19 The Logic of Individual Choice:

• Discuss the principle of rational choice and the principle of diminishing marginal utility.

• The principle of rational choice accounts for the laws of demand and supply.

• Discuss why three assumptions of the theory of choice may not reflect reality.

• It's Friday night and you've managed to save $50 to take a break from classes and buy two tickets, one for yourself and one for a friend, to see the rock concert at the field house.
• You might consider going to a movie and having a hot fudge sundae after for the two of you.
• Or maybe ordering a meal.
• The money could be given to the homeless shelter.

• You have choices all the time.

• Microeconomics deals with how individuals make choices.
• It gives economics a lot of its power.

• The first part of this chapter shows you the basics and leads you through some exercises to understand the reasoning.
• The second part of the chapter gives you a sense of when the model is useful and when it's not.

• The goals for this book were set in Chapter 1.
• One goal was to make you think like an economist.
• The reasoning process behind economists' cost/benefit approach to problems is developed in this chapter.

• A group of economists, called behavioral economists, have explored the different sciences and their deviations from rationality and self- interest.
• The building blocks of economics have been expanded.
• Freudian psychology tells us that an internal complicated model is much more difficult to use and that we have a cost.
• The advantage of fight between the id, ego, and superego using traditional building blocks is that it allows you to decide whether the model is bodies or not.
• It's not applicable according to other psychologists.

• Behavioral economists recognize the cost and are trying to be ok.
• The work is still in an early stage and they have a long way to go.
• Most economists agree that the best place to start is with get us all mixed up.
• The models are based on the traditional building blocks.
• The underlying psychologi book should be simpler because it focuses on models with the traditional cal foundation.
• Calculating self-interest is one of the building blocks of economists' research.
• People are doing what economists are doing.

• Economists' traditional analysis of individual choice doesn't deny that most of us have quirks.
• We're penny pinchers on certain items and big spenders on others.

• Through it all, there is a certain rationality.
• The rational self-interest of many people is reflected in what they do.
• That's why economists begin their analysis of individual choice with a psychological foundation.

• The market uses price to bring the quantity supplied equal to the quantity demanded.

• Understanding how price affects our choices is what economics is all about.
• The effect of price on quantity demanded is what we focus on.
• We want to know how a change in price will affect us.

• The economists' theory of rational choice shows howpleasure and price are related.

• As consumption increases, marginal utility decreases.

• There are two ways in which total utility is presented.

• The marginal utility line is graphed at the halfway point because it relates to changes in quantity.

• The 4,700 is the total utility; Utility and Pleasure the 3 is the marginal utility.

• Figure 19-1 shows the relationship between total utility and marginal utility.
• The marginal utility of the first slice of pizza is 14 and the total utility is 14 since you only ate one slice.
• The total utility of 2 slices of pizza is 26 because the marginal utility of the second slice is 12.
• For the third, fourth, and fifth slices of pizza, their marginal utilities are 10, 8, and 6.
• The marginal utilities you get from eating each of the 5 slices of pizza is the total utility.

• To make the examples more understandable and to make the points I want to make, I choose specific numbers throughout the book.
• Economists do not use actual numbers to discuss utility.
• The numbers are used to make the presentation easier.
• You can use an exercise to choose different numbers and reason your way through the analysis.
• I use the same analysis in the appendix of the chapter.

• There is a marginal utility between the rows.
• Changing from 1 to 2 slices of pizza has a marginal utility of 12.
• The relationship between total and marginal utility can be seen graphically.
• After 8 slices of pizza, you're so stuffed that you can't look at another slice.

• Utility becomes zero when there is a marginal point.

• marginal utility is zero when total utility stops increasing between 7 and 8 slices.
• Total utility decreases and marginal utility is negative after this point.
• An extra slice of pizza will make you worse off.

• With each slice of pizza eaten, the marginal utility that a person gets from each additional slice decreases.
• Economists believe that the shape of these curves is a good description of the pattern of people's enjoyment.

• When individuals increase their consumption of a good, they will simply not get as much pleasure from consuming another unit.

• Consider that late-night craving for a pizza.
• You have to bite into it.
• If you've ordered a large pizza and you're eating it alone, you'll enjoy each additional slice less.
• The marginal utility you get is going to decrease with each slice of pizza you consume.
• It's the principle of diminishing marginal utility.

• Consuming more enjoy consuming more of a good; it simply states that as you consume more of a good, you enjoy the additional units less than you did before.

• marginal utility can become negative at some point.
• You only had two hours to eat the pizzas.
• It could be torture to eat the last slice.
• Diminishing Marginal is a good sign that the marginal utility is still positive.

• Rational choice is the analysis of how individuals choose goods within their budget in order to maximize total utility, and how maximizing total utility can be accomplished by considering marginal utility.
• Rational people want as much satisfaction as they can get from their resources, according to the analysis.
• The problem is that people have a budget constraint.
• They have to choose among the alternatives.

• Consider three choices.

• Spending another dollar on a slice of pizza will give you an additional 41 units of utility, or spending another dollar on a cup of coffee will give you an additional 30 units of utility.

• Between reading an additional chapter in this book that gives you an additional 200 units of utility at a cost of one hour of your time, or reading an additional chapter in psychology that gives you an additional 100 units of utility at a cost of 40 minutes of your time.

• Between having your next date with that awesome guy Jerry, which gives you an additional 2,000 units of utility and costs you $70, or taking out plain Jeff on your next date, which gives you an additional 200 units of utility and costs you $10.

• The pizza, chapter of the book and Jerry are the correct choices in terms of marginal utility.

• Either you are lucky or you have a good intuitive understanding of the principle of rational choice if you answered all three correctly.
• The principle of rational choice can be explored more thoroughly by considering each of the three examples.

• Since the slice of pizza and the cup of coffee both cost $1, and the pizza gives you more units of utility than the coffee, the pizza is the rational choice.
• If you spend $1 on coffee instead of pizza, you're losing 11 units of utility and not making yourself as happy as you could be.
• Any choice that doesn't give you as much utility as possible is irrational.

• If the price of coffee falls to 50 cents a cup, you can buy two cups for the same price you had to pay for one.
• Remember the principle of diminishing marginal utility when you say that two cups of coffee would give you 56 units of utility.
• Their 56 units of utility are 15 more than you would get from one slice of pizza, so they have two cups of coffee.

• One way to think about your choice is to know that what you're doing is buying units of utility.
• You want to get the most for your money, so you choose goods that have the highest units of utility per unit of cost.

• Consider our second choice when thinking about a decision.

• The two alternatives have a cost.
• One hour of CNN gives the same analysis.

• Pick the activity that has a higher marginal utility per unit of cost or a lower marginal utility per unit of cost.
• The psychology chapter gives you 21/3 units of utility per minute, while this chapter gives you 31/3 units of utility per minute.
• To keep the analysis simple in this example, I consider either/or decisions.
• I show you how to extend the analysis to marginal choices.

• I choose the numbers to make the points I want to make.
• If you want to see what your rational choices are, you can choose different numbers that reflect your estimate of the marginal utility you get from a choice.

• Taking out Jerry will give you 28 1/2 units of utility per dollar, while taking out Jeff will give you 20 units of utility per dollar.
• Rational choice is important for us to restate.

• By substituting the marginal utilities and prices of goods into these formulas, you can always decide which good it makes more sense to consume.
• The one with the highest marginal utility should be consumed.

• We've considered the choices separately so far.
• Choices are not neatly separated in real life.
• You were presented with all three choices at the same time.
• The answer is no.
• The pizza gives you 41 units of utility per dollar, while taking out Jerry gives you 28 1/2 units of utility per dollar.
• You aren't maximizing your utility.
• It makes sense to eat more pizza and pay for it by cutting the date with Jerry short.

• The costs of both studying alternatives are expressed in terms of time, not money, so we can't compare them.

• We can make the comparison if we can assign a money value to the time.

• The value of your time is 10 cents per minute if you earn $6 an hour.

• We can think about both alternatives in terms of dollars and cents.
• 60 minutes x 10 cents is the cost in money of reading a chapter in economics.
• The cost of 40 minutes to read the psychology chapter is $4.

• We can compare our decisions with these values.

• Jerry has 28 1/2 units of utility per dollar.
• You can study this chapter while eating pizza.

• As you consume more of something, the marginal utility you get from it falls.
• The marginal utilities of these activities will fall as you consume more pizza and read more.
• The marginal utilities you get from the goods are changing as you vary your consumption.

• I assume that the "goods" are divided.
• This assumption is needed for marginal utilities to be fully specified.

• When there is no clear winner, you have to adjust your spending.

• You're in equilibrium when you maximize utility.
• It's important to remember to maximize total utility only when marginal utility is diminishing.
• The marginal marginal utility of all goods is zero as we consume more of an item.

• Tell me your answer.

• It takes more information than I've presented to achieve equilibrium by maximizing utility.
• We need to know how much we have to spend on all those items and the marginal utility of alternative amounts.
• Given our available resources, we can choose among alternatives.

• In Table 19-1 we can see an example in which we have the information to make simultaneous decisions and maximize utility.
• We have $7 to spend on ice cream cones and Big Macs.
• There is a choice between ice cream and Big Macs.
• The principle of diminishing marginal utilization in action can be seen in the table.

• By following the rule that we choose the good with the higher marginal utility per dollar, we can quickly determine the optimal choice.

• The table has the information needed to make simultaneous decisions.
• As we consume more of it, we get the marginal utility from another decline.
• Until the marginal utility of all goods is equal, adjust your choices.

• We would only eat ice cream.
• If we spent $2 on a Big Mac, we would get 20 units of utility.
• The 10 units of utility per dollar from the Big Mac is better than the 7 units of utility per dollar we can get from ice cream cones.
• We buy 1 Big Mac and 2 ice cream cones with our first $4.

• Let's look at our sixth and fifth dollars.
• We ask McDonald's if it will, and it tells us no, so we have to choose between two additional ice cream cones or a Big Mac.
• Since the marginal utility per dollar of the fourth ice cream cone is only 2, it makes sense to spend our fifth and sixth dollars on another Big Mac.
• We have one more dollar to spend and now we have 2 Big Macs and 2 ice cream cones.

• 7 additional units of utility can be obtained if we spend it on a third ice cream cone.
• Since we only have a dollar and Big Macs sell for $2, this is our only choice if McDonald's only sells whole Big Macs.

• McDonald's wants the sale and this time they will sell us half a Big Mac for $1.
• The answer is no.
• The third ice cream cone gives us 7 units of utility per dollar, whereas half of the next Big Mac gives us only 5 units.
• The seventh dollar is spent on an ice cream cone.

• The marginal utilities per dollar are the same for both goods and we're maximizing total utility with these choices and $7 to spend.
• Our total utility is made up of 34 from 2 Big Macs and 53 from 3 ice cream cones.

• The $7 we have to spend is the most total utility they give us.
• The utility maximization rule says to maximize utility by adjusting your choices until the marginal utilities per dollar are the same.
• The marginal utility between the last Big Mac and the last ice cream cone is equal.

• We know we can't do any better because the marginal utility per dollar of each choice is the same.
• We could increase our total utility if we switched to one of the two choices.

• Our example only involved two goods, but the reasoning can be extended to many other goods.
• The principle of rational choice among many goods is an extension of the principle of rational choice applied to two goods, according to our analysis.

• The principle of rational choice is to consume more of the good that provides a higher marginal utility per dollar.

• When the marginal utili ties are equal, stop adjusting your consumption.

• The per son's decision of how much to consume is combined with the person's choice of how much to work.
• When you say you want a car but can't afford it, economists ask if you're working two jobs and saving money to buy it.
• If you aren't, you're showing that you don't really want a car, because you'd have to do a lot to get it.

• The rule for maximizing utility relates to the laws of demand and supply.
• We start with demand.
• The law of demand says that quantity is related to price.
• When the price of a good goes up, we consume less of it.

• The law of demand is related to the principle of rational choice.

• It goes down.
• The principle of rational choice is no longer valid when the price of a good goes up.

• The rule is no longer satisfied.

• The marginal utility we get from the good whose price has gone up must be raised to satisfy our utility-maximizing rule.
• The marginal utility of ice cream rises and the marginal utility of a Big Mac falls as we reduce the number of ice cream cones and Big Macs.

• If you are in equilibrium you can increase your utility by consuming less.
• When the price of a good goes up, and the price of one good goes down, how consumption of that good will go down.

• As price falls, other things are constant.

• As price rises, quantity demanded falls.

• The rise in price is one of the effects that we have to cut back on.

• The price of ice cream has gone up.
• The law of demand is based on the substitution effect.

• Let's assume that someone compensates us for the increase in the price of ice cream cones.
• We'll assume someone gives us an extra $3 to compensate for the rise in price since it would cost $10 to buy what $7 bought previously.
• The income effect is eliminated because we are not any poorer because of the price change.
• We can buy 2 Big Macs and 3 ice cream cones now that we have $10, because we did before.
• If we do that, our total utility is once again 87, which includes 34 units of utility from 2 Big Macs and 53 units of utility from 3 ice cream cones.

• Our total utility goes up to 44 from 3 Big Macs and 46 from 2 ice cream cones, for a total of 90 units of utility.
• We've increased our total utility by taking ice cream out of the equation.
• Even though we were given more money, we didn't buy the same amount of ice cream cones because the price of ice cream went up.

• The law of supply of factors of production, such as labor, indi utility and the price of supplying a good goes up, if there is diminishing marginal choice, you supply more of that good.

• You are getting money in return for your time, land, or other factor of production in supply decisions.
• One final example is how much labor you should give to the market.

• If you work another hour at your part-time job, you will get another $8 and you will be working 20 hours a week.
• 24 units of utility are given from the additional income from the final hour of work.
• If you use that hour to study economics, you will get another 24 units of utility.

• The wage per hour is the opportunity cost of studying because it is the price of studying.

• Say that your boss offers to raise your wage to $8.25 per hour for work you can explain how you would do over 20 hours.
• If your employer raises your wage, the price of studying will change the amount of work you get.
• You can get more goods if you work an additional hour.

• The marginal utility you get from an hour of work to 32 additional units is raised by those additional goods.

• You work an extra hour.

• Say your boss comes to you and asks you what it would take to get you to work more hours.

• The law of supply is demonstrated by the supply curve shown in the margin.

• There is a comparison of marginal utilities for various activities.

• Say that an exam is coming and you haven't studied.

• You're in good shape if you answered that it will shift to the left.

• Rational choice is related to the opportunity cost concept that I presented in earlier chapters.
• The principle of rational choice states that a forgone opportunity is essentially the marginal utility per dollar you forgo from that, to maximize utility, choose.

• The opportunity costs of the alter natives are the same if the marginal utilities per dollar spent are equal.
• The principle of rational choice is stated in this way: To maximize utility, choose goods until the opportunity costs of all alternatives are equal.
• A spe cific measure of utility doesn't exist because people don't use the terminology.
• They use the opportunity cost of the benefit all the time.

• The higher the marginal utility, the more you need it.

• Understanding a theory involves more than understanding how a theory works; it also involves understanding the limits of the assumptions underlying the theory.
• Behavioral economists are questioning some of the assumptions on which traditional economists' analysis of choice is based.
• The assumptions include that decisions are costless, tastes are given, and utility is maximized.
• Let's look at some of their questions.
• The implicit assumption is that decisions can be made costlessly.

• Rational choice makes sense when we limit our examples to two or three choices, as I did in this chapter.
• We make hundreds of thousands of choices at the same time.
• It doesn't make sense to apply rational choice to all of them at once.
• 428 Microeconomics would exceed our decision-making abilities.
• It is only rational to do things without applying the principle of rational choice because of the cost of decision making.
• We all save money by thinking about decisions.

• Modern economists spend a lot of time researching.
• A number of economists have come to rational choice following the work of rationality.

• Rational ity is based on rules of thumb.
• They say that many of our decisions are made with our minds.
• The view of rationality has implications for interpreting and predicting eco Advertising.
• One rule of thumb is "You get what you pay for."

• We rely on price to convey quality information.
• This reliance on price for information can lead to upward-sloping demand curves.

• Do what you think smart people are doing if you don't know what to do.

• The following scenario should be considered.
• You buy a ticket for a con.
• The suppliers lose cert on the way.
• Consider the second scenario.
• It's the "in" thing to buy their product.
• If you buy a $100 concert ticket and lose $100 in cash, they have a gold mine.
• You have enough money to pay for the ticket.
• Most of them have a flop.

• Behavioral economists suggest that because the goods are objectively preferred that people make choices to all other goods, but simply because they have ries, instead of over all catego become focal points to which people have ries.
• The gravitated was in the first scenario.
• Some people started con ticket and others followed.

• It's too much to add another $100 to that mental category.
• People decline Given Tastes doing that.
• The second assumption is that we prefer the concert category, soences are given and are not shaped by spending another $100.
• Our preferences don't add to that "concert", they add to our Stock Photo category.

• The term was created by a famous institutional economist.
• Veblen found mansions, designer clothing, and $300 Appetizers to be examples of conspicuous consumption.
• He argued that male industrialists were so busy with business that they didn't have time to show off enough so they married a trophy spouse who would spend their money in a way that showed off their wealth.

• In reality, economists agree that forces other than price and marginal utility play a role in determining what people want.
• An analysis of what determines taste is necessary to supplement theirs.

• What do you eat today?
• It wasn't the most efficient way to satisfy your needs.
• The best way to do that is to only eat soybean mush and vitamins at a cost of $300 per year.
• The average person spends less than a tenth of what they spend on food each year.
• Most of us don't like soybean mush.
• It's important that tastes are important.

• Some economists have been guilty of forgetting their assumptions.
• In the 1800s, some economists thought that society's economic needs would eventually be met and that we would enter a golden age of affluence.
• They believed there would be surpluses of everything.
• It seems that whenever a need is met, it's replaced by a want, which soon becomes another need.

• A small island in the Caribbean is reported to have found examples of wants being temporarily satisfied.
• Employees didn't show up for work.

• The situation was not good for business, but the firm found a solution.
• When Sears sent catalogs, the workers were no longer satisfied with what they already had.
• They wanted more when they were presented with new possibilities.

• Companies spend a lot of money on advertising to get consumers to like their goods.

• Differences in consumption are explained by taste.
• A Japanese person wouldn't consider having a meal without rice.
• Rice can explain why a change in tastes tastes ceremonial in Japan.
• Supper will change the demand curve in many parts of the United States.

• In the United States, many people consider a large goldfish to be inedible.
• Corn is a desir able vegetable in the United States, but in parts of Europe it was considered pig food.

• It's difficult to make good decisions.

• In the real world, parents and teachers spend a lot of time on training.
• Children's decision-making process is indicative of what teaching is.
• Parents and teachers teach more than a decision one makes must be rational, decision-making process; they also teach children a moral but such usage makes the concept tautological--true by code that often includes the value of honor and selfless definition.

• Most econo making process when applying the theory of rational choice is to modify their preferences, although not always in the way that mists agree.
• They will admit that five-year-olds make ences.
• A lot of what most parents would call stupid ences are taught to us in our decision-making process.

• If the child had logically processes that were taught, not inherent, they would have caused the child not to judge people's deci make that particular decision.
• Eliminating the fixed point makes it difficult to sum up the decisions made by five-year-olds.

• We don't analyze tastes in the core of economic theory, but we take them into account.
• We distinguished shifts in demand from movements along the demand curve in Chapter 4.

• The demand curve was affected by price.

• The shift factors of demand are taken into account by economists.
• A change in tastes is one of the factors economists include in their analysis.

• The third assumption that behavioral economists ask is that individuals maximize their economic choice by getting more for themselves.

• Two people are given the chance to split money.
• One person can decide how to divide it.
• If he wants, he can keep whatever portion he wants, or give 10 cents to the other.

• Most of the rational choices would be kept by the first individual, who would give only a small amount to the other.
• The other person comes out 1.
• Decision making is costless.

• There are some things that are given.

• People maximize utility.

• This is not what happens when people play this game.
• The first person usually offers something close to 50%.
• The offer is usually rejected in instances where the first person only offers a small amount.
• People are willing to pay money to enforce a sense of fairness in their decisions.

• When Sweden privatized its social security system, it was an example of this happening in the real world.
• The citizens of Sweden were offered 456 funds to invest when they privatized retirement.
• One of the funds was offered as a default even though the Swedish government encouraged participants to choose their own portfolio.
• 33 percent chose the default fund, a far higher percentage than would have been expected if the fund had not been identified as the default.

• It is difficult to argue that people are choosing rationally.
• Some behavioral economists suggest that policy makers can take advantage of the status quo bias by structuring programs so that choices are framed in ways that lead people to what the policy makers want them to do.
• They argue that the policy design does not violate consumer sovereignty because individuals are free to choose.

• Behavioral economic insights are changing the face of economics.
• The insights should be seen as comple ments to the standard economic reasoning.

• The chapter began with a discussion of the economists' analysis of rational choice.
• You may be wondering if it's all that easy after you've been through it.
• Most of you would agree that it's complicated enough.
• I'm in agreement when we're talking about formal analysis.

• Most economists agree that the theory of choice is not acceptable if you're talking about informal analysis and applying it to the real world.
• There is more to life than maximizing utility.
• We believe in love, anger, and doing crazy things for the sake of doing crazy things.
• We are real people.

• We argue that simplicity has its virtue and that people hide their selfish motiva tions.
• They're probably partially right, but often hide their interest theory of choice because it cuts through many obfuscations and obscures their self-interested motives.
• The beauty of doing so is that it captures a part of reality that others miss.

• Let's look at a few examples.

• Many of the restrictions do little to protect the public.

• The museum directors' answer is that they're out to preserve our artistic heritage.
• The traditional economic answer is to maximize the utility of the museum staff.
• He supported his argument that more than half of museums' art is in storage and not accessible to the public.

• Approaching problems by asking the Now is not the way to go about it.

• It gets people to ask tough questions.
• You can see how to modify the conclusions by looking into the real-world institutions after you've asked the tough questions.

• Economics and economic reasoning are often thought of as establish ment reasoning by students.
• Economic reasoning can be very offensive to existing establishments.
• Whatever it is, it is not pro establishment in order to be subver sive.
• It's a logical application of a simple idea.

• The law of demand is based on the income effect and the consumption of a product; marginal utility is the substitution effect.
• When the price of a product increases, the income effect is the reduction in tion obtained from consuming one additional unit quantity.
• The principle of diminishing marginal utility states in quantity demanded when price rises is called the substitution effect.

• The principle of rational choice can be used to derive the law of supply.

• The law of demand can be derived from the principle foundations of behavioral economics.

• If you're in equilibrium and the price of a good rises, fairness as well as total income, the ultimatum game suggests that people care.
• The status quo bias suggests that actions are based on perceived equilibrium.

• Answer the questions below and complete the table of Scout's utility from drinking cans of soda.

If the price of B goes up, how will the answer change?

• Tell me your answer.

• The total utility of your consumption is 40; it changes by 2 with each change.

• A, B, and C are three goods and the price of them is $2.

• A $10 200 380 530 630 680 700 630 430 utility concept explains why it is not a paradoxes.

• Explain how the law of demand relates to the principle of rational choice.

• Explain how the law of supply relates to opportunity cost.

Does the utility from the consumption of these goods come from the price?

• You can give an example of a good.

The price of a calzone could go up to $10

• If you are compensated, your study partner will tell you.

• Questions from Alternative Perspectives 1.
• The book suggests that the decisions are economic.

• People buy things to impress others.
• How would it fit into the decision-making?

What implications would such actions have?

• The issue of decision making in worth more to a poor person than a rich person is discussed in this textbook.

How would you design income tax people to make decisions?

• The world would be different if 2.

• You can assign a measure of utility to your studies.

• George Stigler explains from a mined diamond just by looking at it.
• The famous British economist Phillip Wicksteed will have more brilliance and fewer places to live.
• He loved fresh farm eggs more than a mined diamond.

• Given these two b.

• Although the share of Americans who say they are very that bears his name hasn't changed much in the last five decades, the selling of wine right after prohibition has.

• Give an example of a recent purchase where you used a bottle on one and a bottle on the other.
• He let you make your own decisions.
• Did your people ask which one they wanted?

• Even though they were the same wine, most wanted the 10-cent bottle.

• Economic experiments show that people prefer a certain thing.

• Answers to Margin Questions 1.
• The marginal has increased if the total utility curve is straight.
• The utility curve will be flat with a slope of zero since the principle of rational choice.

• The rational choice is to 9.
• It depends on how you watch CNN, since it gives the higher mar pret bounded rationality.
• It can be interpreted within a cost ginal utility per hour.

• When the mar principle of rational choice is used, you are maximizing total utility since there is no reason to be ginal utilities per dollar for all goods.
• You can be zero if it's interpreted in a way that doesn't mean marginal utility is a costly decision-making environment.

• I will reduce my consumption of a good if the price goes up.
• Information does not increase the consumption of other goods.

• The income effect and substitution good are the two effects that will increase consumption.
• A change in tastes will cause a change in the demand curve.
• I would choose tity consumed without a change in the good's substitute labor for leisure since the price of leisure price, if offered one more dollar per hour.

• She can get 10 bars if she spends it all on chocolate bars.
• We have two numbers that are unnecessary and I would use them anyway.

• The line is her budget.
• She lives on two things.

• To see that it is, you have to buy all of her for 50 cents.
• He is trying to get money on chocolate bars.
• She decided to buy a lot of pleasure because of her resources.
• That gives her $1 to spend on tively expressed, she is trying to maximize her utility, since those cans cost 50 cents each, given a budget constraint.

• Don't mention any specific amount of utility.

• The $10 can be used to buy something.
• The line intersects the chocolate-bars axis at 10 and the Graphing the Budget Constraint cans-of-soda axis at 20.

• To be sure that you have it, ask yourself how you can translate the budget constraint into Gra $4 to spend on the two goods.
• Asking what reasoning would lead you to the conclusion that the bud happen if she spends $10 on chocolate bars or all get constraint will shift to the right so that it will intersect on cans of soda is the easiest way to do that.
• You need to explain why.

• You can get a Graphing the Indifference Curve set of combinations of chocolate bars and cans of soda if you continue our thought experiment.

• You can plot the combinations of points on the can.

• Let's ask her if she knew about the one where she was indifferent.

• You had 10 late bars.

• That doesn't sound right, it's bowed inward.

• Let's look at an example.

• The slope of that curve is the absolute value.

• The "prefer-more-to-less" principle would be violated.

• There are 7 cans of soda and 9 chocolate bars in the house.

• Two indifference curves cannot intersect because of cans of soda Latin.
• We drew the group of indiffer ence curves so that they don't intersect.

• You can start with different combinations of goods.
• You can get Combining Indifference Curves in Figure A19-3 if you do that.
• Budget Constraints happiness is represented by each curve.
• If she's on Curve II, the budget constraint and indifference are better off than if she's on Curve I, and if she's on Curve III, the budget constraint and indifference are even better off.
• If she has $10, she will buy cans of soda, even if they are not good.

• Curves in Figure A19-3 can be used to see if you followed the reasoning.

• They're indifference curves.

• That looks like a good point.

• The reasoning is the same for all points.

• We arrived at the same con clusion we found in the chapter, only this time we did it without using actual numbers.

• When without a Utilometer, economists' principle of rationalSophie started with $10 and chose to buy 8 cans of soda, is internally logical.

• She buys 8 cans of soda for 50 cents.

• Say the price of a can of soda goes to $1.
• The principle of rational choice rotates the budget line in from budget line 1 to budget line with indifference curve/budget line analysis.
• She can't buy as much as she can demand.
• We can figure out how much she'll buy.
• The quantity of a good is the same as the reasoning we used before.
• A son will be bought at various prices.
• The relative price of a good and the point of her new budget line are given by the lower indifference curve.
• The price/quantity axis in Figure A19-6(b) shows the curve of soda demand from the indifference curves and budget at $1 each.
• Con thought experiments asking how many cans of soda are in each can, and you can see we're getting aSophie to buy at various prices.
• The downward-sloping demand curve is the law of one of those experiments.

• She'd have to be com changes to continue the analysis for a couple of additional price required by the substitution effect.
• You will see that the demand curve you derive will correspond to a rise in price and a fall in it.

• Let's make a deal.
• You tenta, there's more we can do with indifference, I think that all kinds of stuff can be curves.
• Income effects and substitution can be seen with indifference curves and budget constraints.
• To be as well off as before, and to experience in the intermediate microeconomics courses.

• $5 is enough to buy video games and a.
• The budget constraint would be hot dogs.

What is the rate of substitution of hot dogs?

• The price of hot dogs would fall to 50 cents.

If the mar drew the new budget constraint, what would the indifference curve look like?

• The indifference curves are shown in a graph.

• Discuss how strategic reasoning is used to solve games.

• They are looking at some women and discussing their strategy to meet them.
• Nash tells his friends that if they were to approach the problem on their own, they might all go for the blonde.

• No one gets the blonde if everyone competes for her.
• We all go for her friends.
• No one likes to be second choice so they give us the cold shoulder.
• We don't insult the other girls and we don't get in each other's way.
• That is the only way to win.
• That's the only way to get a girl.

• Nash's eureka moment is when each person acting in his or her own best interest will not necessarily arrive at the best of all possible outcomes.
• Adam Smith is wrong.

• When interdependent decisions are involved, the decision makers' strategy needs to be considered.
• The study of interdependent decision-making processes is central to modern economics.

• Game theory is more than just a tool used by economists.
• Game theory is being used more and more by all social scientists as a tool of analysis.
• Political scientists and sociologists can discuss war strategy and social relationships in game theoretic terms.
• The underlying model of the social sciences is game theory.

• Modern economics is becoming more and more dependent on game theory, which is inconsistent with supply and demand in many cases.

• Graduate students studying microeconomics spend more time learning game theory than they do learning supply and demand models.

• Game theory has become so important because it is a flexible tool that can be applied to many situations without making the restrictive assumptions of the supply/ demand model.

• The film's reasoning can be questioned.
• The filmmakers didn't care about it being wrong because it made for a better scene.

• I think that when you learn a model, it's hard to make it fit in real-world situations.
• Economists are constantly tweaking existing models and developing new models to help us understand real-world problems and issues.
• Game theory offers a new set of models that can be used to approach economic issues.
• Game theory models are more flexible than standard economic models because they can be tailored to fit the problem.

• The individual game theory models are not as broad as the standard models.
• A different game theory model is needed for each situation and set of assumptions.
• In game theory, there are many models that have multiple equilibrium solutions.
• Game theory is a framework rather than a finished set of models for understanding real-world events.

• Four students with A averages had partied the night before the exam and slept through it.
• Since they were "A" students, and the professor liked them, they decided to make up a sad story and convince her that they should be allowed to take the exam late.
• They went to the professor apologetically, explaining how they intended to come to the exam, but when they got back from visiting a sick brother, they had a flat tire.
• They were late for the exam because it took them five hours to get the flat fixed.
• It wasn't the best story, but they thought it was worth a try.

• The professor agreed to let them take the exam two days later.
• They thought they were a shoo-in for A's.
• They were put in separate rooms and given an exam by the professor.
• The first page, worth 10 points, was an easy question, which they all aced.
• The second page had one question and was worth 90 points.

• If they had structured in such a way as to reveal had a flat, the question would be easy to answer, and they would get their A's.
• Information about the person who answers.

• If they had studied game theory or been bright, they would have expected the professor to use a screening device to find out which tire went flat before they took the exam.
• She would have worked out an even more elaborate testing strategy to get them to reveal if the professor had taught them game theory.

• Understanding the strategic interaction of individuals when they take into account the expected reaction of others is the essence of game theory.

• The ultimatum game in the earlier chapter on individual choice is one of the games that comprise game theory.
• The rest of the chapter introduces you to other games and game theory concepts.

• The goal of the chapter is not to make you a game theorist, but to give you a sense of how economists think and try to understand the many puzzles that are out there.

• In the Prisoner's Dilemma example, two people suspected of committing a crime are brought into the police station and questioned separately.
• If neither of them confess, the police will only have enough evidence to charge them with a minor crime for which each will serve 6 months.
• The police know that the criminals are guilty of more serious crimes.
• The police don't have enough evidence to prosecute the more serious crime.

• If both you and the other prisoner confess, the two of you will serve only 5 years in jail, instead of the maximum 10 years.

• If you confess but the other prisoner doesn't, we will drop the charges for the lesser felony and you will be set free.
• You will be sentenced to the maximum 10 years in prison if you don't confess and the other suspect does.
• Both will be charged with a lesser felony and serve 6 months.

• If they could coordinate their actions, they would be the best option for them, with each getting a short sentence of 6 months.
• If they do, consider the possibilities.

• Each confess would get a light sentence.

• The blue triangle shows Prisoner A's punishment and the green triangle shows Prisoner B's punishment.
• If Prisoner A does not confess, we will be in the bottom row of the payoff matrix.
• The payoff matrix is used to consider what options Prisoner B faces.
• If Prisoner B does not confess, they both get 6 months in jail.

• Prisoner B will go free if Prisoner A does not confess.
• If Prisoner A does not confess, Prisoner B's best option is to free him.

• Prisoner A will put us in the top row of the payoff matrix.

• If Prisoner B does not confess, Prisoner B gets 10 years and what is B's best strategy for fesses, 5 years.
• Prisoner B's best strategy is to confess.

• Each of Prisoner B's optimal strategies is to confess, placing them in the upper left corner of the matrix, what is B's best strategy corner.

• Confessing is a requirement for each prisoner.

• The reasoning and assumptions of game theory led to the outcome.
• We assumed that the prison sentences captured all the costs and benefits of their decisions.
• We assumed that no cooperation was possible.
• The optimal strategy for the prisoners is not to con fess each other, and they both get a light sentence.

• The dilemma is real for many prisoners and for many individuals and firms because binding contracts are hard to come by.
• If standard game theory assumptions hold, cheap talk doesn't affect the results since the players can't trust the other players to follow through on what they say.

• Cheap talk may not be so cheap.
• Cheap talk can affect the outcome of a game if players have a hard time figuring out their optimal strategy.

• The analysis of the prisoner's dilemma is based on the assumption that the other player will choose the best strategy, while taking into account the other player's decision.

• Getting used to thinking in terms of payoff matrices is hard.
• Put it in the left-hand box.

• Does not confess gies to each player.

• Each of B's best strategies should be put together.

• Each of A's best strategies should be put an for.

• A row with two s is a dominant strategy.

• Does not confess b.
• A box with two things in it is a Nash equilibrium.

• The pattern of's and's can be used to make conclusions.
• Put it in the left-hand box.

• If B doesn't confess, A's best strategy is to confess, so put an in the upper-right-hand box.

• Ask the same questions for individual B.

• The concept of a Nash equilibrium is a key concept in analyzing games and was first proposed by John Nash.
• A Nash equi player can improve his or her payoff by changing strategy.

• A Nash equilibrium is the solution to the prisoner's dilemma.

• The solution that is best for all players is not the Nash equilibrium.
• Both prisoners in the prisoner's dilemma would benefit from the same solution.
• Not confessing independently is not the best strategy for either prisoner.

• A Cournot Nash equilibrium is a concept that goes back to August Cournot, a French economist in the 1800s.

• Different assumptions about the nature of the interaction lead to different kinds of games.
• In the prisoner's dilemma game discussion, we pointed out that cooperation was not allowed.
• When a game is repeated, the possibility for cooperation increases.
• The outcome of a game that is repeated can be different from the outcome of a game that is only played once.

• Another assumption relates to the order in which players make decisions.

• The order makes a big difference in sequential games.
• Some games have first-mover advantage.
• Other games have an advantage.
• Both Todd and Jenifer attend the same school.
• Jenifer is wild about Todd.
• The dining hall has two tables for them to eat in.
• If Todd is the first one to move, he will sit with Jenifer since she will always sit at the table with him.
• Todd will always sit at another table if Jenifer is the first to choose a table.
• The second mover has an advantage in this game.

• Game theory can be used to study strategic interactions in specific games.
• Let's start with a simple game.
• I think most of you know that tic-tac-toe is not very interesting because it has a clear-cut answer.
• tic-tac-toe will always end in a tie if people play a strategy that gives them the best chance of winning.

• Formal game theory predicts that any tic-tac-toe game will end in a tie because it assumes all players are fully forward-looking, that they always behave in a manner that gives them the highest payoff, and that all formal game theory predicts that.

• When we say that players are rational, we mean this.

• The assumption of rationality allows us to give precise answers.
• It is important to remember that formal game theory only provides a prediction about the outcome of a game, and that people aren't always rational.
• Modern behavioral economists use games in their experiments to find out if the behavior is irrational.

• Theoretic predictions and actual outcomes of games are compared to the theoretical and empirical results.

• Game theory has offered insight into the reach of a collusive result than are non-posted or uncertain ture of economic problems but arrives at the conclusion price markets, where actual sale prices are not known.

• Experiments in game theory have been used extensively in branch of economics to design auctions that give insight into which outcome is most licenses or oil leases.
• Seeing how likely the auctions were.
• Let's look at an example.

• Experiments that involve games, economists, and real-world experience have found that people believe the other players in design policy.
• The policy makers started with the results of the game.
• When the gains from cheating are not too great, the formal game and integration of those into the regulations are used.
• Game theorists don't choose the individual utility-maximizing position, instead they choose a more cooperative strategy, at least regulations.
• Initially, the regulations were modified by policy makers.
• As the benefits of cheating become larger, such solutions tend to break down, and go through the process again.
• Addi is pointing out possible loopholes.
• As the number of participants increases, policy makers will find it harder to come up with the best regulations because the game will result in a cooperative rather than a competitive solution.

• The like airplane designs are tested in wind tunnels before the structure of the game plays an important role in deciding if they are built.
• The solution was the redesign of the auctions.
• For example, posted-price markets, in which and reconsidered by the game theorists, and eventually, the prices are explicitly announced, are more likely to be used as the regulations in auctions.

• Since the controls are never, and often far from, perfect, there is a debate about how much we can rely on such experiments.

• The back ward is continued until you arrive at the best strategy for your first move.
• The tic-tac-toe game is a sequential game with a complete set of choices that can be determined by working backwards from the desired outcome to the initial decision of where to place your X or O.
• It is possible to go to an optimal rollback strategy.

• If the other player is rational and the oner's best strategy is to confess, then a dominant strategy is what the prisoner chooses.
• Such a strategy is called an opponent's move.

• Even though the prisoner's dilemma is a simultaneous game, there is a dominant strategy with both players knowing what the other person will do.

• There are many simultaneous games that don't have a single dominant strategy.
• Again, consider rock-paper-scissors.
• Depending on what your opponent chooses, you can choose rock, paper, or scissors.
• You don't want your opponent to figure out a pattern in your choices.
• Your opponent has no pattern on which to base his strategy if you vary your choices randomly.

• If a game has an optimal solution, we may not be able to figure out which moves to use.

• It is impossible to make a rollback strategy in a sequential move game.
• Chess is an example.
• Once the first move is made, the winner is the one with the most powerful and fast computing ability.
• Chess grand masters have defeated computers whose calculations were based on a rollback strategy.
• Computer chess moves can be based on patterns gleaned from previous winning strategies.
• Chess is not the only game that requires a combination of intuition, calculation, and common sense.

• A single change in the rules can change the strategies in a game.
• The effect of moving from one game to another is considered.
• You are playing a game.
• In the ultimatum game, if Chess is complicated, two players are offered $10 to split between them.

• One player can decide how to split the $10, while the other can either accept the deal or not.

• The optimal strategy in a single-play ultimatum game is to assume that people only care about how much money they get.
• The optimal strategy for the first player is to give himself almost all the money and the second player 1 cent.
• The optimal strategy for the first is to accept because the player is better off getting 1 cent rather than nothing.

• The second player can send a signal to the first player that he needs to raise his offer if he wants to keep any of the money.
• There are more possibilities for implicit coop eration in repeated games than there are in single-play games.

• The two-thirds game is a game that shows how backward thinking works.
• The two-thirds game requires you and your classmates to choose a number between 0 and 100.
• If you choose a number that is two-thirds of the average, you will win.
• Write down what you want to read in the chapter.

• "Never go in against a Sicilian when the winner is Buttercup," is a well-known rule in the game.

• The villain, the Sicilian Vizzini, is offered the challenge by Westley.

• The game is for both of them to have a drink.

• The battle of wits has begun.

• The scene makes for some comic relief in the movie, but our in Westley thinks that the glass is actually the glass of the strategy.
• He thinks that Vizzini is getting something.
• By changing it to a se strategy, Vizzini thinks he can win the game.
• He thought the game he was playing was not the game he was playing.

• He thinks that the game he was playing was a game in which he would only drink if Westley believed he could only lose.
• Another lesson from poisoned glass is presented.
• When another individual presents you with a glass of water, that deci theory says that you can drink safely because the glasses are switched.
• You don't have full information, the scene continues.
• From the general rule of thumb, if it sounds too good to be true, you should drink from my glass.

• Let's look at your reasoning.
• If you chose a number greater than 67, you were not thinking.
• Since 1/3 of 100 is 67, you would lose even if all the other students chose 100.
• If you assumed that people would choose randomly, the average would be 50 and 1/3 of it would be 33.
• John Nash wouldn't have thought much of it as an answer.

• It makes sense to assume that people would not randomly choose the best, but that they would reason and choose 33, 22% of which would be 22, so it would make more sense to choose 22.

• The Nash equilibrium would have arrived at.

• But that is not the end of the reasoning.
• One can carry the reasoning back and forth until the number you choose approaches zero.
• Any number other than zero would lose to a smaller number.
• The equilibrium of the game is zero.

• Some games have no Nash equilibrium, and other games have an infinite number of them.
• Choosing the Nash equilibrium for the two-thirds game would almost always cause you to lose, as the probability of all people following their best strategy is highly unlikely.
• As the game was played the second time, after the reasoning was explained, the average number chosen by students decreased, and thus moved toward the Nash equilibrium.

• A is shown in the graph.

• In practice, repeated games have different results than one-time games.

• After the reasoning of the two-thirds game is explained to students, the average number they choose never reaches zero, so here we have an example of a game with a Nash equilibrium that, in practice, is not reached.
• The Nash equilibrium is not reached because people's reasoning process is more complicated than assumed.

• To apply game theory to real-world, they must be able to sense other people's behavior and have a sense of their own.
• To apply game theory to real world problems, it must be accompanied by a combination of reasoning, intuition, and empirical study.

• Much of the power of game theory is not in its formal application, but in its informal application, which involves setting up a study of human interactions in a game theoretic or strategic framework.
• Informal game theory looks at how people actually think and behave, instead of assuming that people are high-powered calculating machines who can figure out their optimal strategy.
• Informal game theory provides a framework for approaching questions.

• This approach to game theory was developed by Thomas Schelling, who argued that the power of game theory comes in the framework it provides for thinking about problems, rather than from formal solutions.
• The power of game theory comes from structuring a problem as a strategic interaction problem and writing a payoff matrix.
• One of the informal models explored in the box is the Segregation Game and Agent-Based Modeling.

• The long-running TV show of strategy is the first.

• A show that gains a lot of its interest by creating strategic problems for contestants that are mixed with games of skill.
• Each week one contestant is eliminated until two are left, at which time all the eliminated contestants get to vote on who will be the Sole Survivor and win the million dollar prize.
• To be considered fair and nice, contes tants must be ruthless, but also think about how to get other people thrown off.
• The show's hook is that.

• Rudy, a former Navy Seal who was seen as honest and fair, and Richard, a corporate consultant who was seen as cold, were the three players left in the most famous episode of the show.
• In the final challenge, the three of them had to stand on a pole with one hand on an immunity idol for as long as they could.
• The winner of the challenge would get to decide which two went into the final.

• To see the power of economist Thomas Schelling's informal "game" has been computerized and can be explored on approach to game theory, let us consider one of his thought the web.

• The game gives you insight into the process of segregating when there is no single solution, but it does have slight tendencies towards segregation.

• He imagined that a society first created his game and that powerful computers were still in use with two types of people.
• Both types had a small infancy.
• The field of economics, called agent-based mod group, was created because of the preference for living next to individuals from their own.
• He asked if the slight preference would lead to significant segre then allowed to interact.

• To understand complex economic phenomena, he created a model.
• He assumed that people have a slight preference for living next to people who are similar to them, in order to create virtual economies.
• He studied the effects of policy in the virtual economy before looking at the impact of that slight preference.

• There are some interesting uses for a slight individual preference.
• neyland has used agent-based modeling to keep its lines as lead to significant aggregate segregation.

• If Rudy made it to the final, he would win since he was the other player's favorite.
• They both wanted Rudy to go.
• If Richard won the challenge and kicked Rudy off, he would have to violate his alliance with Rudy and lose to Kelly in the final show.
• Rudy would beat Richard in the final, but Richard would continue.

• It is not clear who would win.

• If Richard picked Rudy to continue, he would almost certainly lose in the final voting because he had broken his alliance with Rudy.

• Richard has a dominant strategy to lose, hoping that Kelly wins.
• Richard quit the immunity challenge early, Kelly won the challenge, Richard continued, and Richard won the million-dollar prize.
• Rudy cast the deciding vote for Richard even though he had lost the game.

• A proposal by American billionaire Warren Buffet to get a strict campaign finance reform bill passed is a second example.
• A ban on many types of campaign contributions would make it harder for incumbents to win elections.
• Since incumbents are the ones who vote on campaign reform bills, they have little incentive to vote for effective campaign finance reform since that would make it hard for them to win elections.

• They don't really want the bill to pass because they want to portray themselves as being in favor of campaign finance reform.

• The proposal places both Democrats and Republicans in a prisoner's dilemma, because the bill would sail through Congress and cost our EB nothing.

• Consider their options.
• If they vote against the bil and the bil is successful, they will deliver $1 billion to the other party, which will offset their advantage in fund-raising in the next election.
• If the other party supports the bill, there is no gain in opposing it.
• The main strategy for both sides would be to support the bill.
• The bill would pass.

• With the continued increase in political party fund-raising, it will likely take an eccentric billionaire today to implement the offer.

• There are many more applications of the ideas in informal game theory to the real world, and much of modern economic thinking involves posing problems as strategic games, analyzing the strategic decision-making problem facing both sides, and design ing an institutional structure that accomplishes the goals one wants to achieve.

• The importance of strategy in decision making has been highlighted by game theory.

• He looked at the strategies of people in a sealed-bid auction.
• The person who pays the highest price gets the good.
• If you are bidding on a computer that you really want, you would be willing to pay $500.
• Your best strategy is to lower your bid enough so that it is slightly higher than what you expect the next highest bidder to bid.
• You can do better if you believe that to be very low.

• The second-highest-bid auction changes the strategy of the bidders, giving them an incentive to bid their true value for the good, since a bidder will win the auction without paying the higher amount.

• A bidder's strategy in a high-bid auction is to bid slightly higher than the next highest bidder.
• You would be willing to pay $500, but you don't think the next highest bidder will make a lot of money.
• The author has permission to use this material.

• If the second-highest bidder bids only $220, you would pay only $220, since you are not paying your bid.

• When you guessed the second-highest bidder's bid, the advantage of the auction became obvious.
• You bid $250 because you thought it was going to be only $220.
• The other bidder would win even though you were willing to pay more.
• The person who wants it the most wins the auction.
• Oil lease rights, radio spectrums, and online advertisement programs are some of the things that are being auctioned off.

• Informal game theory explores what rationality is and the nature of individuals' utility func tions.
• Modern behavioral economists use an approach that builds on the traditional economics that you've been presented with in earlier chapters-- maximization, equilibrium, and efficiency--but instead of stopping there, and assuming that the theory has to be right, extends the theory to fit the observations in the real The nature of preferences and choice has improved due to work in behavioral economics.

• One of the basic assumptions of economics is that people are self interested and do what benefits them.
• By definition, this assumption is true.
• altruistic people help others because other people's welfare is a component of their utility function It is not helpful to use a tautological approach to the analysis of choice.
• The degree to which individuals are con cerned with the welfare of others is explored in game theory.

• The trust game is a variation of the ultimatum game.
• The trust game has two players.
• She can either keep it all for herself or give it to the other player, which is tripled and given to the other player.
• The second person in The Dictator Game can either keep the tripled amount or give it back to the first person.
• The game is over at this point.
• The Nash equilibrium of this game is for the first player to keep the entire $10.

• The domi nant strategy of the trustee is to keep any money that is shared since there is no chance for the first player to reciprocate.
• The first person should share nothing in the first place.
• There are no gains from cooperation.

• On average, individuals invest $5 in cooperation and trustees return less than their investment.
• It's like people want to reward trust.
• In other experiments, it has been found that people will spend their own money to punish others who don't respond in a fair way.
• If people feel that someone is being unfair, they will reduce their own income.

• An example of empirical work suggests that people don't behave as the model predicts how people value things.

• Brian Knutson did an experiment in which he offered either an iPod or $100.
• Most people chose $100 when they had the chance.
• When participants were initially given an iPod, but then offered $100 in exchange for the iPod, most chose to keep it.

• If they did not own that item, they would value it less.

• The traditional assumptions about economic behavior do not always reflect reality.

• The classic choice is presented.

• People were asked how they would respond to 600 people who were threatened by a disease.
• The two undesirable options were given to the subjects.
• A guarantee of saving 200 lives for sure but losing the others or a 1/3 chance of saving all 600, but no one, were the options in the first experiment.

• A was the choice of most people.
• If a firm wants to increase the number of employees who participate in 1/3 chance of 600 dying and 1/3 chance of no one, they can offer a Q-9.
• The majority of people chose B over a savings plan.
• The two sets of choices are exactly the same, but people ask if the employee wants to respond differently if the choice is presented in the negative rather than the automatic withdrawal from a paycheck to retirement or an automatic tive frame.

• Behavioral economists are trying to understand the findings with traditional economic reasoning.
• The methods of economics are changing as they do this.
• Game theory is growing in importance.
• Standard theory allows us to state the economic result more precisely, but game theory allows a wider range of assumptions.

• In the example of the two-thirds game, game theory alone does not provide answers.
• Economists are incorporating experimental work into their methodology in order to do more empirical work.

• The field of experimental economics is growing.
• It includes laboratory experiments in which assumptions of the economic model are carefully followed, to see how sub jects actually respond, and field experiments in which the precise conditions are not as carefully controlled.
• Computer simulations and brain scans are used by behavioral economists.
• One of the branches of behavioral economics is called neuroscience, which uses brain scans to study individual choices.

• Behavioral economics provides a more nuanced view of humans.
• They are not fully rational, they show a nuanced view of human behavior, and they areBoundedly Rational.

• The traditional assumptions and model are not irrelevant because people do not act as they are predicted.

• If the standard rationality assumptions hold true, individuals can take advantage of people's actual behavior to make more money.

• Understanding the logic of the traditional model is more important than it would be if everyone acted according to their assumptions, because of the findings of behavioral economics.
• You can expect to lose money if you don't understand it.
• The point is that the traditional economic model doesn't require everyone, or even a majority of people, to behave in accordance with its assumptions.
• The standard economic model is no longer tionality or lack of self-interest because a few people can develop businesses and institutions that make people pay for their behavior.

• Advertising mutual funds is an example.
• Even though past performance of a mutual fund has little or no influence on future earnings of that mutual fund, firms strongly emphasize past performance in advertisements and in selling actively managed mutual funds.
• Investment companies often have many actively managed mutual funds, some of which do well in a specific time period, and some of which do poorly, just because of random variation.
• They can always have funds that have done better than average.
• When the mutual fund salesperson calls his clien tele, he will push the actively managed funds that have done well, taking advantage of people's tendency to think that past history is more relevant to future behavior than it often is.
• Investment salespeople and fund managers make a good living selling such funds that transfer money from the foolish to the wise.
• Most economists suggest that the way around this is to buy mutual funds that contain a broad set of stocks that reflect the broader market and are not actively managed.
• Those who understand the economic model can transfer money to the index funds that have smaller fees.

• The economic model is used to make decisions.
• Alfred Marshall said that the economic model is not a tool that gives answers to questions, but an apparatus of to reasonable conclusions.

• Even if most people don't behave as predicted, the logic of the economic model still provides insight.
• Money is not left on the table, and when people act differently than the economic model, we can expect people and firms to figure out ways to take advantage of their behavior.

• Concerns that you had about the relevance of the traditional economic mod els are also concerns that economists have, and are the basis of current research.
• In their research economists are pushing the boundaries of the traditional model and are developing new models to include such concerns.
• Don't think of economic theory as a static, unchanging theory; think of it as a dynamic theory, which is continually taking into account new discoveries and incorporating them into the model.

• The strategies of players are different in simultaneous that can be used to study a variety of situations in and sequential games.

• A prisoner's dilemma game is one in which both choosing randomly among moves.

• There are deviations between formal game theoretic predictions and actual outcomes.

• No player can improve his or her payoff by using traditional model's predictions because of Nash equilibration findings in behavioral economics.

• A dominant strategy is one that is preferred regardless, and only a few people realize that money has been of one's opponent's move.
• The results of the standard model are randomly chosen for the mixed strategy.

• Each is given the chance to make a statement against the other.

• The payoff matrix shows how much time each will take.

• Player A makes a statement in the payoff matrix.

• The person is silent.

• Two firms have an agreement to set prices.

• If a game has a Nash equilibrium, that will be the equilibrium we will observe in the real world.

• You should expect the next highest bidder to bid $100.

• The prisoner's dilemma game would have results.

• The chapter deals with the Civil War.

• It takes a few people to act rationally for the Segregation Game and Agent-Based Modeling.

• Questions from Alternative Perspectives 1.
• Do you think people with religious training will arrive?

• The author describes a scene 2 in the beginning of the chapter.

• Employers look to see that applicants 3.
• Even though the subject devised an experiment to challenge the Nash equilibrium, Merrill Flood and Melvin Dresher took difficult courses in college.

• The person who guessed closest to the average number won.

Would you expect the equilibrium to approach the Nash a if your class played this game?

What do you think the players decided to do for the 100th?

• Martin Shubik proposed a game in 1970.

• The highest bidder pays his c after winning the dollar bill.

• She knew that the seller had someone at the auction sub bid and that each new bid had to be higher than the current high.

• Answers to Margin Questions 1.
• There is a game theory.
• The optimal strategy for the first player of a single-play more flexible framework than supply/demand analysis ultimatum game is to offer as little as possible because it can account for less restrictive assumptions second player because the second player is better off with compared to supply/demand analysis.

• B's best strategy is to confess if A does.

• The two-thirds game has a zero Nash equilibrium.

• B's best strategy is to confess if A does not confess.

• The highest bidder wins and the highest bidder pays.

• Each person has a will.
• Assuming positive framing effects, the question should be to do what is necessary to show his or her love and framed as a contribution to retirement rather than care for the other.

• The results of a game are not expected to be influenced by 10 percent of rational people.

• The supply/demand light on a broader set of issues than the traditional model was discussed in this chapter.

• You can see the power of game theory when you apply it to the assumptions of the supply/demand model.
• Game theory is consistent with supply/demand analysis.

• Game theory comes from the decisions of the other firms.

• Firms Prisoner's Dilemma and assumed that their decisions had no effect on other firms' Duopoly Example decisions.

• The prisoner's dilemma was the easiest application of game theory to firms.
• There was no other firm to consider.
• We couldn't develop strategic decisions facing a "foam peanut" because of the wasn't the case.

• If we assume that the aver Game theory allows us to develop more precise models age total cost and marginal cost of producing foam of the oligopolistic markets, and that all situations that involve peanuts are the same for both firms, then we can assume that the aver Game theory allows us Strategic interaction is what these costs are for.
• Figure A20-1(a) shows game theory.

• If you double each, you can get the average and marginal costs for the industry.
• The competitive solution for the industry has an output of 8,000 and a price of $500.
• The price is $600 at the monopolistic solution.

• The price will fall to $550 per ton if there is an additional 1,000 efficient scale of 4,000 tons.

• The cheating firm's average total cost is $500 and its profit is $200,000 because the industry demand curve is drawn in a way that the output rises to 4,000.
• The noncheating firm's profit moves in the opposite direction when the price is $500 per ton.
• The curve is also drawn.

• If the firms can coordinate their actions.
• The total of profits and output will be shown in Figure A20-2.

• The firm that you can see in Figure A20-2(a) will make $600 with a cost of $575 per ton for a joint economic loss.
• It gets $550 if the firms don't price it.
• Did not cheat at this level.
• The price for a ton of cheating is $500.
• Noncheating firms have an average cost of $500 and have an economic profit of $125,000.
• If they cooperated, the firms prefer fully $125,000.
• By colluding to the situation where they don't coordinate cheating, the firm has transferred $125,000 of their actions to the other firm and reduced their economic profit.

• The strategic reasoning doesn't benefit from cheating and can't enforce the agreement.
• One firm's reasons that it can earn more will do better by cheating.
• If one firm makes 4,000 loss and the other firm makes 4,000 profit, what would that mean?
• Both firms don't make a profit.

• A's and B's strategies are listed in different ways.

• A makes $200,000, but B loses $75,000.

• It will lose $75,000 if the other does not cheat.

• It is precisely to provide insight into this type of firms and tends to push oligopolies toward a zero-profit situation that game theory was developed in.
• It is a competitive solution.

• Amazon matched Walmart's free shipping minimum.

• A variation of the prison threshold is presented by the duopoly.
• The results can be presented in an example.
• When a low-fare airline payoff matrix that captures the essence of the prisoner's enters a market, the existing airlines usually match or dilemma.
• The payoff goes below the low-fare airline's fare in Figure A20-3.

• The blue triangles show A's profit, while the green triangles show B's profit.
• If neither cheat, the result is shown in the lower-right square, and if they cheat, the result is shown in the upper- left square.

• If cheating can't be detected, they have a dilemma.
• If they can't detect whether the other one Game theory sheds light on institutional arrange cheated and each believes the other is maximizing profit, they're out of luck.
• If firm A is a standard practice for many firms, the payoffs are in the price guarantee, in which a store states that it will first column.
• If firm A doesn't say that the price it charges is lower than the price at any cheat, it will lose $75,000.
• Firm A's optimal strategy is to another store.
• The cheat is needed to back up that guarantee.
• If the store expects firm A to cheat, it will give any customer who finds a lower price a payoff in the first row.
• One's initial strategy is to cheat.
• If they both cheat, they will end up with zero profit because of the low-price guarantees.

• The conclusion is not clear when considering the low-price guarantee within a con game theoretic framework.

• In markets where similar seller: It provides information about the pricing of conditions hold time after time, the cooperative solution competing firms and warns the other firms that their is more likely since each firm will acquire a reputation competitor will have that information very quickly.

• Consider what this low-price guarantee does to someone else.
• It makes no sense to try to follow the other firm's strategy.
• Fight on price with the low-price guarantee.
• If it tries to charge a lower price, the other "low-price guarantee" can be to raise the overall price store will quickly and automatically reduce its price to that consumers pay.

• In 2, they expect profit to rise by $100,000.
• The coming year will be made up of two firms.
• It thought it would like its net entire market forwidgets.
• They have the same costs.
• They profit to rise by more and are making $2 million for the Super Bowl.
• There will be an advertisement during the Super Bowl.
• Mr. Notsonice cost $80,000.
• The person who is considering cheating and producing more than he expects his profit to rise by $230,000 has agreed to produce.
• He has been told that the profit of the company will rise by only $50,000.
• If he cheated, he could increase the firm's profit by $1 million at the expense of twiddleDum, but if he didn't, he could increase the firm's profit by only $50,000.
• If both cheat, their profits will go up by over a million dollars.
• If neither was hired to advise Mr. Notsonice, their profit will rise the same.

• The payoff matrix should be developed for the decision facing b.
• If the game is only played once, what strategy would you use?

• Economics is what economists do.

• My son doesn't like economists.

• I know it's common for kids to not have high regard for their parents, but it hurts.

• I don't want to sell more copies of Levitt's book.

• I stated in an earlier economics and traditional chapter that economists are not parrots and that modern economics uses supply and demand analysis policy prescriptions.

• It is an important stepping-stone, but still just a stepping-stone.

• The reason is that Levitt didn't use the formal supply and demand model.
• He applied the general ideas behind supply and demand within a variety of other models, and most of his conclusions derive from his ability to collect data and analyze them with statistical tools.
• His approach is typical of how modern applied economists approach problems-- they collect data, or use data collected by others, and analyze them.
• The purpose of this chapter is to give you a sense of what modern economists do, and how principles of economics relate to what modern economists do.

• Modeling is the glue.
• Work with the model and empirical evidence to understand the problem.
• The approach to modeling economics is modern.

• Modern economic models are not defined by a single model.
• Q-1 What is the glue that holds a group of social scientists together?

• Economists aren't the only people who use models.
• Everyone does.
• A computer model or wooden model of a house is created by an architect.

• An engineer will test a new design with a model.
• Modeling alone doesn't differentiate an economist from other scientists and engineers.

• The building blocks are used in models.
• Economists find the structure of formal models acceptable.

• The assumptions that form the basis of economic models are what I mean.

• The models of economists differ on how incentives are important.
• The picture people are reacting to is the structure of a model.
• You can assume that individuals are form it takes.

• The investigation included modeling the crime in order to solve it.
• Many of the show's episodes were built around models that economists use in their analyses.

• Informal models and virtual models can be embodied in computer simulations.
• The computer is expressed in words.

• The online virtual world,Minecraft, can be thought of as a model of society and its economy can provide insight into the real-world economy.
• Economic models come in many different forms with different building blocks.

• Over time, the models that economists use have evolved.
• The early economists used a highly restricted set of building blocks and a nar row set of relatively simple models.
• A major change is that modern economists use a 1In, which is a reaction diffusion equation.

• How well the models fit the data is how they are developed.

• There are many purposes for models.
• Scientific models are designed to provide an understanding of what is happening for the sake of understanding.
• Other models can be used to provide insight into policy issues.
• There is no firm line between engineering and science.
• The models presented within the book are applied-policy models.
• They are designed to give insight into what is happening in a way that serves as a foundation for a discussion of policy.

• Rational and self-interested economists are used by traditional economists.

• Modern economists use supply and demand models, but they also use more sophisticated models that integrate dynamics and strategic interactions into the analysis.

• Modern economists vary in their willingness to deviate from the traditional approach.
• Gary Becker is a modern economist who advocates limiting economic models to these building blocks.
• Adam Smith and economists preferred Becker's view until the end of the 1970s.

• Self-Interest is edging away from traditional building blocks.

• Behavioral economists study people's behavior and use those behaviors in Q3 if an economist argues that their models.
• They argue that the assumptions of both people should be changed because they tend to follow rationality and self-interest.

• Behavioral economics is a field of economics research.
• There are two important differences between traditional and behavioral building blocks.

• People are rational.

• People behave in a certain way.

• People are interested.

• People are interested in their self-interest.

• Behavioral economists assume that people follow their enlightened self-interest.
• In the previous chapter, we saw the work of economists Matt Rabin and Ernst Fehr who developed models that rate a sense of fairness.
• They found that people try to divide the money fairly rather than giving it all to themselves, even though they could keep it all.
• The individuals would be considered enlightened self-interested if they cared about fairness for their own sake.
• People act posefully rather than rationally as defined in the traditional sense.
• Herbert Simon and Thomas Schelling found that people will make decisions based on rules of thumb, without considering the costs and benefits of each decision.
• They assume that people follow habit, which reduces the costs of making decisions.

• The assumptions of a model affect how one interprets the data.
• One can observe a firm not taking advantage of its patterns in the data.

• It would seem very strange to use traditional building blocks of rationality and self-interest.
• You would look for some hidden reason why the firm isn't taking advantage of that position and keep searching until you find the selfish motive underlying the behavior.

• Researchers can consider the possibility that the firm is not taking advantage of its market position for reasons other than self-interest with models based on behavioral building blocks.
• AIDS drugs are sold by pharmaceutical companies in African countries at prices far below market price.
• It could be because of political pressure or it could be out of a sense of fairness.
• A traditional economist would focus on the first, while a behavioral econo mist would consider both possibilities and use empirical data to make a decision.
• The point of this example is that an economist who is willing to use a wider set of building blocks sees different information than an economist who uses the same building blocks.
• There is a lively debate about what build ing blocks economists should use.

• In some ways, all types of behavior can be considered rational and selfish, and an entire book could be written on that.
• It can be argued that behavioral economists are not arguing for irrational behavior, but for a different type of rationality than is allowed in traditional economics.

• People behave in Microeconomics.
• The real-world nature of humans requires giving up some of the power of models that are based on assumptions.

• Behavioral models are dependent on context.
• One can choose from a variety of models, instead of having one model.

• Let's look at an example.
• You can choose between two income streams.
• In the first scenario, you will make $30,000 the first year, $27,000 the second and $24,000 the third.
• In the second scenario, you will make $24,000 in the first year, $27,000 in the second and $30,000 in the third.
• A model based on traditional rationality predicts that you would choose the first, since you will be able to save the additional $6,000 in the first year, put it in the bank, and end up with more than $30,000 of income in the third year.
• It is "rationally" preferred to the second since you get more total income with the first stream of income.
• Econo mists have found that most people choose the second stream even if it is explained that they could be better off choosing the first.

• Behavioral economists argue that most people know that they don't have complete self-control and that they will spend the extra $6,000 earned in the first year rather than save it.
• They don't believe that they have the discipline to switch the first income stream to the second one, even if it was possible.
• They prefer the second to the first because it precommits them to saving and strains them from doing something they believe they will do, but which they actually don't want to do.

• The behavior is irrational because people tend to choose the stream that results in less total income; it's predictable because in experiments time and time again, people make the same choice.
• This seemingly irrational choice is not unique to this example and occurs in a variety of contexts.

• Most people answer yes, no, and yes.
• An economist would use the traditional building blocks to predict what people would say.
• Behavioral economics says that we need more economic models that account for predictable behaviors.

• The models that reflect people's actual behavior are complex and don't provide much insight because they are impractical to generalize.
• If one were modeling her behavior, it would make sense to assume that a pool player does not calculate the angles and spin of a ball to hit it.
• A model built on her actual behavior may be a better predictor of what will happen than a model built on her actual behavior.
• The advantage of simplicity and ease of testing is emphasized by modern traditional economists.
• If you have one model, you can test it and see if it works.
• You have to do more testing with many models.
• Modern traditional economists say that a single model that is easy to apply and test is the most useful model.

• Modern traditional economists point out that moving away from the traditional building blocks is difficult because models in which people follow their enlightened self-interest rather than self-interest and act purposefully rather than rationally lead to much less clear cut models and results.
• Behavioral models depend on the specific context of the choices involved, so instead of a single model, there are many.
• Many more patterns can be seen in the data with the broader build ing blocks.
• That is an advantage and a disadvantage.
• It is an advantage that such models can more accurately reflect actual behavior, and it is a disadvantage that it is hard to know which pattern to focus on.

• In an experiment, half the participants were given a mug and the other half were given a pen, each of approximately the same value.
• The participants were able to exchange one for the other by returning the first item.
• The rationality building block suggests that about half of each group would choose to trade the gift they had for the other.
• Only 10 percent of each group chose to trade, suggesting that what one has influences what one wants.
• Endowment effects fit the broader "behav- that what one has affects what one is doing" building block; they do not fit the narrower "rationality" building block.

• Natural selection of what is useful for survival is the basis of models of how an individual's preferences are determined.
• The social conflict over who gets what decreases when people have what they want.
• The endowment effect makes it possible for parents to put up with their children and believe that they are close to perfect, even though they are not.

• Without the endowment effect, we would probably have an online market where you could trade yours for someone else's.

• Modern economists don't like the idea of behavioral economics giving up the old building blocks, they prefer to stay with the nar rower building blocks of rationality and self-interest.

• The result of both traditional and behavioral economics is that the most basic build different electrochemical processes occur in the brain.
• The people are called vidual.
• The hardwired makes the two groups different.
• They make assumptions about how the indi is making decisions.

• When the Caltech economist Colin Camerer and the rational side of your brain question whether economists sway, there are the "emotional you" and the "rational you".
• Building blocks that are more basic affected should be studied by whoever is being studied.
• They say that individu is quite different.
• When both you's are made up of cells, the result is often confusion.

• We need to use building blocks that are different from under a variety of controlled conditions to see what part of the traditional ones are in people's brains.
• The brain is reacting in a whole new way.

• The choice is a very good example of a precommitment strategy.
• It's a good idea to keep dessert in the refrigerator to avoid temptation.

• Traditional models give clear-cut results that highlight issues in ways that the modern build clear results, which can highlight issues that are not highlighted in the traditional models.
• Gary Becker expressed this view when behavioral models couldn't.

• Recently, a number of University of Chicago school economists such as Richard Thaler have begun using a broader set of building blocks, and have been in the forefront of drawing policy implications from models based on modern building blocks.

• They advocate for thinking about individuals as reflecting their evolutionary tendencies and being shaped by the market into the type of individuals that traditional economists assume are their inherent natures.

• Their argument is not that models built on the traditional building blocks are irrelevant; it is simply that the traditional building blocks do not explain everything, and that attempts to use them to explain everything actually undermines our understanding of what models using the traditional building blocks do.
• Modern economics must take into account the fact that people are predictably irrational in some of their models based on traditional building blocks.

• The hope of modern economics is that economists will have a set of models that explain the decisions we observe, along with a guide that explains which models fit what situations.
• You're not going to get that guide in this book.
• Economists are not there yet.
• We are far from it, and even those who use the new building blocks don't believe that the behavioral models are enough to replace the traditional models.
• In the book, I focus on the traditional building blocks and the standard supply/demand model.
• The supply/demand model and its assumptions should not be thought of as anything more than an introduction to modern economics.

• There are many types of models that economists have.
• All of them are used by modern economists.
• To understand modern eco nomics, you need to know the advantages and disadvantages of various types.

• Let's start with the models that are known to work.

• Lay people don't see the underlying formal model when they hear about an economist's analysis.
• They don't see a discussion that conveys the essence of the model.
• If you look deeper into the discussion, you can see if the economist is using behavioral or traditional building blocks.

• To demonstrate the difference between models based on traditional building blocks and ones based on broader behavioral building blocks, we will look at two popular books that apply economic reasoning to everyday events.
• There is a difference between an economist using traditional building blocks and one using behavioral building blocks.

• Steven Landsburg is an economist at the University of Rochester.
• Landsburg calls himself an "armchair economist" because he provides models to explain everyday events.
• Landsburg's models use traditional economic building blocks and he happily pulls out unexpected implications from models built on those assumptions.
• Landsburg is an example of a modern economist who sticks to traditional building blocks.

• His model is designed to make the reader think, and to see how economic reasoning can come to counterintuitive conclusions.
• Modern economic thinking blocks are seen as a plus because they get people to think of questions in a different way than they do.

• Landsburg said that Martin and Joan thought they might go home together after an office party the next day.
• On the way to the party, Martin sees a subway advertisement from the Centers for Disease Control and Prevention.
• He decided to stay at home because he was guilty of his thoughts.

• The result of this hookup is that Joan ends up with AIDS because of Martin's virtue.

• According to Landsburg, the story shows that Martin's withdrawal from the game made it more dangerous for others.
• If everyone with less than 2.25 partners per year had had a few more partners, we could have slowed the spread of AIDS.

• Landsburg's model was intended to shock.
• It was also meant to hone people's reasoning ability.

• Most people would prefer the aggregate outcome of decisions about sexual activity.
• Landsburg thought people would make the best decisions for the individuals involved, but they were the decisions that have externalities.
• The be best for society was the basis of Landsburg's model.

• While Landsburg is traditional in his building blocks, he is not always traditional in the formal models he uses, and in some of the issues he has studied, he has gone far beyond the simple supply/demand model.
• He considered the issue of why car insurance cost three times as much in Philadelphia, Pennsylvania, than in Ithaca, New York, even though the theft and accident rates were not significantly different between the two cities.
• The model he used has two equilibria instead of one.
• Depending on people's initial choice, the model can arrive at different results.
• Without knowing the path one cannot predict the equilibrium.
• A knowledge of the history is required to reach a conclusion.
• The supply/demand model would not lead to an equilibrium price.

• Landsburg gave an argument.
• The cost of insurance is affected by the feedback effect of the initial choices people make when buying insurance.

• There are two arguments that I present.
• Disaster assistance is bad news for text, as an example of Landsburg's provoc.

• Modern traditional economists should beware of malicious computer hackers.

• Traditional building blocks are used to support the most charitable people.
• If there are the least charities.

• It is socially irresponsible to write books.

• Children cause divorce.

• The taste for revenge is better than traditional building blocks.
• The models want gold.

• A ban on elephant hunting is bad for elephants.

• The rates for those who do buy insurance are going up because more people are driving without insurance.
• Landsburg claimed that it was what happened in Philadelphia.
• In Ithaca, the situation went the other way--many initially bought insurance, which meant that insurance costs for everyone were lower, which led to others buying insurance, which led to even lower rates.
• Both equilibria were self-reinforcing, and it was very difficult to change without a government intervention.

• In the supply/demand model, we see a model based on reasoning that people are rational and self interested.
• Because it is not a supply/demand model with a single equilibrium, it leads to two possible equilibria.
• It leads to a policy solution that requires all individuals to have insurance.

• Landsburg's approach is very similar to Frank's.
• He observes the events around him and tries to understand them using economic building blocks.
• Frank is more willing to go beyond the traditional building blocks than Landsburg is.
• This allows for a wide range of models and explanations, as well as a wide range of policy interven tions that follow from the model.
• He presented two models in his book.

• The first model that we will consider is designed to explain why people are more likely to return cash to a store when given too much change than to return merchandise for which they were not charged.
• He reported the results of a survey in which 90 percent of the respondents said they would return $20 to the store if the cashier didn't charge for it, but only 10 percent said they would return a $20 lamp.
• People should not return if they only took their own interests into account.

• Most people don't want her to be punished.
• It would be the store that would suffer the loss, not the individual, and people were less worried about hurting stores than they were about hurting people.
• Frank's assumption is different from Landsburg's.
• People were somewhat self-interested in Frank's model, but not completely.
• The prediction would be that no one would return the money.
• Frank's model allowed for the possibility that people cared about the impact of their actions on others.

• Frank found a second model in his book that dealt with why people continue to wear shoes with shoelaces even though they are more practical.
• Frank believes that the reason shoelaces are still used is because the young and old are associated with the same thing.

• The ratio nality assumption was deviated from the traditional building blocks.
• It doesn't make sense to use a technology that was less efficient than another.
• Frank's model assumed that people care about what other people think about them and thus take social issues into account when making their decisions.
• Social dimensions of problems are not taken into account by models.

• Two models are recounted in the text.

• Stores post signs saying Frank's book.

• Men's fashions are put on the ground in most U.S. department stores.

• Among the li 4, Frank followed can be found.

• Behavioral economists have discovered other dimensions of my behavior.
• If you study a model and use its assumptions as your own, you can influence your behavior by looking at the world in a different way.
• It is possible that studying economics may change you.

• The principles course is meant to do more than entertain; it is meant to teach, and only when they are writing for lay people.
• The validity of the models is impossible to test because they are not sufficiently precise.
• When we presented the models, we asked you how convinced you were.
• Each was easy to modify and come up with a different conclusion.

• The argument would be reversed.
• It is a good question to ask if we really know anything more about the world after learning about the models that are embodied in the vignettes.
• In a scientific sense, the answer is no, we don't.
• Science is not based on models.

• Scientists are hesitant to base their knowledge on anecdotes or models that are highly convincing.

• Humans have a tendency to have a sense of understanding, but not necessarily a scientific understanding.
• Scientists say that to extend a model to true understanding, you have to quantify and test your arguments.

• The second important element of modern economics is highly empirical.

• Modern economics is based on experiments that can be replicated.
• The importance of empirical work has been in economics since the 1600s, but economics focused on reasoning until the 1940s.
• That happened because of the lack of data and the lack of power to analyze it.

• Because of limited data and computing power, empirical work in economics did not move to the forefront until the late 1980s.
• Deduction was the economist's method for understanding the real world.
• It is fair to say that the development of computing power has fundamentally changed the way economic research is done.

• All modern economists rely on empirical work, even those who use traditional building blocks and those who use behavioral building blocks.
• Today's empirical work in economics is not based on formal observations.

• The economic scientist doesn't stop with the heuristic model, as did Frank's and Landsburg's presentations.
• He or she builds an empirical model and supports the argument with empirical evidence.
• Essentially, what he or she does is look at the relationships found in the heuristic model and see if they can be generalized.
• You collect data and analyze it with statistical and econometric tools.

• The researchers studied the relationship in their models.
• Steve Levitt did a lot with his creativity and success.

• A combination of points is shown here.

• 2.5 is the average grade.

• He used informal models and hypotheses to structure his study.
• He reasoned that if a wrestler was close to winning enough matches to raise his ranking, it wouldn't matter if he won a match or not.
• He said that if wrestlers are self-interested and rational, they will have an incentive to cheat and throw a match in order to win a match.
• He had a testable hypothesis.

• He collected and analyzed the data.

• Say you are wonder to another.

• "Run a regression" means that you use a statistical package to find a line that "best fits" the data, where "best fit" means making the distances between that line and the points as small as possible.
• If the "best fit" line is upward-sloping, then the regression model's answer to the question is a tentative yes, subject to all the things that were held constant.

• Every point will be on the "best fit" line if it is a perfect fit.

• This isn't a statistics class so I won't go into further explanation, but the short descrip tion should give you a sense of how empirical regression models work.
• The workhorses of applied microeconomists are regression models, and modern economists are almost magicians at pulling information out of data.

• Issues far from the standard domain of economics are explored by economists' empirical models.
• He created a model to predict whether a particular year's wine would be a good vintage.
• The quality of a wine depends on a number of factors, including weather and rainfall.
• He ran a regression to get the data related to the price of wine.

• The relationship tells us that the quality of a Bordeaux wine depends on the weather.
• He argued that the regression model he used did a better job of determining a good year for wine than the tast ing method.
• He argued that his model could determine the quality of the wine before it was even tasted.
• When choosing a wine, forget about sniffing, swirling, and tasting; just get out your computer, collect the data, plug in the numbers, and solve the equation.
• I don't like wine, but the people I talk to think he is.

• Baseball teams use a regression model to determine how good a prospect is.

• As hits, modeling is important.
• They argued that a person's ability to draw a walk should be one of the variables considered in choosing a recruit.

• Regression models can help a team win.
• Oakland's success didn't go unrecognized when the Boston Red Sox were on the verge of a team's season record.

• The modern micro economist's tool kit has become more important because of the increase in computing power and statistical software.
• Economic researchers can find stable patterns in data much more easily now that computer power has increased.
• Computers can find patterns and turn them into models with sophisticated econometric software.

• The development of computer power and empirical models has led to an enormous change in how modern microeconomics is done.
• As a principles student, you will not be developing regression models, but you will be building models based on data, which may change in the future since other social sciences are becoming more empirical as well, but for the next decade they will likely still lag behind economics.

• The charts and graphs are useful even though they don't have the full scientific look of a regression model.

• The modern economic way of thinking uses quantitative data to make an argument, often by presenting those data with a simple chart or graph.

• Empirical models would replace all other types of modeling if economic modeling were only a matter of data mining.
• Data has no meaning, they have to be interpreted and given meaning, and how one uses the data depends on the model and the building blocks one has in mind.
• One's model can guide how one organizes the data.
• That's why theory is important, and an important part of this principles course is meant to give you practice in understanding the theoretical structure of economic thinking.

• You can see the importance of theory when you think about a magic eye picture.
• The old woman shown here is a simpler example.

• I think you might have seen the picture in a different light.
• The implicit model or frame that you bring to the picture or the data affects which pattern your eye sees.

• The difficulty of pulling information from an empirical model is highlighted by this issue.
• Even with the same empirical model, two different economists may see different results.
• Let's look at an example of a recent debate in economics.
• The debate is about the deterrent effect of the death penalty.

• One could do a controlled experiment to see if the death penalty has a deterrent effect by changing anonymous German postcards and isolating specific variables.
• Experiments that were controlled in the late 19th century are not possible in economics.
• An economist can't suggest that we try out the (c)Chronicle/Alamy Stock Photo death penalty to see what it would do.

• The economists found a correlation between the number of murders and the death penalty.

• Ehrlich found that an increase in the number of executions is associated with a decrease in the murder rate, while Shepherd found that one execution deterred seven to eight murders.
• A number of economists disagree with the statistical relationships.
• They pointed out that how the variables are interpreted is important.
• Economists use the same data in multiple ways.
• John and Justin came to different conclusions.
• They said that the theoretical models would help them interpret the data.

• I don't claim to know who is right, so I won't get into the debate.

• I recount it to give you a sense that given the limited ability economists have to conduct controlled experiments, letting the data speak will not provide the definitive answer.
• Modern economics will have implications from their work.

• A third characteristic of modern economics can be found in the above discussion.
• The supply/ demand model is an example of a simple model used in earlier econo mists.
• Modern economists still use simple models, but they also use models that allow for more complex relationships among variables.
• The two-dimensional graphs used by earlier economists cannot be used to express these sophisticated models.

• The "tipping-point" model that Landsburg used to analyze Q-9 Is the supply and demand differences in car insurance prices is an example of the difference between earlier economists and modern economists.

• If you know the path the model takes, you can know what will happen.
• It is more difficult to specify path- dependent models than it is to specify supply/demand models.

• Technology has changed the reason why formal models have evolved from simple models to more complex models.
• The technology is mathematics.
• Today's economists are better trained in mathematics than their predecessors, which allows them to go far beyond the interrelationships allowed in supply/demand models.
• It is difficult to know what an equilibrium is with models with many equilibria.

• Changes in variables and changes in variables are related to models in which variables are related.

• Even though the system is in equilibrium, the individual parts are not.

• There are models in which an infinitely small change can lead to vastly different results.

• The number of potential outcomes in the economy is awesome when one studies the broad range of models with all the potential interrelationships.
• A formal theoretical model can arrive at any conclusion.

• The questions are used in the modern economists' debates.

• The broadest model would give you the broadest approach, so you might think that one should use the most complex model.

• The harder it is to arrive at a conclusion, the more technical the model is.
• Calculating, economists make a trade-off between simplicity andpleteness.
• The graphical supply/demand model is the workhorse of the principles of economics because of the KISS rules.
• Even though modern economics goes far beyond supply and demand, the principles course focuses on supply and demand and teaches students the traditional model.
• It's perfect for moving on to models with more complicated behavioral building blocks.

• The state of the U.S. is an example of where the model one uses matters.

• The standard textbook model at the time was the traditional aggregate-supply/ aggregate-demand model.
• Policies exist to move the economy to equilibrium if it isn't, if the economy is close to equilibrium.
• That's not the case for some of the more complex models.
• The aggregate econ omy could change depending on what people think.
• The economy will go into a depres sion if people think it will.

• A small change could tip the economy into a low-growth, high- unemployment equilibrium that would be difficult to escape.
• There was reason to be concerned about the U.S. economy going into a depression.
• The slow growth suggests that the models were correct.

• There are many different types of models.

• Game theory models are the core of what is studied in graduate microeconomics today.
• The stan dard graduate microeconomics text only has three supply and demand diagrams.

• You can't find the equilibrium in a model if you don't solve the equations.
• A model that you couldn't solve analytically didn't provide any insight, so these complicated ana lytic models were useless for a traditional economist.
• That is not the case for a modern economist.
• If an economist can't solve a model with logic, he or she will use a computer to model it.
• While the supply/demand model captures these ideas, for mathematically inclined students, as Harold Kuhn once told his students, the lessons can be generalized into a set of constrained optimization models assuming convex functions, and if principles students were strongly mathematical inclined, many of the models could.

• Modern Economic Thinking economists use both behavioral and traditional assumptions, and in their research they will often go from struggling with analyti cally solving a model to simulating it on the computer, and then back to trying to solve it.

• There are different types of computer simulations used by economists.
• A simulation was designed to solve a model with a set of equations that can't be solved by other means.
• The computer can arrive at estimated solutions to complicated equations in those simulations.
• This approach is widespread.
• A more novel approach to com puter simulation is designed to deal with problems that are so difficult that you don't know how to specify the equations.
• The com puter is used to guide them.

• Standard modeling is fundamentally different from ACE modeling.

• It doesn't have equations that have to be solved.
• Instead, the researchers try to create virtual computer models that capture the essence of the interdependencies.
• Rather than solve a model, you build a computer model with computer agents, run it, and keep track of the results.

• This approach to modeling complex systems allows for all types of interactions.
• It allows researchers to consider more complicated interactions than they could if they had to solve the model on their own.
• Multiple equilibria and the possibility of many levels of path dependency are possibilities that are beyond tra ditional models.
• The modeler sees the range of results when he or she runs the program thousands of times.
• Just like engineers are using virtual computer modeling to design planes and cars, economists are using virtual computer models to design policies that might make the economy work better.

• Economists try to see which model works best.
• This reverses the process used in empirical modeling, where the data are collected and lyzed before the hypothesis is determined and used to determine the hypoth esis.
• Before the hypothesis is tested to see if the data fit the model, it is formulated without knowledge of the data.
• Economists try to test hypotheses on data that wasn't used in the creation of the hypothesis.
• They try to develop the data or something close to them if they don't have it.

• Modern economists do a lot of fitting the models to the data.

• "Bringing the model to the data" is a phrase you hear a lot.

• To truly bring the model to the data, one needs a formal model where all relationships are specified, rather than a model where relationships are ambiguous.
• The "empirical models" discussed earlier are different from the formal models that form the foundation of economic science.
• For policy analysis and for guiding real-world policy deci sions that have to be made before one has a full scientific understanding of an issue, empirical models are fine.

• These models are necessary.
• One needs more precise models before they can elevate the level of scientific knowledge.

• I stated at the beginning of the chapter that the majority of the book is concerned with engi neering models, not scientific models, which is why we will not explore the intricacies of testing formal models.

• There is a subtle, but important, difference between the empirical models discussed earlier and the formal models described here.
• One has an empirical model that lets the data speak first, and the other has an informal model that lets the data be heard through your building blocks.

• The process of testing a model from a data set is different.
• The implications of the formal model are developed here.
• The model's implications are tested against another set of data.

• An example of a puzzle that economists faced was considered.
• This example shows how the results of the two models differ even though they have the same data.
• The price of chocolate is the puzzle.
• The price of chocolate went up from 2005 to 2009.
• The question is why.

• You should be able to give the traditional economic analysis of what likely happened from the analysis of earlier chapters, which would involve supply falling, demand rising, or a combination of the two.
• That would be the correct answer in a principles course.
• It isn't enough for real-world researchers.
• The data doesn't show any apparent shifts in supply or demand.

• There was a structural change in the market.
• Investment funds representing rich investors who had few constraints on what they could buy were moving their investments out of real estate and into commodities over this time period.
• Oil and grains experienced sudden large increases in price during the same time period, as did chocolate, which was one of these commodities.
• The hedge funds didn't want chocolate and didn't store it.
• The right to buy large amounts of chocolate at a specified price in the future.
• They increased their demand for chocolate futures from less than 10 percent to more than 20 percent over the course of a couple of years.
• The price of chocolate went up in more than 30 years.

• The supply/demand model does not directly answer that question.

• An analysis that includes inventories and captures the rela tionship between future expected prices and the current price of chocolate is required for the answer.
• You need a model of intertemporal equilibrium with heterogeneous agents.

• How the new behavioral economics building blocks might be playing a role in determining the outcome is something you need to figure out.
• An anchor point is a key concept of behavioral economics.
• Multiple equilibria can be created by the existence of anchor points.
• It is possible that the hedge funds increased other participants' anchor points for chocolate prices, which in turn led them to increase their inventory of chocolate.
• Even though there was no need for price to increase had the anchor point not changed, the demand increases and ratifies the increase in price.

• The supply/demand model is more advanced than the formal model that one needs to deal with the question.

• The economists said that the hedge fund purchases could have temporarily pushed up the price of chocolate, but did not do so permanently.

• After bumper crops and a continued decline in consumer demand due to a weak global economy, chocolate prices fell nearly 40 percent.
• There was a run-up and price reversal again between 2013 and 2017, but these reversals were tied to the weather.
• Econo mists are hard at work on the related puzzles.
• The lesson of this example is that supply and demand are just the beginning for an economist.

• Let's look at what difference these modeling considerations have for policy.
• The answer is a lot.
• I want to distinguish the differences.
• An economist who concentrates on a single frame tends to be more consistent in his or her policy recommendation.
• The framework used to be that the market is the best way to deal with a problem, and that the market will guide people toward doing the best they can, given the constraints.
• Steven Landsburg summed up what a traditional economist expects in his discussion of the insur ance markets.

• Modern economists don't know if the market will solve every problem.
• The market has nice properties, but it also has limitations.
• They know that there are many models where public policy could be used to deal with those limitations.
• People's welfare will be reduced by general rules for public controls.
• Does it follow that economists will advise governments not to impose price with knowledge of history and limitations of the models, if the precepts are developed from theorems that follow from various models?

• There are three examples where a modern economist's precepts might differ from a traditional economist's precepts.

• The traditional economist says that more is preferred to less and that more output is good for society.
• Growth should be the behavioral economic precept.
• After an annual per capita income of about $75,000 is reached, they point out that people's happiness depends on their relative, not their absolute income.

• That suggests that more focus should be given to how the existing income is distributed, rather than just focusing on total income.

• Government probably shouldn't have.
• The value of the house was represented by the rise in housing prices.
• There is no reason to believe that the government would have gotten it right, and you can only tell if houses are overvalued after the fact.

• Financial bubbles, where prices of assets significantly exceed their sustainable prices, are possible, and that the housing market in the early 2000s had all the signs of a bubble, is the modern precept for both traditional and behavioral economists.
• The bursting of the housing bubble was predictable and policy could have eliminated the need for it.

• People make rational decisions and if they are choosing to save little, that reflects their desires and best estimates of their future needs.

• With so much of the institutional structure of the economy designed to get people to spend, people likely save far too little.
• Government does not have to tell people to save more.
• People will save more if the institutional structure is changed.
• Saving 15 percent of income is the default option when employees choose among savings plans at work.
• If people don't want to save, they have to check a box.
• Changing the default option on retirement savings plans can change the amount of money people choose to save.

• I could give more examples.

• This has been a wide-ranging survey of what economists do.

• Modern economics goes far beyond supply and demand.
• Microeconomics is open to a wide range of models and building blocks.
• Thinking like a modern econ Omist means approaching problems through modeling, and then linking the results of the model to the empirical evidence.
• The choice of models is made by testing those models and choosing the one that does the best job of predicting.

• Modern and traditional economists are not the same.
• There is a difference in when to put real-world problems into the model.
• Traditional economists adjust the model to fit the more complicated real world by using the traditional building blocks.
• It has the advantage of keeping the basic model clean and simple, but it also has the cost of not fitting many real-world situations.
• More complicated models are used by modern economists to make fewer adjustments.
• The advantage is that the models fit more real-world situations, but the disadvantage is that the models are not as clear-cut as the traditional approach.

• Most economists, including me, emphasize the traditional micro- and macroeconomic models for teaching purposes.
• Modifications and addenda are added to modern insights.

• The glue that holds economics together is modeling.

• Calculating patterns in observed data is different for economists.
• Modern economists use.

• How is a model different from reality?
• Give an example.

• The approach to economics differs from 7.

• The two main building blocks are traditional 8.

• The rule of thumb is against the law.

• A model of 18 might explain why government intervention makes sense.

Robert Frank thinks that people are more 19

• More goods are preferred to less goods.

• Economists rely more on empirical evidence.

• Questions from Alternative Perspectives 1.
• Modeling itself might frame an economist's analysis.
• Which way is it?
• Large questions can't be answered if modern economics focuses on empirical models.

• A group of Asian American women were 5.
• If an economist can't solve a model for a math exam, what will he do?

• People in the first 6 are going to take the test.
• A student is given the option of selecting two homework groups and being asked their opinions about coed dorms while schedules include three five-page papers and one question about their family history.
• Those who have a one-page paper due at the end of the semester are more likely to perform worse than those who have three papers due.
• This is an example that is due at the end.

• Answers to Margin Questions 1.
• The glue that holds people's tendency to be fast pattern modern economics together is modeling, not supply and demand.

• Science involves slow and precise.
• The rules of scientific models are more likely to be used in ways that slow people down compared to earlier economists who gave more weight to the patterns they complete.

• Both of these assumptions are associated with behavioral 8.
• It would be nice if that were the case.

• It depends on the model you use.
• The data in economics can't be provided because people choose what is best for them.
• Economists must rely on their constraint upon choice to make them worse off.
• Modelling to guide them.

• The path to equilibrium is not assumed to have complete self-control.

• Both have their advantages and disadvantages.

• The purpose of the model is what derives the theorems.

• It shows that he is affected by them in most economists who oppose price controls.