individuals and rational decision-making

Question 1

psychology in economics

Answer 1

• 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

Question 2

malsow’s hierarchy of needs

Answer 2

• 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

Question 3

behavioural economics

Answer 3

• 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

Question 4

rational decision-making theory

Answer 4

• ideally: self-control, unmoved by emotions, logic, objectivity, analysis
• reality: people are emotional and easily distracted (psychological factors and emotions influence individuals)

Question 5

rational consumer

Answer 5

considered to be the person making rational consumption decisions
- opportunity cost and budget constraints

Question 6

the determinants of price: price

Answer 6

• 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

Question 7

the determinants of price: value

Answer 7

• 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

Question 8

theories of value: cost-of-production analysis

Answer 8

• 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)

Question 9

theories of value: theory of utility

Answer 9

• 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

Question 10

the classical economic theory of consumer choices

Answer 10

assumes that people attempt to maximize their total satisfaction (utility) subject to budget constraint

• want-satisfying power of goods/services
• purely subjective

Question 11

with tastes and preferences

Answer 11

• 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

Question 12

analyzing utility

Answer 12

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

Question 13

total utility

Answer 13

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

Question 14

marginal utility

Answer 14

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

Question 15

applying marginal analysis to utility

Answer 15

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

Question 16

the law of diminishing marginal utility

Answer 16

• 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

Question 17

marginal utility with the law of demand

Answer 17

• 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

Question 18

the water-diamond paradox: the paradox of values

Answer 18

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

Question 19

the water-diamond paradox: demand and supply

Answer 19

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

Question 20

elasticity

Answer 20

how supply and demand reacts to change

- measures of a variable’s sensitivity to a change in another variable

Question 21

price elasticity of demand (Ep)

Answer 21

% change in Qd/ % change in P

- the responsiveness of Qd of a commodity to changes in its price

Question 22

price elasticity ranges: elastic demand

Answer 22

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

Question 23

price elasticity ranges: unit elastic demand

Answer 23

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

Question 24

price elasticity ranges: inelastic demand

Answer 24

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

Question 25

extreme elasticities: perfectly inelastic demand

Answer 25

only one quantity demanded for each price

- zero responsiveness to price changes

Question 26

extreme elasticities: perfectly elastic demand

Answer 26

only one price for every quantity

- the flightless increase in price leads to zero quantity demanded

Question 27

determinants of the price elasticity of demand

Answer 27

• degree of necessity
• whether the subs are available
• the significance of brand and loyalty
• the influence of habit
• share of the budget

Question 28

determinants of the price elasticity of demand: degree of necessity

Answer 28

the greater the need for the product the lower the Ep

Question 29

determinants of the price elasticity of demand: whether the subs are available

Answer 29

the larger the number of subs, the more elastic is demand

Question 30

determinants of the price elasticity of demand: the significance of brand and loyalty

Answer 30

the more significant brand in the mind of the consumer, the lower the Ep

Question 31

determinants of the price elasticity of demand: the influence of habit

Answer 31

the greater the purchasing habit, the lower the Ep

Question 32

determinants of the price elasticity of demand: share of the budget

Answer 32

the greater the share of the consumer’s total budget spent on a good, the greater is the Ep