Consumer Choices and Behavioral Economics

Flashcards covering consumer choices and behavioral economics.

Consumer Surplus (CS)

The difference between what consumers are willing to pay and what they actually pay.

Producer Surplus (PS)

The difference between the price producers receive and the minimum price they would be willing to accept.

Total Surplus (CS + PS)

Total surplus, representing the gains from trade in a market.

Equilibrium

Occurs where supply equals demand.

Deadweight Loss (DWL)

Lost efficiency in a market due to distortions like price controls, taxes, or monopolies.

Budget Constraint

The limit on consumption choices based on income and price levels.

Optimal Consumption Rule

Consumers maximize total utility when MU/P is equal across all goods.

Marginal Utility (MU)

The additional satisfaction gained from consuming one more unit of a good.

Law of Diminishing Marginal Utility

As consumption increases, additional satisfaction from each extra unit decreases.

MU/P (Marginal Utility per Dollar)

A method of comparing how much satisfaction you get per dollar spent across different goods.

Fungible

Goods that are interchangeable—one unit is identical to another.

The Endowment Effect

People tend to overvalue things they own simply because they own them.

Sunk Cost Bias

People continue investing in something even when it no longer benefits them.

Hyperbolic Discounting

Humans prefer smaller rewards sooner rather than larger rewards later, even if waiting is objectively better.

Reference Dependence

People evaluate choices relative to a "reference point" rather than considering absolute values.

Framing Effect

The way information is presented influences decisions, even if the core facts remain the same.

Loss Aversion

Losses hurt more than equivalent gains feel good. People go to great lengths to avoid losing, often irrationally.

Mental Accounting

People mentally categorize money in ways that affect spending decisions irrationally.

Base Rate Neglect

People ignore statistical probabilities (base rates) and focus too much on specific details.

System 1 Thinking

Automatic, instinctive reactions—used for quick decisions and gut feelings.

System 2 Thinking

Analytical thinking—used for careful reasoning and solving complex problems.