Transcript RATIONAL DECISION MAKING Module 8 Review

Explorations in Economics
Alan B. Krueger & David A. Anderson
Chapter 3: Making Economic Decisions
- Module 7: Understanding Costs and Benefits
- Module 8: Rational Decision Making
- Module 9: Behavioral Economics: Decision Making in Practice
MODULE 7:
Understanding Costs and Benefits
KEY IDEA:
To make a good decision you need to weigh all the costs
against all the benefits.
OBJECTIVES:
• To identify the opportunity costs of decisions you make.
• To describe the tradeoffs necessitated by budget
constraints.
• To explain why sunk costs should not affect
decisions.
THE TRUE COST OF DECISIONS:
OPPORTUNITY COST
Opportunity Cost and Tradeoffs
Budgets and the Budget Line
SUNK COSTS
Sunk costs are costs that have been
paid and cannot be recovered.
Module 7 Review
What is…
A. Budget?
B. Budget line?
C. Sunk cost?
D. Opportunity cost?
MODULE 8:
Rational Decision Making
KEY IDEA:
To make rational decisions, people must compare the costs
and benefits of each option and choose the one that best
serves their interests.
OBJECTIVES:
• To explain the requirements of rational decision making.
• To identify key types of decisions.
• To apply the concept of marginal analysis to real- world
situations.
COMPARING BENEFITS & COSTS TO
MAKE RATIONAL DECISIONS
A rational decision benefits the
decision maker as much as possible.
A self- interested individual makes
decisions for his or her own benefit.
Wearing a seat belt is an example of a
rational decision.
RATIONAL DECISION
MAKING
The net benefit of a choice is the benefit of the choice (measured in dollars)
minus the cost of the choice.
MARGINAL ANALYSIS:
DECIDING HOW MUCH?
Marginal benefit is the additional benefit of doing something
one more time.
Marginal cost is the additional cost of doing something one
more time.
RATIONAL DECISION
MAKING
Module 8 Review
What is…
A. Rational decision?
B. Self- interested?
C. Net benefit?
D. Marginal benefit?
E. Marginal cost?
MODULE 9:
Behavioral Economics: Decision Making
in Practice
KEY IDEA:
Recognizing six common decision- making mistakes can help
you make better choices.
OBJECTIVES:
• To explain why decision making is often less than fully
rational.
• To identify common decision- making mistakes.
• To present guidelines for avoiding irrational behavior.
WHAT IS BEHAVIORAL
ECONOMICS?
Behavioral economics is the branch of
economics that uses ideas about decision
making from psychology to explain economic
behavior.
Are holiday “door busters” really a great deal or a way to lure customers to
a particular store?
Holiday sales are analyzed by economists yearly.
MISTAKES MADE WHILE
MAKING DECISIONS
1. Allowing the presentation or framing of options to affect
decisions
2. Letting sunk costs matter
3. Being too impatient
4. Making errors due to overconfidence
5. Avoiding change even when things could be better
6. Devoting time and energy to punish people who treat
them unfairly even when it is not in the punisher’s selfinterest.
MISTAKES PEOPLE MAKE
Module 9 Review
What is…
A. Behavioral economics?
B. Framing?
C. Status quo bias?
D. Sunk cost bias?
E. Impatience?
F. Overconfidence?
G. Worry over fairness?