In the 1st part of problem 1 it has been observed that majority of investors chose a certain profit i.e. receiving $ 240 now while in the 2nd part of the same problem it was observed that majority of investors chose a higher loss which is uncertain i.e. instead of losing $750 now they want to opt for a 75% probability of losing $1000. Although the situations were similar in reference of wealth creation and destruction but it was observed that the investors prefer any profits which are certain and try to minimise their loss by choosing an uncertain situation. This reflects non rational choices among same category of investors. If they have chosen an uncertain profit and could not achieve it then they will regret because they will feel that they would have opted for a certain one. However in the second case we can see that investors are loss averse. They don’t want to incur any loss and are ready for a higher loss if they get an opportunity to reduce their loss to zero.
In the 1st part of Problem 2 it is observed that majority of investors choose a profit which is certain one i.e. receiving $ 100 now instead of a 50% probability of earning $ 200 now. In the second part of the same problem it was observed that the investors opt for a 50% probability of losing $200 now instead of losing $100 with certainty. The situation is same as the previous one. It was observed that in case of loss the investors opt for an opportunity to reduce loss to zero knowingly that if they are unsuccessful then they will be required to pay a higher amt of loss i.e. $200. However for profit the same rule is not followed. The investors are opting for profit of $100 now instead of 50% probability of profit of $200. The investors are asking for a certain profit since if they opt for profit of $200 then there is a probability they end up earning $0. So a non rational behaviour among investors is observed. In case of profit the investors are being less greedy and accepting any amount which is certainly accruing to them but in case of loss, they are trying to eliminate loss and so are also ready to accept risk of incurring higher loss if their decision proves to be incorrect.
Neo Classical Economics & Its Assumptions
Neo classical economics is an approach to economics that relates supply and demand to an individual’s rationality and his ability to maximise utility and profits. The theory is said ‘classical’ due to belief that competition leads to efficient utilisation of resources, establishing equilibrium between demand and supply through operating market forces. The theory is said ‘neo’ due to involvement of various mathematical techniques.
- Rationality: It is assumed that all the consumers are rational in their approach. It is assumed that the consumers want to enhance their personal satisfaction with the help of products and services purchased. They have same choices and prefer more valuable products and services.
- Perfect Knowledge: The second assumption is that the buyer and seller have complete knowledge of the market conditions. The buyers and sellers know the prices of all similar products available in the market, their quality and use, other influencing economic factors and upcoming government policies.
- Diminishing Returns: Third assumption is that law of diminishing returns is followed, i.e. as the consumer buys the product more and more after a certain level their utility derived from the additional unit purchased starts decreasing. If we see from supplier point of view it is observed by selling more and more product their profit derived from each additional unit reduces. If this assumption is not made then it’s difficult to reach equilibrium since the consumers will be buying happily forever and the sellers will be selling the product happily forever.
- Equality between demand and supply: There is no demand and supply gap. The quantity demanded by consumers and supplied by suppliers are equal.
- Unique Equilibrium: Equilibrium is achieved when all economic agents are content and there is no requirement for any change. In case of neo classical economics consumers play a very important role in determination of price and demand. If the consumers are happy by what they purchase and sellers are happy by what they sell there would not be any requirement for price change.
- Many Participants: The market is freely competitive. There are many buyers and sellers in the market and any one is free to enter the market or exit from the market. This is necessary to bring an efficient equilibrium in the economy. The suppliers can shift to other goods and services from the one they supply. Labour can also shift from one job to other where is capable of earning more.
- Independence of demand and supply: The action of buyers is independent of sellers. Similarly the sellers are also not affected by any act of the buyers.
Heuristics And Decision Making
Image 1: In the first case the boss has made a judgement that his colleagues are not listening to him. This was because it seemed to boss that asok is sleeping. But this is not the case. He is just not interested because the matter being discussed is not important. The other colleagues know that asok is attentive because if anything important if said asok will send a message to them to pay attention. The thing is everyone is applying heuristics here. It is a common activity among us that we pay attention only to those matters which are important or are relevant to us.
Image 2: Following heuristic principle it is seen that the employee has done a fraudulent task knowing very well that it is a fraudulent activity. This was done just because the boss has already made a decision and the employee is required to do his job that is produce documents to prove his boss decision correct. The employee has applied heuristic by just doing what his boss said without giving importance to the fact that the act is fraudulent. An employee is always trusted to do what his boss says him without thinking whether it is rational or fraud.
Image 3: A razor blade is an item of necessity and is used for shaving purpose. The less explanation provided on the item makes it easier for the person to understand. Therefore without being confused the person should choose the razor blade which has least explanation. The purchaser should apply his common sense and choose any razor whose features he is being able to understand because functions are the same performed by each product with slight variances.
Image 4: In this case the project is too complex for logical reasoning or supporting the decision on base of evidence. But since the person has made the project he has understood it completely and considered all facts while making it. The only problem is it is being difficult for him to explain. Therefore on the basis of his gut feeling he can trust his project to be correct.
What are the assumptions behind neo classical economics? Retrieved from:
Neoclassical Economics. Retrieved from:
Neoclassical Economics. By E. Roy Weintraub. Retrieved from:
The Methodology of the Behavioral Analysis of Law. By Avishalom Tor (2008). Retrieved from:
Expected Value Theory. Retrieved from:
Fast and Frugal Heuristics – The Adaptive Toolbox. By Gerd Gigerenzer & Peter M. Todd. Retrieved from:
The mind as an adaptive toolbox. By Gerd Gigerenzer. Retrieved from:
Heuristics in judgement and decision making. Retrieved from: