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Welcome to Welcome to EC 209: Managerial EC 209: Managerial Economics- Group AEconomics- Group ABy:By: Dr. Jacqueline KhorassaniDr. Jacqueline Khorassani

Week FiveWeek Five

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Managerial EconomicsManagerial Economics

Week Five- Class 1Week Five- Class 1Monday, October 1Monday, October 1

11:10-12:0011:10-12:00Fottrell (AM)Fottrell (AM)

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This week’s Aplia This week’s Aplia AssignmentAssignment1.1. APLIA ASSIGNMENT IS DUE APLIA ASSIGNMENT IS DUE

BEFORE 5:00 PM on Wednesday BEFORE 5:00 PM on Wednesday (October 3)(October 3)

2.2. special tutorial tonightspecial tutorial tonight– 6 and 8 p.m. in Kirwan theatre. 6 and 8 p.m. in Kirwan theatre.

3.3. Darragh will also be available in Darragh will also be available in his office (234 , St. Anthony's) his office (234 , St. Anthony's) today between 10 and 1 and today between 10 and 1 and between 3 and 5 between 3 and 5

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In generalIn general

1.1. You will have to do the practice You will have to do the practice problems first in order to do well problems first in order to do well on the graded problemson the graded problems

2.2. Use the discussion board feature Use the discussion board feature on the Course Blackboard to on the Course Blackboard to post any questions about any of post any questions about any of the assignments. the assignments.

http://http://blackboard.nuigalway.ieblackboard.nuigalway.ie

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I made a mistake in I made a mistake in preparation of this week’s preparation of this week’s study guide (oooops!!!)study guide (oooops!!!)

Instead of moving from Chapter Instead of moving from Chapter 4 to Chapter 5 of Baye (your 4 to Chapter 5 of Baye (your main textbook), we have to do main textbook), we have to do other things this week other things this week

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This weekThis week

1. Read Chapter 8 of the sixth edition of 1. Read Chapter 8 of the sixth edition of “Microeconomics and Behavior” by “Microeconomics and Behavior” by Robert Frank (required) Robert Frank (required)

The bookshop’s textbooks have this on a CD; The bookshop’s textbooks have this on a CD; otherwise, the library has the book.otherwise, the library has the book.

2. Read an article published in economist 2. Read an article published in economist available on blackboard (required)available on blackboard (required)

3. Read a paper by 3. Read a paper by Camerer available on Camerer available on blackboard (recommended)blackboard (recommended)

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About the aplia About the aplia questions on the questions on the utility functionutility function Utility is satisfactionUtility is satisfaction ExampleExample U = 2XU = 2X11 X X22

Along a given indifference curve, U is constant (say = 100)

To draw the indifference curve, you just plug in different values for X1 and solve for X2

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Consumer is at equilibriumConsumer is at equilibrium

Point CPoint C buying 0.5 buying 0.5

pizzapizza

Pizza

Other goods

C

0.5

II

A

B

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Now, she is offered a buy Now, she is offered a buy one pizza, get one free dealone pizza, get one free deal

How does it How does it affect the affect the budget budget line?line?

Up to 1 Up to 1 pizza, no pizza, no difference difference (AD)(AD)

When she When she buys the 1buys the 1stst pizza, she is pizza, she is given one given one for free for free (DE)(DE)

Pizza

Other goods

C

0.5

I

1

D E

2

A

From that point on, she will have to pay the same price for each additional pizza (EF)

New budget line is ADEFB F

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How many pizzas will she How many pizzas will she end up buying?end up buying?

She will She will end up end up buying 2 buying 2 pizzaspizzas

Is she Is she better better off?off?

Pizza

Other goods

C

0.5

I

1

D E

2

A

B F

II

1111

Are you going to be Are you going to be happier ifhappier if I gave you I gave you €100? Or€100? Or I gave you €100 gift certificate to I gave you €100 gift certificate to

the bookshop? Orthe bookshop? Or I gave you €100 gift certificate I gave you €100 gift certificate

toward vacation in Spain?toward vacation in Spain? People in general prefer the cashPeople in general prefer the cash Why?Why? It gives you more flexibility?It gives you more flexibility?

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Let me see how many Let me see how many books you are buying books you are buying now?now?

Only 1?Only 1?I.

Y

books

A

1

50

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Now let’s give you a €100 Now let’s give you a €100 gift certificate to the gift certificate to the bookshopbookshop

and say the price and say the price of each book is of each book is €100 €100

Your budget line Your budget line changes to BACDchanges to BACD

And you buy one And you buy one more bookmore book

Are you happier?Are you happier? YesYes But will you be But will you be

happier if I gave happier if I gave you 100 in cash?you 100 in cash?

Y

books

A

1

50

2

B

C

D

III

III

F

At F you are happier than C

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Managerial Economics- Managerial Economics- Group AGroup A Week Five- Class 2Week Five- Class 2

– Tuesday, October 2Tuesday, October 2– 15:10-16:0015:10-16:00– CairnesCairnes

How did the tutorial go yesterday?How did the tutorial go yesterday? Aplia Assignment is due before Aplia Assignment is due before

5PM tomorrow5PM tomorrow

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Do you have a job? Do you have a job?

Suppose a person gets utility or Suppose a person gets utility or satisfaction from both income and satisfaction from both income and leisure. leisure.

People face a tradeoff between income People face a tradeoff between income and leisure because and leisure because – Hours are limitedHours are limited– If work mereIf work mere– Less leisure.Less leisure.

As your income goes up, do you As your income goes up, do you consume more or less leisure?consume more or less leisure?– It would seem reasonable to assume that It would seem reasonable to assume that

leisure is a normal good. leisure is a normal good.

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Let’s look at the Let’s look at the indifference curve indifference curve

Does it make Does it make sense to sense to draw the draw the indifference indifference curve this curve this way?way?

I

Income/day

Hours of leisure/day

II III

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Now let’s find the budget Now let’s find the budget lineline

Suppose you Suppose you can do a job can do a job that pays that pays €10/hour€10/hour

You won’t You won’t consider consider working 24 working 24 hours /dayhours /day– But 16 hours?But 16 hours?– MaybeMaybe

Income/day

Hours of leisure/day

€160

16

Slope = wage rate

2

€140

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Now let’s find consumer Now let’s find consumer equilibriumequilibrium

To To maximize maximize your your satisfactionsatisfaction, you will , you will work 8 work 8 hours a hours a dayday

I

Income/day

Hours of leisure/day

II III

8

€80

A

160

16

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Now let’s give you a raiseNow let’s give you a raise

Increase Increase wage to 15 wage to 15 euros/ dayeuros/ day

Budget line Budget line rotatesrotates

Do you Do you always work always work less when less when your wage your wage rate goes rate goes up?up?

I

Income/day

Hours of leisure/day

II III

8

€80

A

€160

16

B

€240

9

€105

2020

No, it depends onNo, it depends on

Substitution effect/Income effectSubstitution effect/Income effect1.1. Substitution effect: wage rate is Substitution effect: wage rate is

higherhigher it is costlier not to work it is costlier not to work opportunity cost of leisure opportunity cost of leisure went upwent up work morework more

2.2. Income effect: higher wages Income effect: higher wages mean higher incomemean higher income consume consume more leisuremore leisure work less work less

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If the substitution effect is greater If the substitution effect is greater than the income effect, work than the income effect, work more.more.

If income effect is greater than If income effect is greater than the substitution effect, work less.the substitution effect, work less.

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Opinion AssignmentOpinion Assignment

Answer the questions.Answer the questions. There are no right or wrong There are no right or wrong

answersanswers Just your opinionJust your opinion ThanksThanks

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Managerial EconomicsManagerial Economics

Week Five- Class 3Week Five- Class 3– Thursday, October 4Thursday, October 4– 15:10-14:0015:10-14:00– TyndallTyndall

The next Aplia Assignment due The next Aplia Assignment due next week before 5PM on October next week before 5PM on October 99

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I received a feedbackI received a feedback

the aplia assignment is some what of the aplia assignment is some what of a disaster; very time consuming yet a disaster; very time consuming yet not very enlightening…. still confusednot very enlightening…. still confused

My response:My response:1.1. We heard youWe heard you2.2. Next assignment was just shortenedNext assignment was just shortened3.3. Sometimes learning process can be Sometimes learning process can be

painful.painful.4.4. Start early & ask me questions. Start early & ask me questions.

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Criticisms of Rational Criticisms of Rational Choice Theory Choice Theory

Sources:Sources:1.1. Chapter 8 from Robert Frank’s Chapter 8 from Robert Frank’s

bookbook2.2. An article published in economist An article published in economist

available on blackboard (required)available on blackboard (required)3. A paper by 3. A paper by Camerer available on Camerer available on

blackboard (recommended)blackboard (recommended) There will not be an aplia assignment on There will not be an aplia assignment on

this material but we will examine it in the this material but we will examine it in the final examfinal exam

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Last class, I asked youLast class, I asked you

1.1. Yesterday, you purchased a €20 Yesterday, you purchased a €20 ticket to see a performance at ticket to see a performance at the local theatre. Today, after the local theatre. Today, after you arrive at the theatre, you you arrive at the theatre, you discover that you have lost the discover that you have lost the ticket. Will you buy another ticket. Will you buy another ticket and see the performance? ticket and see the performance?

According to a study: less than According to a study: less than 50% of the people said yes50% of the people said yes

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And I asked youAnd I asked you

2. You arrive at the local theatre just 2. You arrive at the local theatre just before a performance to buy a before a performance to buy a ticket. You discover that you have ticket. You discover that you have lost €20 on your way to the lost €20 on your way to the theatre. Will you buy the ticket theatre. Will you buy the ticket and attend the performance and attend the performance anyway? anyway?

According to studies: 88% of the According to studies: 88% of the people said yes.people said yes.

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In both casesIn both cases

You lose €20You lose €20 Why behave differently?Why behave differently? Are you not rational, the way Are you not rational, the way

economists say you are? economists say you are?

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Kahneman and Tversky Kahneman and Tversky (KT)(KT)

Explanation Explanation – wealth is not fungiblewealth is not fungible

Fungibility = total wealth (not Fungibility = total wealth (not the break-down) matters the break-down) matters

– people have different people have different mental accounts.mental accounts.

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Another Case Another Case

You simultaneously learn that You simultaneously learn that 1.1. Someone gave you a gift of €100 Someone gave you a gift of €100

2.2. You have to pay an unexpected tax €80. You have to pay an unexpected tax €80.

– Are you better off?Are you better off? Rational Choice model would say Rational Choice model would say

‘yes’ – your wealth has gone up by ‘yes’ – your wealth has gone up by €20.€20.

But KT found that many people would But KT found that many people would say “No”say “No”

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Rational Choice: Utility of Rational Choice: Utility of a Pair of Events that a Pair of Events that Increases Total WealthIncreases Total Wealth

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The Asymmetric Value The Asymmetric Value Function by KTFunction by KTPeople seem to view People seem to view

each event each event separatelyseparately and attach considerably and attach considerably more importance to the more importance to the loss than to the gain.loss than to the gain.

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The KT Value FunctionThe KT Value Function1. We don’t look at the net gain

2. We have separate account for gains and losses

3. Losses are harder to take

Likes go up fast in the beginning and then slowly with additional gain

Dislikes go up much more sharply in the beginning and then slowly with additional loss

Non-linear value function

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ApplicationApplication

Hedonic Framing Hedonic Framing 1.1. Segregate gains. Don’t Segregate gains. Don’t

wrap all the Christmas wrap all the Christmas presents in a single box.presents in a single box.

2.2. Combine losses.Combine losses.

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The Benefit of Segregating The Benefit of Segregating GainsGains

The value (utility) of 100 is less than the value (utility) of 40 + the value (utility) of 60

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The Benefit of Combining The Benefit of Combining LossesLossesThe negative value (dislike) of a loss of 50 is less than the negative value (dislike) of a loss of 20 plus a negative value (dislike) of a loss of 30

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Hedonic FramingHedonic Framing

Specific ways in which sellers Specific ways in which sellers could enhance the appeal of could enhance the appeal of their productstheir products

1.1. Offset a small loss with a Offset a small loss with a larger gain. larger gain.

2.2. Segregate small gains from Segregate small gains from large losses. large losses.

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The Benefit of Offsetting…The Benefit of Offsetting…

Give them the gains in small packages

Give the loss in one package

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The Silver-Lining Effect The Silver-Lining Effect and Cash Rebatesand Cash Rebates

The value (utility) of a $1200 rebate > the value of a discount of $1200

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Last class I asked youLast class I asked you

1.1. You spent €100 to buy a ticket to You spent €100 to buy a ticket to your favorite performance. When your favorite performance. When you arrive at the theatre, you notice you arrive at the theatre, you notice that the performance is old out. that the performance is old out. Someone offers you €500 for your Someone offers you €500 for your ticket. Will you sell him your ticket? ticket. Will you sell him your ticket?

– Most people say no to thisMost people say no to this– You give up the opportunity to make You give up the opportunity to make

€400€400 So you choose to lose €400So you choose to lose €400

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Then I asked youThen I asked you

2. You arrive at the theater the night of 2. You arrive at the theater the night of your favorite performance to buy your your favorite performance to buy your ticket which is priced at €100; but the ticket which is priced at €100; but the tickets are sold out. Someone offers to tickets are sold out. Someone offers to sell his ticket to you for €400. Will you sell his ticket to you for €400. Will you purchase his ticket?purchase his ticket?– Most people say no to this one tooMost people say no to this one too– This is an out of pocket costThis is an out of pocket cost– You chose to not lose €400You chose to not lose €400

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Why this Why this inconsistency? inconsistency? People code the out-of-pocket People code the out-of-pocket

expenses as a expenses as a lossloss While the opportunity cost of not While the opportunity cost of not

selling the ticket is coded as a selling the ticket is coded as a foregone gainforegone gain

People have an asymmetric value People have an asymmetric value function over function over losses and gainslosses and gains..

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Last class I asked youLast class I asked you

You have purchased a pair of €200 You have purchased a pair of €200 fashionable shoes, only to discover that fashionable shoes, only to discover that they are painfully tight. They improve they are painfully tight. They improve slightly after being broken in, but still slightly after being broken in, but still cause considerable discomfort. Will you cause considerable discomfort. Will you continue wearing them? continue wearing them?

Some people say yes to thisSome people say yes to this But according to rational choice But according to rational choice

assumption, this is assumption, this is sunk costsunk cost; it should ; it should not matternot matter