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Chapter 8-9

by: Kasandra Guyette

Chapter 8-9 ECON 101

Kasandra Guyette
SUNY Oswego
GPA 3.46
Dr. John Kane

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About this Document

These are notes I've taken while reading through the textbook. Hope they help!
Dr. John Kane
Class Notes
Microeconomics, Economics, Econ
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This 5 page Class Notes was uploaded by Kasandra Guyette on Wednesday October 14, 2015. The Class Notes belongs to ECON 101 at State University of New York at Oswego taught by Dr. John Kane in Summer 2015. Since its upload, it has received 19 views. For similar materials see Microeconomics in Economcs at State University of New York at Oswego.

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Date Created: 10/14/15
Micro Chapter 8 Behavioral Economics A closer look at decision making Revealed preference no matter what you had thought you wanted to do your actions reveal that you actually wanted to do something else Another way to look at this is to consider that you weren39t acting rationally Third way to improve accuracy in predicting how we deal with struggles against procrastination and temptation time inconsistency competing selves and commitment Time inconsistency competing selves and commitment People can hold two sets of preferences 0 One set holds what we would like to wantin the future 0 One set holds what we will wantin the future Time inconsistency when we change our minds about what we want simply because of the timing of the decision Timeinconsistent individuals are being neither irrational nor rational but future oriented and presentoriented selves Commitment device an arrangement entered into by an individual with the aim of helping ful ll a plan for future behavior that would otherwise be difficult Thinking irrationally about costs Sunkcost fallacy A sunk cost is a cost that has already been incurred and can39t be refunded or recovered It makes no sense to consider sunk costs when weighing the tradeoff between opportunity costs and bene ts but we nd it hard to accept our losses It is more rational to think about futurebene ts and futurecosts rather than sunk costs Undervauing opportunity costs Everything has an opportunity cost Opportunity costs are harder to see than bene ts so you might overvalue the bene t of what is concrete and immediate and undervalue its opportunity cost People are especially prone to undervaluing opportunity costs when they are non monetary such as time The implicit cost ofownership is another nonmonetary opportunity cost that is often overlooked It refers to a cognitive bias documented by behavioral economics which leads people value things more once they possess them Forgetting about fungibility If something is fungible it is easily exchangeable or substitutable Money is fungible Creating mental categories for money By categorizing money you are less tempted to take from places you know you shouldn39t This helps you quotforgetquot you have the money so you don39t spend it Separating money into mental categories may help you organize your expenditures and stay on budget Can cause people to take risks they otherwise wouldn39t take Chapter 9 Game theory and strategic thinking Games and strategic behavior Game any situation involving at least two people that requires those involved to think strategically Game theory the study of how people behave strategically under different circumstances Behaving strategically acting to achieve a goal by anticipating the interplay between your own and others39 decisions Rules strategies and payoffs All games share three features rules strategies and payoffs Rules the actions that are allowed in a game Strategies the plans pf action that players follow to achieve their goals Payoffs the rewards that come from particular actions Onetime games and the prisoners39 dilemma Prisoners39 dilemma a game of strategy in which two people make rational choices that lead to a lessthanideal result for both The police lack the evidence to convict either person of a serious crime but he does have evidence of a minor crime They are looking for confessions Finding the dominant strategy Dominant strategy when a strategy is the best one to follow no matter What strategy other players choose Reaching equilibrium Nash equilibrium when all players choose the best strategy they can given the choices of all other players the point in a game when no player has an incentive to change his strategy given what other players are doing In the prisoners39 dilemma there is a stable outcome you both confess Noncooperative equilibrium negativenegative outcome not good for both participants Avoiding competition through commitment In prisoners39 dilemmatype games prearranged agreements to cooperate are tough to make work because both players have a strong incentive to defect One solution to this is to reduce the players payoffs by creating a punishment for defecting that is so bad that it outweighs the incentive not to cooperate Commitment strategy players agree to submit to a penalty in the future if they defect from a gien strategy By changing the payoffs agreeing to future penalties can allow players to reach a mutually bene cial equilibrium that would otherwise be dif cult to maintain Promoting competition in the public interest If two gas stations are in competition the dominant strategy is to charge low prices but both stations will do so even though they39d be better off if they agreed to both keep high prices example of noncooperative equilibrium There is a more negative word for cooperation in this business context it39s called colusion while a more positive word competition is used to describe the noncooperative equilibrium Repeated play in the prisoners39 dilemma Repeated game a game that is played more than once Strategies and incentives often work differently when games are repeated The titfortat strategy Titfortat whatever the other player does you do the same thing in response This leads to lasting cooperation Sequential games People move sequentially rather than simultaneously Think forward work backward Backward induction the process of analyzing a problem in reverse starting with the last choice then the secondtoIast choice and so on to determine the optimal strategy Start with the outcome you want then work backward in time to determine each choice you must make to achieve that outcome Deterring market entry a sequential game Many rms have to make strategic decisions in sequential quotgamesquot that make backward induction a useful process Ex entering a market We can analyze the decision the rst company is facing using a chart called a decision tree Using backward induction starting at right of tree Even though making a choice might not be best in the absence of competition it is the best strategic decision because it deters competitors from entering the market Firstmover advantage in sequential games Firstmover advantagethe player who chooses rst gets a higher payoff than those who follow Can be extremely important in oneround sequential games Ultimatum game one player makes an offer and the other player has the simple choice of whether to accept or reject Repeated sequential games Repeated play changes the nature of a simultaneous game such as the prisoners39 dilemma by allowing cooperation to be sustained Repeated play can also change the outcome in sequentialgames by reducing the rstmover advantage The ability to make counteroffers transforms bargaining from a game in which rst mover advantage trumps everything to a game in which patience is the winning strategy The value of a given sum in the future is less than the value of that same sum now For every round of bargaining the value of the surplus they are splitting goes down The person who is willing to hold out longer haws more bargaining power and so receives a better payoff Commitment in sequential games Making a credible commitment can change the payoffs and in uence the strategy of the other players By committing to reduce options you can force a change in your opponents strategy this results in a payoff that would otherwise be out of reach This is called quotburning your boatsquot


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