Tutorial Terms 1 Flashcards
Why have Bertrand and Cournot such different outcomes
Bertrand are perfect substitutes –> compete on price
Cournot are still substitutes to an extent but not perfect substitutes –> compete on quantity
Economic examples of Prisoner’s Dilemma
Collusion in Duopoly or Cartels; Collusion between two firms to advertise less;
Reputation effects: firms don’t want their “reputation” to be hurt that’s why
they don’t do anything.
Probable reasons why people have diminishing marginal returns
As you have probably learned in the first year microeconomics class, the util
ity for most goods has diminishing marginal returns. This means, the more of
the good you consume, the less additional utility from an additional unit you
get. Thus, if you spend a fixed amount of money on buying each unit of the
good, your utility of money will also have decreasing marginal returns (de-
creasing MU(x)).
This immediately implies risk aversion. In many studies in
experimental economics or field studies this is indeed what researchers find: on
average and under normal conditions, people are mildly risk averse.
Framing
Levin and Gaeth (1988) show experimentally that people’s opinion
about the quality of beef differs depending on whether it was presented as “75%
lean” or “25% fat”. Framing is a well known effect in marketing. It is widely
used to make products look more attractive to consumers
Prospect Theory
Almost all fallacies above can be explained by Prospect The-
ory by Tversky and Kahneman (1992). This is the most used model of decision
making in social sciences as well as in applied work. It assumes that people are
risk seeking in the loss domain and risk averse in the gain domain. Whether
something is a gain or a loss is determined by an exogenously given reference
point that represents a neutral option.
Prospect Theory Example
or example, when you come to a casino
with X Euro, this can be seen as your reference point, with amounts less than
X being counted as losses and the amounts higher than X as gains. To incorpo-
rate certainty effects and the biases related to low probability events the model
assumes probability weighting, namely that low probabilities are overweighted
and high probabilities are underweighted.
When are mixed strategies important? Example
In many sports like tennis, football and baseball being a good mixer pays off.
Palacios-Huerta (2003) in his paper about football penalty kicks shows that foot-
ball players are amazingly good at mixing when they perform penalties.
Examples Public goods
Examples of public goods include fresh air, knowledge, lighthouses, national defense, flood control systems, and street lighting.
Streetlight: A streetlight is an example of a public good. It is non-excludable and non-rival in consumption.
Lemons Market + example
In a lemons market, there are products or services with different quality, which
is observable by the seller and unobservable by the buyer.
An example is the
recruitment process on the labor market if the potential employer cannot per-
fectly observe the applicants ability. According to standard economic theory,
agents will maximize their profits under such an information asymmetry. This
will lead to the crowding out of high quality agents from the labor market.
Inefficiency in the lemons market
A market with asymmetric infor-
mation, where the seller of a product/service observes its quality and the buyer
does not, is inefficient if the buyer’s expected valuation of the product is smaller
than the seller’s valuation of a good quality product. Sellers of good products
won’t sell it if the price they can get is below their valuation of the product.
Thus the expected value of the products on the market is equal to the value of
bad quality products. Assuming that buyers update their expectations they will
be willing to pay only up to their valuation of bad quality products. Thus, only
bad quality products will remain in the market and will be traded, whereas the
good quality products are not traded, which is inefficient.
5 ways to limit inefficiency from assymetric information
Screening Signaling Auctions Third party comparison Certifications and standards
Describe what a Principal-Agent problem is.
How an uninformed principal contracts with
an informed agent determines whether moral hazard occurs and how risks are
shared.
How is Moral Hazard different from adverse selection
Adverse selection refers to a process where high qual-
ity products/services are driven out of the market (hidden quality/characteristics,
exists before signing a contract). Moral hazard refers to process where the provi-
sion of high effort is ”driven out of the market” (hidden action/effort, happens
after signing a contract).
