Uncertainty and Consumer Behavior
"Rational" but bounded, capability limited.
Likelihood that a given outcome will occur.
- Objective interpretation of probability
- Subjective probability (perception that an outcome will occur)
- Expected Value: Probability-weighted average of the payoffs associated with all possible outcomes.
- Payoff Value: associated with a possible outcome.
Preferences Toward Risk
Different Preferences Toward Risk:
- risk averse: Condition of preferring a certain income to a risky income with the same expected value.
- risk neutral: Condition of being indifferent between a certain income and an uncertain income with the same expected value.
- risk loving: Condition of preferring a risky income to a certain income with the same expected value.
Risk Aversion and Income:
The extent of an individual’s risk aversion depends on
- the nature of the risk and
- the person’s income.
Positive Framing: gains more import;
Negative Framing: losses more important.
Not only influenced by economics, it is very subjective.
- Herd behavior
- Endowment effect
- Frame effect
The Production Decisions of a Firm
|Consumer preferences||Production Technology|
|Budget constraints||Cost Constraints|
|Consumer choices||Input Choices|
Inputs: Labor, Material, Capital.
Firms and Their Production Decisions
q = F(K,L)