Microeconomics Flashcard
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What assumptions about people are made in traditional "Neoclassical" economics (TRAD)?
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People are rational (we understand costs and benefits and, our choices reflect out preferences) and self-interested.
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What are potential issues of Behavioral Economics Policy (BE)?
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1. Designing helpful policies is complicated because we may not have enough information 2. Nudges or Precommitment strategies may not have improve the situation because government may make things worse
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A person is dynamically consistent if what?
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They always follow through on plans Lapses in self-control never happen They're preferences over alternatives available at some future date do not change as the date approaches or once it arrives
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What are some examples of an information or encouragement nudge?
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Lunch line redesign (encouraging students to eat healthier) Utility report (encouraging people to be more energy efficient) West Virginia crime newspaper (encouraging people to stay out of jail)
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Which choice demonstrates the Advantageous Default Option Nudge? - Check if you want to opt out of savings - Check if you want to opt into savings
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The check if you want to opt out of savings option
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Which choice demonstrates the Advantageous Default Option Nudge? - Check if you want to donate - Check if you do not want to donate
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The check if you do not want to donate option
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Advantageous Default Option Nudge
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Makes the default choice the best choice
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Behavioral Economics Policy allows people to maintain free choice but...?
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Guides people to make good decisions
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What are 2 strategies of behavioral economic policy?
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Precommitment Device and a Nudge
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What is a precommitment device? What are its issues?
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A way to lock yourself into making a good decision Because it is used in situations where we have present bias there are issues with time. (Bear costs now, receive benefits later)
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What is the issue when: Q(monopoly)
P(perfect competition) (The monopoly represent any market structure with market power)
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Consumer surplus falls Total Surplus falls DWL exists
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What are common resources? (Nonexcludable and Rival)
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Common resources can't be prevented. If 1 person consumes it, another person cannot consume it. For example, Water fountains
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Which goods have Public Good characteristics?
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Nonrival Goods Nonexcludable goods Artificially Scarce Goods Common Resources Pure Public Goods
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Freeriders
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People that enjoy the good but do not pay for it
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Why do freeriders exist?
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Because private markets only produce private goods and artificially scarce goods
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Freeriders arise from what type of good characteristic? What does that mean for private markets?
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Arise from nonexcludability characteristic. This means that private markets will underproduce goods that have public good characteristics.
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How does the government intervene with private markets and freeriders?
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They pay suppliers to produce public goods. Or they produce public goods themselves
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Coase Theorem
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Even in the presence of externalities, an economy can always reach an efficient solution as long as transactions costs (the costs to individuals of making a deal) are sufficiently low
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In terms of the Coase Theorem, What is the relationship between costs, benefits, and production?
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If... Benefits > Costs = Produce Benefits < Costs = Don't produce
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Why won't the Coase Theorem lead to inefficiency?
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Because individuals have an incentive to make mutually beneficial deals, deals that lead them to take externalities into account when making decisions
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When do individuals internalize the externalities?
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When individuals take external costs or benefits into account
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What are 3 examples of transaction costs?
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The costs of communication among the interested parties The costs of making legally binding agreements Costly delays involved in bargaining
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What is the government intervention solution for promoting competition?
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Antitrust laws Price regulation
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What are the 3 antitrust policies?
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Sherman Antitrust Act of 1890 Clayton Antitrust Act of 1914 Federal Trade Commission Act
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What does the Sherman Antitrust Act of 1890 do? What case study is associated with it?
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It breaks up existing monopolies and prevents the creation of monopolies Case study: Standard Oil (1890-1900)
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What does the Clayton Antitrust Act of 1914 do? What 2 case studies are associated with it?
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It prohibits price discrimination, exclusive dealings, tying contracts, anti-competitive mergers, and interlocking directories. For exclusive dealings and tying contracts, case study: Microsoft (1990-2000) For anti-competitive mergers, case study: Beer - SAB miller)
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What does the Federal Trade Commission Act do? What case study is associated with it?
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It outlaws price fixing, output restrictions, and actions that prevent entry of new firms. For price fixing, Case study: Barnes & Noble, Amazon)
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What are exclusive dealings?
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When companies say "you can only buy this from me" They exclusively sell a product
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What are tying contracts?
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When companies say "you can't buy this product without buying this product" Companies won't sell a product without the purchase of another product.
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What are interlocking directories?
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When managing firms work together.
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How do Mavericks ensure competition?
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Mavericks cause other firms to keep their price low
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What is a Maverick?
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A firm that refuses to change or increase their price. Competition enforcers.
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What do TRAD and BE argue about Departures from Self-interest?
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TRAD: we care about ourselves and we make decisions to maximize our own happiness BE: Fairness matters
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What are 2 dynamically inconsistent examples of choices involving time?
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Present Bias Projection Bias
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Present Bias
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A form of dynamic inconsistency where we are biased towards immediate gratification (we don't like the idea of costs now, and benefits later) ex. exercising & saving
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Projection Bias
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We have a tendency to evaluate future tastes and needs based on the tastes and needs at the moment of decision making (we underestimate adaptability to good and bad events)
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What do TRAD & BE argue about choices involving time?
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TRAD: Preferences over alternatives at some future date do not change as the date approaches. We always follow through on plans and intentions and we never lose self control BE: We are dynamically inconsistent. We change our preferences, we sometimes lose self control, and we don't always follow through on plans.
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What do TRAD & BE argue about Rules of Thumb? What are examples of things we use Rules of Thumb for?
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TRAD: We weight benefits and costs carefully BE: We're lazy so we rely on rules of thumb and shortcuts Examples: eating foods, savings, exercise
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What do TRAD & BE argue about Salience and how things are presented?
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TRAD: How things are presented should not effect our decision making BE: We are influenced by the way things are phrased or presented
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What do TRAD & BE argue about Narrow Framing?
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TRAD: People can make complex decisions and take into account many different variables BE: We have a psychological tendency to group related items into categories, then we only consider items within that category
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What do TRAD & BE say about Bias Toward the Status Quo? What are 2 examples?
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TRAD: People will change their choice if another choice is better. BE: Change is hard so we resist it Example 1: Endowment Effect Example 2: Default Effect
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What do TRAD & BE argue about incoherent choices? What are 2 examples?
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TRAD: Choices reflect our preferences BE: Purposeful behavior (we are reasoned not rational) Example 1: Choice reversals (changing your mind when options change) Example 2: Anchoring (choices are linked to prominent but irrelevant information)
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What 6 things are associated with departures from rationality?
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Incoherent choices Bias toward the status quo (Endowment Effect & Default Effect) Narrow framing Salience Rules of Thumb Choices involving time (Present Bias & Projection Bias)
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What are the 2 departures BE makes?
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Departures from rationality and Departures from self-interest
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What are the disadvantages of experiments?
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Lab setting is not real life (not realistic) Lab setting can influence decisions Experiments are expensive to run
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What are the advantages of experiments?
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We can truly hold everything constant They are easier to establish causality We are able to measure plans and expectations
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What main point did Dan Ariely stress in his TED talk in lecture?
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When making difficult/complex decisions we are limited (we aren't rational and we don't know our preferences)
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What assumptions are made about people in Behavioral Economics (BE)?
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People are predictably irrational and we care about fairness
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Nonrival Goods
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A good that can be consumed by more than one person
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Tradable Emissions Permits
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Licenses to emit a limited amount of pollution (or negative externalities) They can sometimes be sold or traded They get us to similar results as a tax Firms (because of different MSB) will buy and sell permits, decreasing "pollution" of different amounts
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With a government imposed tax, a firm will...
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Produce until Marginal Social Benefit (MSB) = tax
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What solution does the government offer for externalities?
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Increase goods with positive externalities Decrease goods with negative externalities
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Why can externalities lead to inefficiency in a market economy?
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Markets will under produce good that generate positive externalities and overproduce goods that generate negative externalities.
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Externalities
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A market consuming or producing activity that causes a negative or positive impact on an unrelated third party
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What are the 3 market failures?
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Externalities Public goods Non-competitive markets
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A behavioral economist, in contrast to a traditional economist, would argue that one reason people have a hard time losing weight is that...?
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The cost of losing weight (exercising and eating less) must be incurred now, while the benefit (being thinner) isn't enjoyed until later
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A business can make profit by taking advantage of customers dynamic inconsistency. Why do health club members allow health clubs to take advantage of them?
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To counteract present bias
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Default Effect
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When confronted with many alternatives, people sometimes avoid making a decision and end up with the option that is assigned as a default
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Behavioral Economists view the standard economy theory of decisions involving time as being too restrictive because people have what?
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Lapses in self-control
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What two assumptions are traditional economists likely to make that behavioral economists are less likely to make?
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People are rational and self-interested
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Motivations for behavioral economics include what?
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People sometimes make choices that are inconsistent with standard economic theory. Standard economic theory can lead to unreasonable conclusions about consumer welfare.
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A dieter who prefers to eat small portions at his next meal, but chooses a large portion at meal time when it arrives is exhibiting what?
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A present bias
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Endowment Effect
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People tend to value something more highly when they own it than when they don't
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The following is what type of nudge? The government raises taxes on gasoline to reduce pollution
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This is not a nudge
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What are some examples of precommitment devices?
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Precommitment device for exercising: Gym membership, nice workout clothes Precommitment device for saving: Automatic saving from bank, 401K
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Precommitment devices change the decision from now vs. later to what?
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Now vs. Now
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Nudges
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A deliberate design of choices and information to change decisions in predictably positive ways without restricting choices
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What 2 things are incorporated into nudges?
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Salience: Decisions are influenced by how choices are presented Default Effect: When decisions are complex we do not make a decision and end up with the default
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What are the 2 types of nudges?
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Advantageous Default Option Nudge Information or Encouragement Nudge
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Information or Encouragement Nudge
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Provides information or encouragement to help you make the best decision
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When are behavioral economic policies useful?
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When the benefits and costs are separated by time When decisions are complicated When there's infrequent choices (choices we don't often make)
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The following is what type of Nudge? A firm redesigns its health enrollment form so that employees must explicitly choose to forgo health insurance.
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Potentially Advantageous Default Nudge
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What type of nudge is the following: A consumer-advocacy group sets up a site with side-by-side comparison auto insurance cost based on estimated risk of drivers
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Information or Encouragement Nudge
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A precommitment device is a solution for...?
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Dynamic inconsistency
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Traditional Economic Policy is what?
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Market based
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Artificially Scarce Good (Excludable & Nonrival)
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This good can be used simultaneously and can prevent someone who has not paid for it from using it Example: Cable TV
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Pure Public Good (Nonexcludable and Nonrival)
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This good cannot be prevented if not paid for and can be consumed simultaneously.
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Private Goods (Excludable and Rival)
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Goods consumed on a day-to-day basis. You must pay to consume and if one person consumes the good another person can't consume the good
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Rival Goods
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Rival in consumption. When a good cannot be consumed by more then one person
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Nonexcludable Goods
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Suppliers cannot prevent consumers who don't pay, from consuming the good
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Excludable Goods
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Suppliers can prevent those who don't pay from consuming the good
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Which government intervention seems to be most effective?
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Taxation systems
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Government Regulation
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Governments sets a limit on the quantity of "pollution" each firm can emit
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In what 3 ways does the government intervene?
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Tax - Pigoivian Tax (gets us to optimal Q) Tradable Emissions Permits Regulation
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Marginal Social Benefit (MSB)
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The additional benefit to society from one more unit
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Marginal Social Cost (MSC)
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The additional cost imposed on society from an additional unit
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If Marginal Social Benefit is greater than zero what will happen?
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A firm in the private market will increase production
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In an externality, what quantity is produced in the private market without government intervention?
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Marginal Social Benefit = 0
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If the quantity of a private market is greater than the optimal quantity what happens?
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When Q(private market) > Q(optimal) the government intervenes
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In an externality, what is optimal level of production?
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Marginal Social Benefit = Marginal Social Cost
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What is the role of the government in a market economy?
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Pick up the market when it falls down because it's not efficient or not producing an optimal mix of goods
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Price Fixing
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When all firms agree to charge a price (typically higher than if they were competing)
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What is important about the regulation of natural monopolies?
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It's best to have one supplier It results in a lower cost compared to having multiple firms because of economies of scale
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What are examples of natural monopolists?
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Firms with high fixed costs. Examples: Water company, Electricity, Cable
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At what point on a graph do you profit maximize without regulation?
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Where Marginal Revenue = Marginal Cost
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At what point is Average Total Cost (ATC) regulated? What does regulating ATC do?
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Where Price = Average Total Cost (P=ATC) It causes zero profit because P=ATC at Q(atc)`
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At what point is marginal cost regulated? What does regulating MC do?
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Where P = MC It causes negative profit or economic losses because P<ATC at Q(mc)
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What is the difference between negative externalities and positive externalities?
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Negative externalities: External costs Positive externalities: External benefits
