HCOL Econ Test 2

Microeconomics

Provides a framework to model economic activity; based on utility maximization

Utility

A measure of satisfaction or happiness from consuming goods/services

Maximization and Constraint

Maximization: individuals aim to achieve the highest utility possible

Constraint: real life has limits like buget, time, etc; force tradeoffs

Indifference curve

Curves showing combos of x and y giving the same utility; downward sloping, convex, don’t intersect

Income effect

Higher income (M) means more consumption of normal goods

Substituition effect

Price changes mean people will switch to cheaper goods

Price Elasticity

How demand responds to price; % change in consumption relative to % change in price

Health as a good

Utility from health (h) and other consumption; tradeoff between health and consumption of unhealthy goods; constraints: budget, time, info asymmetry

Policy implications for subsidies

lower price of medical care means a higher budget for siad care; substitution effects and positive income effects

Insurance policy implications

Reduces effective price of medical care, increases demand

Behavioral Economics

Study of psych, cognitive, emotional, and social factors influencing economic decisions

Experiments

Controlled tests to observe reak behavior; isolate variables, test hypotheses, reveal biases; can be lab, field, or survey

Traditional Econ Assumptions

Rational agents: maximize utility with perfect info and consistent preferences

Homo economicus: acts in her best interest (according to her taste) and with perfect info

Bounded Rationality (Simon)

Limited info, time, cognition. Posits that when making decisions, human rationality if limited by 3 nmain factors mentioned above

Heuristics

mental shortcuts leading to biases

Prospect Theory

“overweighing small probabilities” means that people tend to give disproportionately high importance to unlikely events compared to what their objective probability warrants

value function: gains and losses relative to reference point; loss aversion (losses hurt more)

Bias #1: Anchoring

Reliance on initial info (anchor) for decisions; ex. estimating a number after hearing a random one

Confirmation bias

Seeking info that confirms beliefs, ignoirng contradictions; ex. political views shaping news consumption

Endowment Effect

Valuing owned items more

Hyperbolic discounting/present bias

Overvaluing immediate rewards over future ones inconsistently

Ultimatum Game

A proposes a split of 10; B accepts/denies (reject - both get ($0);

Rational prediction: A offers $1, B accepts

Actual: fair splits; unfair rejected due to fairness/reciprocity

Asian Disease Problem

Choice between programs for 600 deaths, (framed as saves and losses

Gain frame: prefer 100% guarantee to save 200 over 1/3 save all

Loss frame: prefer risky 2/3 dies over sure 400 dies

Dictator game

A dives $10 with anon B

Rational: A keeps it all

Actual: average five $2-3 (altruism

Grossman’s model of health decisions

Health is a capital that depreciates with age but increases with investments

If it falls below a certain threshold, individuals die

Limitations to Rational Decision Making

Info available, ability to process and critically think, addiction, social, biological and psychological factors

Systems of decision making

Deliberative system: involves foresight and attention planning

Affective system: involves reaction and impulsivity

Discounting as a determinant for risk

Limited foresight, impatience, instant gratification

Impulsivity as a determinant for risk

varies across RHB more than the individual, more motivated by reward than harm, relates to time perception, decreases with age

Self control as a determinant for risk

limited and exhausted easily for most, when exerted in one domain one has a limited ability to exert self-control in another; for poor people, managing day to day existence is taxing cognitive resources and can explain RHB

Early life experiences as determinants for risk

Increases probability: parental risk-taking, adverse early life circumstances, violence, orphanhood

Social Determinants for risk

Norms and networks, social capital, stigma and group dynamics

Biological determinants of risk

½ the variation in risk preferences can be explained by a genetic factor

Two outputs of health capital (Grossman)

1. Consumption Benefit (direct pleasure): good health feels good, vice versa

   1. Investment Benefit (productive time): health is an investment that gives you more healthy time

Inputs for health capital

Market goods: medical care, gym membership, healthy food

Your time: exercising, meal prep, doctor’s appointments

Efficiency Effect (link between health and education)

people who are more educated are healthier, a more efficient producer of health

3 Characteristics of Addiction

Reinforcement: the marginal utility of consumption increase with the stock of past consumption

Tolerance: stock of past consumption lowers utility

Withdrawal: the marginal utility of consumption is positive

Becker and Murphy’s Theory of Rational Addiction

1. Reinforcement: the more you consume a good in the past, the more you desire it in the present and the more pleasure you get from consuming it

2. Tolerance: you need more of the substance over time to get the same level of satisfaction 

3. The “Addiction Stock”: mental or physical capital built up from past consumption; the larger this stock, the stronger the desire for the addictive good and the higher the enjoyment from a new dose

Conclusions from TORA

1. Not a moral failing of addicts

2. Time matters: dynamic choice over time where past consumption directly influences future decisions

3. Policy Implications: permanent taxes very valuable

The role of advertising

Most ads are not informative; depends on the characteristics of the good

Search goods: qualities known to consumers, ads focus on price and availability

Experience goods: qualities can be determined upon consumption, ads include little info on price and product characteristics

Credence goods: even less info than above, even after consumption

3 channels through which individuals affect each other

Shared constraints and resources

Expectations

Tastes: bandwagon reinforces price elasticity, snob effects do the opposite

Optimism bias

It won’t happen to me

Strategies to counteract optimism bias

Peronsonalized risk feedback, tailored framing, “what if” scenarios, targeting cognitive process

Cognitive Limitations and Bounded Rationality

Bias toward present rather than future, individuals can make small errors over time that accumulate 

“Full wallets” hypothesis

some individuals have limited resources and use up all their paycheck. Can’t optimize inter temporally and may for that reason appear time inconsistent.