Welcome to EC 209: Managerial Economics Group A By: Dr. Jacqueline Khorassani

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Welcome to EC 209 Managerial Economics- Group
ABy Dr. Jacqueline Khorassani

• Week Five

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Managerial Economics

• Week Five- Class 1
• Monday, October 1
• 1110-1200Fottrell (AM)

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This weeks Aplia Assignment

• APLIA ASSIGNMENT IS DUE BEFORE 500 PM on
  Wednesday (October 3)
• special tutorial tonight
• 6 and 8 p.m. in Kirwan theatre.
• Darragh will also be available in his office (234
  , St. Anthony's) today between 10 and 1 and
  between 3 and 5

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In general

• You will have to do the practice problems first
  in order to do well on the graded problems
• Use the discussion board feature on the Course
  Blackboard to post any questions about any of the
  assignments.
• http//blackboard.nuigalway.ie

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I made a mistake in preparation of this weeks
study guide (oooops!!!)

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

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This week

• 1. Read Chapter 8 of the sixth edition of
  Microeconomics and Behavior by Robert Frank
  (required)
• The bookshops textbooks have this on a CD
  otherwise, the library has the book.
• 2. Read an article published in economist
  available on blackboard (required)
• 3. Read a paper by Camerer available on
  blackboard (recommended)

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About the aplia questions on the utility function

• Utility is satisfaction
• Example
• U 2X1 X2
• 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 equilibrium
Other goods

• Point C
• buying 0.5 pizza

A
C
I
I
B
Pizza
0.5
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Now, she is offered a buy one pizza, get one free
deal
From that point on, she will have to pay the same
price for each additional pizza (EF) New budget
line is ADEF
Other goods

• How does it affect the budget line?
• Up to 1 pizza, no difference (AD)
• When she buys the 1st pizza, she is given one for
  free (DE)

I
A
C
E
D
2
B
F
Pizza
1
0.5
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How many pizzas will she end up buying?
Other goods

• She will end up buying 2 pizzas
• Is she better off?

I
II
A
C
E
D
2
B
F
Pizza
1
0.5
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Are you going to be happier if

• I gave you 100? Or
• I gave you 100 gift certificate to the bookshop?
  Or
• I gave you 100 gift certificate toward vacation
  in Spain?
• People in general prefer the cash
• Why?
• It gives you more flexibility?

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

• Only 1?

I.
A
50
books
1
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Now lets give you a 100 gift certificate to the
bookshop

• and say the price of each book is 100
• Your budget line changes to BACD
• And you buy one more book
• Are you happier?
• Yes
• But will you be happier if I gave you 100 in cash?

Y
At F you are happier than C
B
F
III
C
A
50
II
I
books
1
D
2
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Managerial Economics- Group A

• Week Five- Class 2
• Tuesday, October 2
• 1510-1600
• Cairnes
• How did the tutorial go yesterday?
• Aplia Assignment is due before 5PM tomorrow

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Do you have a job?

• Suppose a person gets utility or satisfaction
  from both income and leisure.
• People face a tradeoff between income and leisure
  because
• Hours are limited
• If work mere
• Less leisure.
• As your income goes up, do you consume more or
  less leisure?
• It would seem reasonable to assume that leisure
  is a normal good.

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Lets look at the indifference curve

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

Income/day
I
II
III
Hours of leisure/day
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Now lets find the budget line

• Suppose you can do a job that pays 10/hour
• You wont consider working 24 hours /day
• But 16 hours?
• Maybe

Income/day
Slope wage rate
160
140
Hours of leisure/day
16
2
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Now lets find consumer equilibrium

• To maximize your satisfaction, you will work 8
  hours a day

Income/day
I
II
III
160
A
80
Hours of leisure/day
8
16
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Now lets give you a raise
Income/day

• Increase wage to 15 euros/ day
• Budget line rotates
• Do you always work less when your wage rate goes
  up?

240
I
II
III
160
B
105
A
80
Hours of leisure/day
16
9
8
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No, it depends on

• Substitution effect/Income effect
• Substitution effect wage rate is higher? it is
  costlier not to work ? opportunity cost of
  leisure went up? work more
• Income effect higher wages mean higher income?
  consume more leisure? work less

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

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Opinion Assignment

• Answer the questions.
• There are no right or wrong answers
• Just your opinion
• Thanks

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Managerial Economics

• Week Five- Class 3
• Thursday, October 4
• 1510-1400
• Tyndall
• The next Aplia Assignment due next week before
  5PM on October 9

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I received a feedback

• the aplia assignment is some what of a disaster
  very time consuming yet not very enlightening.
  still confused
• My response
• We heard you
• Next assignment was just shortened
• Sometimes learning process can be painful.
• Start early ask me questions.

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Criticisms of Rational Choice Theory

• Sources
• Chapter 8 from Robert Franks book
• An article published in economist available on
  blackboard (required)
• 3. A paper by Camerer available on blackboard
  (recommended)
• There will not be an aplia assignment on this
  material but we will examine it in the final exam

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Last class, I asked you

• Yesterday, you purchased a 20 ticket to see a
  performance at the local theatre. Today, after
  you arrive at the theatre, you discover that you
  have lost the ticket. Will you buy another
  ticket and see the performance?
• According to a study less than 50 of the people
  said yes

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And I asked you

• 2. You arrive at the local theatre just before a
  performance to buy a ticket. You discover that
  you have lost 20 on your way to the theatre.
  Will you buy the ticket and attend the
  performance anyway?
• According to studies 88 of the people said yes.

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In both cases

• You lose 20
• Why behave differently?
• Are you not rational, the way economists say you
  are?

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Kahneman and Tversky (KT)

• Explanation
• wealth is not fungible
• Fungibility total wealth (not the break-down)
  matters
• people have different mental accounts.

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Another Case

• You simultaneously learn that
• Someone gave you a gift of 100
• You have to pay an unexpected tax 80.
• Are you better off?
• Rational Choice model would say yes your
  wealth has gone up by 20.
• But KT found that many people would say No

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Rational Choice Utility of a Pair of Events that
Increases Total Wealth
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The Asymmetric Value Function by KT

• People seem to view each event separately and
  attach considerably more importance to the loss
  than to the gain.

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The KT Value Function

• We dont look at the net gain
• We have separate account for gains and losses
• Losses are harder to take

Non-linear value function
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
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Application

• Hedonic Framing
• Segregate gains. Dont wrap all the Christmas
  presents in a single box.
• Combine losses.

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The Benefit of Segregating Gains
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 Losses
The 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 Framing

• Specific ways in which sellers could enhance the
  appeal of their products
• Offset a small loss with a larger gain.
• Segregate small gains from large losses.

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The Benefit of Offsetting
Give the loss in one package
Give them the gains in small packages
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The Silver-Lining Effect and Cash Rebates
The value (utility) of a 1200 rebate gt the
value of a discount of 1200
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Last class I asked you

• You spent 100 to buy a ticket to your favorite
  performance. When you arrive at the theatre, you
  notice that the performance is old out. Someone
  offers you 500 for your ticket. Will you sell
  him your ticket?
• Most people say no to this
• You give up the opportunity to make 400
• So you choose to lose 400

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Then I asked you

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

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Why this inconsistency?

• People code the out-of-pocket expenses as a loss
• While the opportunity cost of not selling the
  ticket is coded as a foregone gain
• People have an asymmetric value function over
  losses and gains.

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Last class I asked you

• You have purchased a pair of 200 fashionable
  shoes, only to discover that they are painfully
  tight. They improve slightly after being broken
  in, but still cause considerable discomfort.
  Will you continue wearing them?
• Some people say yes to this
• But according to rational choice assumption, this
  is sunk cost it should not matter