Welcome back. So this is part two of our chapter two lecture. So I'm going to pull my screen back up so you can see my notes again. So I'm going to talk about rational decision making.
So now we have this idea of opportunity cost, which is a non-monetary cost, which plays in this idea of rational decision making. So remember that picture we had of John Maynard Keynes back in chapter one, we're talking about thinking like an economist. So rational decision making.
In chapter one, we introduced that phrase, thinking like an economist, and that means adopting the concept of rational decision-making. So economists operate under the assumption that when individuals make a choice, they have made a rational decision. Okay, so you can think of all these decisions you or your friends made that are irrational, that seem like bad choices.
But remember, we're not saying, when I say rational decision making, I'm not saying that every choice is a good choice. What I'm saying is that every time you make a choice, that choice you made was because you perceived the benefit of the decision being greater than the cost. So a phrase economists use is marginal benefit versus marginal cost.
And marginal is just a fancy word to say we're isolating the benefit of that decision and the cost of that decision, as opposed to looking at an overall benefit and cost of lots of decisions. So every time you decide to buy a pack of strawberries, you're thinking about the benefit of having those strawberries versus the cost, which is the money, which is not being able to buy apples anymore. It's whatever that cost is.
And if you buy that, then I think that. you've made a rational decision. Okay.
So I liked it. There was this example I was using classes. Every time I talk about this in an in-person class is I pick out somebody in class who's got a Starbucks or a Gatorade or something like that. And I say to them, like, so the guy will be sitting there with a $4 Starbucks and I'll say, I've never met this kid until, you know, he entered my class, but I know one thing about him. I know that the benefit he places on that cup of coffee is more than $4.
How do I know this? Because that's what I mean by saying, assuming his decision is rational, is I assume that when he made the choice to spend $4 in the coffee, he decided he willingly, no one put a gun to his head, he willingly traded his $4 for that coffee. So in his mind, the coffee was worth more than $4. If he thought that coffee wasn't worth it, he wouldn't have bought it.
Okay. And that's what we mean by rational decision making. It means anytime you make a choice. Therefore, you've looked at the benefit, you've looked at the cost.
and you've thought that the benefit outweighed the cost, okay? And this is a concept that's going to follow us all the way through this semester, okay? This assumption is very useful because it allows us to consider why decisions are made.
So I gave you, so I, in the last chapter, I gave an example of if enrollment is down in a school, right? If enrollment is down at Valley College, what can we do? Well, in order to do that, you need to think about the benefit and and the costs associated with going to college. If people are not going and not enrolling, people are not going to college. It's because they think the benefit is less than the cost.
And so I don't think that's true. And so we have to do one of two things. Either we have to raise the perceived benefit by, by outreach and explain to these high school students how important going to colleges. That's one way to get more people. Or if you think that's that the benefit is actually appropriate, you need to find a way to lower the cost by things like the Valley promise program.
And when you do that, eventually you can change people's perceptions around and enrollments can go Okay, that's what we mean by understanding cost and benefits. Okay, so I want to talk about rational decision making. And I like to give an example of a big decision I had to make once in my life.
And this is kind of entertaining. So we're going to look at this. That's Drew Carey.
And he is standing in front of the board of what is the Dice Game. I'm hoping you'll be able to hear this audio. If not, I think the video speaks for itself.
And if you download my slides, you can click this to see the audio. There I am trying to win a car on the price is right. So just to set that moment is if this number is going to light up and it's going to light up here and it's a five or six and I don't win the car.
If it light up here, it's a one, two or three. I do win the car. So if it's less than a four, it's one, two or three.
I just won a car. If it's five or six, I didn't win the car. Those are all my friends and my wife.
All right. Yes, so I won a car and the price is right. And so this is a rational decision-making example.
So suppose you win a car on a popular primetime game show. It's not primetime. Why did I put primetime?
It's a daytime game show. Anyway, so here was the choice I was faced with. I owned a car at the time. It was a little old. It was probably about five years old, had 60,000 miles or so.
But it was a relatively nice car. It was a Camry. And I figured I could sell it for around $8,000. Okay.
The new car was worth $23,534. But if I take it, I have to pay $7,000 in taxes. Of course, if you don't know, when you win a prize in a game show, it gets taxed like regular income. And depending on your tax bracket, that's what you're gonna have to pay in taxes. So I was going to pay about $7,000 in taxes.
The dealership has offered to give me $12,000 with taxes withheld. So I wouldn't have to pay any more taxes instead of the car. So what do I do? Okay.
Do you take the car and sell the one you own? Think you're gonna get about $8,000. Do you take the car itself, this $23,534 car, you have to pay taxes on it and then try to sell it? Or do I take the cash, the $12,000 cash? And again, taxes withheld from that, so I don't have to pay any more in taxes.
It was $12,000 clean slate. What do you do? So this isn't a math problem. It's an economics problem.
That's trying to get at. Decisions shouldn't be based on carefully considering the cost. It should be based on carefully considering the cost and benefits of each decision. You're not supposed to be looking here and trying to find out mathematically what makes the most sense.
And obviously, that should be. part of your consideration, but it's more than that. You have to think of all the costs and benefits. You have to think about the opportunity costs.
If you sell the car, you lose the opportunity. If you sell the car, you lose the opportunity to sell your car. Yes. So I have to think about selling my car, my Camry. If you keep the car, you lose the opportunity to get money from the dealership.
So you lose every choice you make, you're giving up something else. And you have to consider the non-monetary costs and benefits. These are part of the decision-making process. So to me, one of the biggest, so first of all, like.
Forget the dollars and cents. I'm moving from a car that's 60,000 miles to a car that has zero miles. That obviously has a lot of benefit and longevity of owning the car. And honestly, like a lot of it is just, I want a car and the price is right. I want to drive around in that car.
I don't want to just have some cash. I'd rather be driving around this cool thing that I want. And so that's something you have to consider also.
That's a non-monetary cost. And so it was all said and done. And, you know, you can watch the entire clip of me on the show.
If you look at my profile on Canvas, there's a link there. But when it's all said and done, I decide to keep the car, the new car. So I drove around the brand new car. And the idea was that I took all my prizes and sold the ones I didn't need.
I sold my current car and all that combined basically paid for the taxes. So I didn't end up with any extra cash. but I had a trip to Europe and a new car at zero cost. And it was pretty awesome. And it was worth it to me.
And yes, had I sold that or taken the cash from the dealership, I'd probably have a little bit more money in my bank account now. But yeah, maybe not. Cause maybe the maintenance on that Camry would have been an issue moving forward and eventually I'd have to pay for it. So who knows? Okay, anyway, but that's one of my favorite decision-making examples because it was something I had to think about.
And again, the whole idea is that The right choice is different for everybody. If you needed that $12,000 and that was much more important to you at the time, that's what you pay. I didn't have any credit card debt at the time.
That would have changed my answer if I did. Another important aspect of rational decision-making is what's called marginal analysis. This is that I was talking about, marginal decision-making. Using the budget constraint framework, like we saw with Jasmine, is she didn't have to pick between points A and F. I think it was A and E, actually, in this example.
She could pick somewhere in between. That's marginal analysis. You can pick in these like these incremental differences between your choices. It's not necessarily all or nothing, okay? And so what I mean by that and why that affects rational decision making is let's say you're deciding how many pieces of pizza to eat for lunch, okay?
You don't have to just say, I want four slices of pizza or I want zero slices of pizza, right? Marginal analysis would say. You consider buying one slice of pizza.
You think about how much it costs and you think about how much you want that slice of pizza. If you decide it's worth it, you order that slice. Then you consider, well, should I have two slices? Well, you consider the cost of that slice, which is probably the same as the first slice, but now the benefit has changed.
Why has the benefit changed? Because when you're really hungry, that first slice of pizza has a lot of benefit. The second slice, not as much benefit. But if you're a hungry person like I am, that second slice does a lot of benefit.
Now you consider the third slice. Does the cost outweigh the benefit? If the answer is no, you know your answer.
You want two slices of pizza. So that's marginal analysis. Why is it that the benefit to that slice of pizza goes down over time? it's called diminishing marginal utility.
Okay. So utility is the satisfaction you get from buying something. So anytime you buy a slice of pizza, you do it to get utility, to get satisfaction, to get enjoyment.
And even if pizza is your absolute favorite thing, the more and more pizza you get, the less and less the utility. Okay. So that first slice of pizza is the one that's going to make you happiest when you're hungry, because that's the, that's going to satiate your hunger. That second slice of pizza might still do that, might still help solve your hunger. But by the fourth, fifth, sixth, twelfth slice of pizza, you're no longer getting very much benefit.
And at some point, if you keep eating pizza, you start to lose benefit. In fact, it makes you less happy, right? Forget the costs. If you're going to force me to eat a 15th slice of pizza, that is going to make me feel worse than I did before. And that's going to be what we call disutility or negative utility.
So that pattern is called the law of diminishing marginal utility. And we think that's a fundamental law in economics that no matter what you're talking about, the more and more you get of, of a certain, of a, of a good, eventually your enjoyment will start to decrease. It doesn't necessarily mean the first one's the best.
You know, you could one is good. Two is even better. Three is the best and then start to diminish. It just means eventually it's going to diminish no matter what it is, whether it's.
cars or homes or pizza or clothing or going to movies or spending time at Disneyland, no matter what it is, eventually, if you get too much of it, you get this diminishing marginal utility where it's not as good as the previous units. Like the fifth slice of pizza is not as good as second. Your, you know, 10th movie you see this month is not as enjoyable as the third. And that's the idea of diminishing marginal utility.
Okay. So that's it for part two. I'll back for part three in just a second. Thank you