming a good depends on their tastes and preferences
- these tastes are assumed to be given and stable for an individual
analyzing utility
study of consumer decision making based on utility maximization (attaining highest feasible satisfaction)
- the higher the utility level, the higher the item will be prioritized in the consumer’s budget
total utility
the amount of satisfaction (measured in utils) from consuming a good/service
- the TU begins from the origin, increases at a decreasing rate, reaches max and starts falling
marginal utility
the change in total utility due to a one-unit change in the quantity of a good/service consumed
- consumer choice is made on margins, meaning consumers constantly compare marginal utility from consuming additional goods to the cost they have to incur to acquire such goods
- a consumer buys goods as long as the marginal utility for each additional unit exceeds its price
applying marginal analysis to utility
the change in total utility divided by the change in the number of units consumed
- marginal utility falls as more is consumed
- equals zero at its max
the law of diminishing marginal utility
- as more of any good/service is consumed, its extra benefit declines
- increases from consumption of a good/service become smaller as more is consumed during a given time period
- the more you acquire, the less enjoyable every additional one becomes
marginal utility with the law of demand
- the price a consumer is willing to pay for a good depends on marginal utility
- the more benefits a consumer feels a product provides the more a consumer is willing to pay for it
- the decreasing utility the consumer feels from additional units places less value on each additional unit
the water-diamond paradox: the paradox of values
the paradox of value is the contradiction that although water is more useful than diamonds (survival), diamonds command a higher price in the market
- the total utility of water exceeds that of diamonds, but marginal utility determines the price
- diamonds are not essential but expensive
- water is essential but cheap
the water-diamond paradox: demand and supply
there’s no paradox in having a product with a high total value, such as water, selling for a low price and hence a low marginal value
elasticity
how supply and demand reacts to change
- measures of a variable’s sensitivity to a change in another variable
price elasticity of demand (Ep)
% change in Qd/ % change in P
- the responsiveness of Qd of a commodity to changes in its price
price elasticity ranges: elastic demand
a good has an elastic demand whenever the price elasticity of demand is over 1
- ex.: soft drinks, cars, electronics, clothing, cereals, etc.
- total expenditures and price are inversely related in the elastic region of the demand curve
price elasticity ranges: unit elastic demand
a good has a unit elastic demand whenever the price elasticity of demand is equal to 1
- total expenditures are invariant to price changes in the unit-elastic region of the demand curve
price elasticity ranges: inelastic demand
a good has an inelastic demand whenever the price elasticity of demand is smaller than 1
- consumers are relatively unresponsive
- ex.: gas, cigarettes, electricity, goods where firms have a monopoly
- total expenditures and price are directly related in the inelastic region of the demand curve
extreme elasticities: perfectly inelastic demand
only one quantity demanded for each price
- zero responsiveness to price changes
extreme elasticities: perfectly elastic demand
only one price for every quantity
- the flightless increase in price leads to zero quantity demanded
determinants of the price elasticity of demand
- degree of necessity
- whether the subs are available
- the significance of brand and loyalty
- the influence of habit
- share of the budget
determinants of the price elasticity of demand: degree of necessity
the greater the need for the product the lower the Ep
determinants of the price elasticity of demand: whether the subs are available
the larger the number of subs, the more elastic is demand
determinants of the price elasticity of demand: the significance of brand and loyalty
the more significant brand in the mind of the consumer, the lower the Ep
determinants of the price elasticity of demand: the influence of habit
the greater the purchasing habit, the lower the Ep
determinants of the price elasticity of demand: share of the budget
the greater the share of the consumer’s total budget spent on a good, the greater is the Ep
