Lecture 1 Flashcards
What is prospect theory?
The idea that investors value losses and gains differently.
An investor when presented with a choice, both equal, will choose the one presented in terms of gains
What is prospect theory also known as?
Loss aversion theory
What is the fundamental principle of loss aversion theory?
Losses hurt more than gains
What does the certainty theory say?
Individuals prefer certain outcomes over probable ones
What does evidence say about Prospect Theory?
That it is the most satisfactory decision theory under risk and uncertainty.
What is myopic loss aversion?
The empirically supported tendency to use very short horizons to evaluate gains and losses.
What is behavioural economics?
Studying Economic behaviour and its consequences and applying insights from laboratory experiments, psychology and other social sciences in economics.
What is bounded rationality?
Recognize the constraints people face.
What are heuristics?
Effectively rules of thumb
What is the discovered preference hypothesis?
The idea that the standard economic model is a good predictor if people have had ample opportunity to learn from experience
What is a Nash Equilibrium?
A point in which an individual has no incentive to change their strategy
What is Pareto efficiency?
A state in which resources cannot be reallocated to make someone better off without making somebody else worse off
What are the three assumptions that Behavioural economics shares with standard Neoclassical microeconomic theory?
- Decision makers are highly sophisticated
- Markets and incentives play a key role in shaping behaviour
- Markets tend be better allocate resources more efficiently than governments
What is Positive Economics?
Studying what has occurred and what will occur
What is Normative Economics?
Says what policymakers should do
What is Prescriptive Economics?
Says what advice we should give to individual agents if we are looking to help them privately optimise
What is a Model?
A simplified representation of the world
What are the properties of a good model?
Parsimony Tractability Conceptual Insightfulness Generalisability Falsifiability Empirical Consistency Predictive Precision
What is rationality limited by?
Available Information, Time Constraints and Cognitive Limitations, e.g. maths ability or memory
What is a bias?
A systematic violation of the normative assumption
What is an ultimatum game?
The ultimatum game is an experimental economics game in which two parties interact anonymously and only once, so reciprocation is not an issue. The first player proposes how to divide a sum of money with the second party. If the second player rejects this division, neither gets anything.
