Intro - Chptr 8/Logic of Individual Choice Flashcards
Utility
Refers to the satisfaction one gets from consuming a good or service.
Total vs. marginal utility
Total utility is total satisfaction received from a consuming a product while marginal utility is the the satisfaction one gets from consuming one additional unit of a produce- it is the additional satisfaction received above and beyond satisfaction already derived.
Principle of diminishing marginal utility
As you consume more of a good, after some point the marginal utility (MU) received from each additional unit of a good decreases with each additional unit consumed, other things equal.
What is the economic definition of “rational”?
People prefer more to less and will make choices that give them as much satisfaction as possible.
What is the principle of rational choice and its formula?
Spend money on those goods that give us the most MU per dollar: If MU(x)/P(x) > MU(y)/P(y), consume additional unit of x. If MU(x)/P(x) < MU(y)/P(y), consume additional unit of y.
What is the utility maximizing rule and its formula?
You are maximizing utility when ratios of the MU to price of two goods are equal: If MU(x)/P(x) = MU(y)/P(y), you’re maximizing utility.
How does the principle of of rational choice relate to the law of demand?
It leads to the law of demand: If there is decreasing MU and increasing price, we consume less of that good.
How does the principle of rational choice relate to the law of supply?
It is derived from the principle of rational choice. According to the principle of rational choice, if the is decreasing MU and the price of supplying a good goes up, you supply more of that good.
How does the principle of rational choice relate to opportunity cost?
The principle of rational choice states that to maximize MU, choose goods until the OC of all alternatives are equal.
What are the three assumptions on which economists’ analysis of rational choice is based?
(1) decision making is costless; (2) tastes are given; and (3) individuals maximize utility.
An assumption in the principle of rational choice is that choices are costless, what is the reality and how do people compensate?
Decision making is not costless and thus it is somewhat rational to be irrational given all the choices we face. One way we compensate is referred to as bounded rationality.
What is bounded rationality?
Rationality based on rules of thumb such as (1) “you get what you pay for,” i.e. lower cost equals lower quality and vice versa, and (2) “follow the leader,” i.e. if you don’t know what to do, do what you think smart people are doing. Advertising is designed to take advantage of these rules of thumb. “Follow the leader” leads to “focal point equilibria.”
What is focal point equilibria?
Stems from “follow the leader.” A set of goods is consumed, not because the goods are objectively preferred to all other goods, but simply because, through luck or advertising, they have become focal points to which people have gravitated.
An assumption in the principle of rational choice is that our tastes are given, what is the reality?
Our tastes are, in part given, but are also significantly shaped by society. An example is “conspicuous consumption” which is the consumption of goods not for one’s direct pleasure, but simply to show off to others. Other phenomena of tastes include (1) whenever a need is met, it’s replaced by a want which soon becomes a need and (2) When presented with new possibilities, people’s wants increase.
The principle of rational choice assumes that people maximize utility, what do some behavioral economists argue?
Behavioral economists argue that people aren’t as calculating as economists assume. People have a sense of fairness that also guides their decisions (ultimatum game) and have a “status quo bias.”
