Managerial Economics Week Five - Class 1, 2, 3: Aplia Assignment, Consumer Equilibrium, Opinion Assignment

1. Welcome to EC 209: Managerial Economics- Group ABy:Dr. Jacqueline Khorassani Week Five

2. Managerial Economics Week Five- Class 1 Monday, October 1 11:10-12:00Fottrell (AM)

3. This week’s Aplia Assignment • APLIA ASSIGNMENT IS DUE BEFORE 5:00 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

4. 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

5. I made a mistake in preparation of this week’s 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

6. This week 1. Read Chapter 8 of the sixth edition of “Microeconomics and Behavior” by Robert Frank (required) • The bookshop’s 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)

7. 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

8. Consumer is at equilibrium Other goods • Point C • buying 0.5 pizza A C I I B Pizza 0.5

9. 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

10. 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

11. 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?

12. Let me see how many books you are buying now? • Only 1? Y I. A 50 books 1

13. Now let’s 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 50 A II I 1 D books 2

14. Managerial Economics- Group A • Week Five- Class 2 • Tuesday, October 2 • 15:10-16:00 • Cairnes • How did the tutorial go yesterday? • Aplia Assignment is due before 5PM tomorrow

15. 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.

16. Let’s 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

17. Now let’s find the budget line Income/day • Suppose you can do a job that pays €10/hour • You won’t consider working 24 hours /day • But 16 hours? • Maybe Slope = wage rate €160 €140 Hours of leisure/day 16 2

18. Now let’s 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

19. Now let’s 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 €160 III B €105 A €80 Hours of leisure/day 16 9 8

20. 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

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

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

23. Managerial Economics • Week Five- Class 3 • Thursday, October 4 • 15:10-14:00 • Tyndall • The next Aplia Assignment due next week before 5PM on October 9

24. 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.

25. Criticisms of Rational Choice Theory • Sources: • Chapter 8 from Robert Frank’s 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

26. 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

27. 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.

28. In both cases • You lose €20 • Why behave differently? • Are you not rational, the way economists say you are?

29. Kahneman and Tversky (KT) • Explanation • wealth is not fungible • Fungibility = total wealth (not the break-down) matters • people have different mental accounts.

30. 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”

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

32. 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.

33. The KT Value Function • We don’t 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

34. Application • Hedonic Framing • Segregate gains. Don’t wrap all the Christmas presents in a single box. • Combine losses.

35. The Benefit of Segregating Gains The value (utility) of 100 is less than the value (utility) of 40 + the value (utility) of 60

36. 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

37. 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.

38. The Benefit of Offsetting… Give the loss in one package Give them the gains in small packages

39. The Silver-Lining Effect and Cash Rebates The value (utility) of a $1200 rebate > the value of a discount of $1200

40. 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

41. 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

42. 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.

43. 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