微观经济学（第八版-英文）课件：Uncertainty and Consumer Behavior

5.1

DescribingRisk5.2

PreferencesTowardRisk5.3

ReducingRisk5.4

TheDemandforRiskyAssets5.5

Bubbles5.6

BehavioralEconomics

UncertaintyandConsumerBehaviorCHAPTEROUTLINEToexaminethewaysthatpeoplecancompareandchooseamong

riskyalternatives,wetakethefollowingsteps:Inordertocomparetheriskinessofalternativechoices,weneedtoquantifyrisk.Wewillexaminepeople’spreferencestowardrisk.Wewillseehowpeoplecansometimesreduceoreliminaterisk.

Insomesituations,peoplemustchoosetheamountofrisktheywishtobear.Sometimesdemandforagoodisdrivenpartlyorentirelybyspeculation—peoplebuythegoodbecausetheythinkitspricewillrise.Inthefinalsectionofthischapter,weofferanoverviewoftheflourishingfieldofbehavioraleconomics.Probability●

probabilityLikelihoodthatagivenoutcomewilloccur.DescribingRisk5.1Subjectiveprobabilityistheperceptionthatanoutcomewilloccur.●

expectedvalueProbability-weightedaverageofthepayoffsassociatedwithallpossibleoutcomes.ExpectedValue●

payoffValueassociatedwithapossibleoutcome.Theexpectedvaluemeasuresthecentraltendency—thepayofforvaluethatwewouldexpectonaverage.Expectedvalue=Pr(success)($40/share)+Pr(failure)($20/share)=(1/4)($40/share)+(3/4)($20/share)=$25/shareWithtwopossibleoutcomes,theexpectedvalueis E(X)=Pr1X1+Pr2X2E(X)=Pr1X1+Pr2X2+...+PrnXnWhentherearenpossibleoutcomes,theexpectedvaluebecomesVariability●

variabilityExtenttowhichpossibleoutcomesofanuncertaineventdiffer.TABLE5.1INCOMEFROMSALESJOBSOUTCOME1OUTCOME2PROBABILITYINCOME($)PROBABILITYINCOME($)EXPECTEDINCOME($)Job1:Commission.52000.510001500Job2:FixedSalary.991510.015101500TABLE5.2DEVIATIONSFROMEXPECTEDINCOME($)OUTCOME1DEVIATIONOUTCOME2DEVIATIONJob120005001000−500Job2151010510−990●

deviation Extenttowhichpossibleoutcomesofanuncertaineventdiffer.●standarddeviation SquarerootoftheweightedaverageofthesquaresofthedeviationsofthepayoffsassociatedwitheachoutcomefromtheirexpectedvaluesTheaverageofthesquareddeviationsunderJob1isgivenby.5($250,000)+.5($250,000)=$250,000Theprobability-weightedaverageofthesquareddeviationsunderJob2is.99($100)+.01($980,100)=$9900Thestandarddeviationsofjob1andjob2are$500and$99.50,respectively.Thusthesecondjobismuchlessriskythanthefirst;thestandarddeviationoftheincomesismuchlower.TABLE5.3CALCULATINGVARIANCE($)OUTCOME1DEVIATIONSQUAREDOUTCOME2DEVIATIONSQUAREDWEIGHTEDAVERAGEDEVIATIONSQUAREDSTANDARDDEVIATIONJob12000250,0001000250,000250,000500Job21510100510980,100990099.50OUTCOMEPROBABILITIESFORTWOJOBSFIGURE5.1ThedistributionofpayoffsassociatedwithJob1hasagreaterspreadandagreaterstandarddeviationthanthedistributionofpayoffsassociatedwithJob2.Bothdistributionsareflatbecausealloutcomesareequallylikely.UNEQUALPROBABILITYOUTCOMESThedistributionofpayoffsassociatedwithJob1hasagreaterspreadandagreaterstandarddeviationthanthedistributionofpayoffsassociatedwithJob2.Bothdistributionsarepeakedbecausetheextremepayoffsarelesslikelythanthosenearthemiddleofthedistribution.Figure5.2Supposeweadd$100toeachofthepayoffsinthefirstjob,sothattheexpectedpayoffincreasesfrom$1500to$1600.Thetwojobscannowbedescribedasfollows:Job1:ExpectedIncome=$1600StandardDeviation=$500Job2:ExpectedIncome=$1500StandardDeviation=$99.50Job1offersahigherexpectedincomebutismuchriskierthanJob2.Whichjobispreferreddependsontheindividual.Whileanaggressiveentrepreneurwhodoesn’tmindtakingrisksmightchooseJob1,withthehigherexpectedincomeandhigherstandarddeviation,amoreconservativepersonmightchoosethesecondjob.TABLE5.4INCOMEFROMSALESJOBS—MODIFIED($)OUTCOME1DEVIATIONSQUAREDOUTCOME2DEVIATIONSQUAREDEXPECTEDINCOMESTANDARDDEVIATIONJob12100250,0001100250,0001600500Job21510100510980,100150099.50DecisionMakingFinesmaybebetterthanincarcerationindeterringcertaintypesofcrimes,suchasspeeding,double-parking,taxevasion,andairpolluting.Thesizeofthefinethatmustbeimposedtodiscouragecriminalbehaviordependsontheattitudestowardriskofpotentialviolators.Inpractice,itistoocostlytocatchallviolators.Fortunately,it’salsounnecessary.Thesamedeterrenceeffectcanbeobtainedbyassessingafineof$50andcatchingonlyoneintenviolators(orperhapsafineof$500withaone-in-100chanceofbeingcaught).Ineachcase,theexpectedpenaltyis$5,i.e.,[$50][.1]or[$500][.01].Apolicythatcombinesahighfineandalowprobabilityofapprehensionislikelytoreduceenforcementcosts.Thisapproachisespeciallyeffectiveifdriversdon’tliketotakerisks.Anewtypeofcrimethathasbecomeaseriousproblemformusicandmovieproducersisdigitalpiracy;itisparticularlydifficulttocatchandfinesarerarelyimposed.Nevertheless,finesthatareleviedareoftenveryhigh.In2009,awomanwasfined$1.9millionforillegallydownloading24songs.Thatamountstoafineof$80,000persong.EXAMPLE5.1DETERRINGCRIMEPreferencesTowardRisk5.2●

expectedutilitySumoftheutilitiesassociatedwithallpossibleoutcomes,weightedbytheprobabilitythateachoutcomewilloccur.Inthissection,weconcentrateonconsumerchoicesgenerallyandon

theutilitythatconsumersobtainfromchoosingamongriskyalternatives.Tosimplifythings,we’llconsidertheutilitythataconsumergetsfromhisorherincome—or,moreappropriately,themarketbasketthattheconsumer’sincomecanbuy.Wemeasurepayoffsintermsofutilityratherthandollars.Inourexample,aconsumerhasanincomeof$15,000andisconsideringanewbutriskysalesjobthatwilleitherdoubleherincometo$30,000orcauseittofallto$10,000.Eachpossibilityhasaprobabilityof.5.Toevaluatethenewjob,shecancalculatetheexpectedvalueoftheresultingincome.Becausewearemeasuringvalueintermsofherutility,wemustcalculatetheexpectedutilityE(u)thatshecanobtain.

Theriskynewjobisthuspreferredtotheoriginaljobbecausetheexpectedutilityof14isgreaterthantheoriginalutilityof13.5RISKAVERSE,RISKLOVING,ANDRISKNEUTRALPeopledifferintheirpreferencestowardrisk.In(a),aconsumer’smarginalutilitydiminishesasincomeincreases.Theconsumerisriskaversebecauseshewouldpreferacertainincomeof$20,000(withautilityof16)toagamblewitha.5probabilityof$10,000anda.5probabilityof$30,000(andexpectedutilityof14).Theexpectedutilityoftheuncertainincomeis14—anaverageoftheutilityatpointA(10)andtheutilityatE(18)—andisshownbyF.Figure5.3

(1of2)●

riskaverseConditionofpreferringacertainincometoariskyincomewiththesameexpectedvalue.DifferentPreferencesTowardRiskRISKAVERSE,RISKLOVING,ANDRISKNEUTRALIn(b),theconsumerisriskloving:Shewouldpreferthesamegamble(withexpectedutilityof10.5)tothecertainincome(withautilityof8).Figure5.3

(2of2)In(c)isriskneutralandindifferentbetweencertainanduncertaineventswiththesameexpectedincome.●

riskloving Conditionofpreferringariskyincometoacertainincomewiththesameexpectedvalue.●

riskneutral Conditionofpreferringariskyincometoacertainincomewiththesameexpectedvalue.●

riskpremiumMaximumamountofmoneythatarisk-averse

personwillpaytoavoidtakingarisk.RISKPREMIUMTheriskpremium,CF,measurestheamountofincomethatanindividualwouldgiveuptoleaveherindifferentbetweenariskychoiceandacertainone.Here,theriskpremiumis$4000becauseacertainincomeof$16,000(atpointC)givesherthesameexpectedutility(14)astheuncertainincome(a.5probabilityofbeingatpointAanda.5probabilityofbeingatpointE)thathasanexpectedvalueof$20,000.Figure5.4RISKPREMIUMRISKAVERSIONANDINCOMETheextentofanindividual’sriskaversiondependsonthenatureoftheriskandontheperson’sincome.Otherthingsbeingequal,risk-aversepeoplepreferasmallervariabilityofoutcomes.Wesawthatwhentherearetwooutcomes—anincomeof$10,000andanincomeof$30,000—theriskpremiumis$4000.Nowconsiderasecondriskyjob,alsoillustratedinFigure5.4.Withthisjob,thereisa.5probabilityofreceivinganincomeof$40,000,withautilitylevelof20,anda.5probabilityofgettinganincomeof$0,withautilitylevelof0.Theexpectedincomeisagain$20,000,buttheexpectedutilityisonly10:Expectedutility=.5u($0)+.5u($40,000)=0+.5(20)=10RISKAVERSIONANDINDIFFERENCECURVESFigure5.5Part(a)appliestoapersonwhoishighlyriskaverse:Anincreaseinthisindividual’sstandarddeviationofincomerequiresalargeincreaseinexpectedincomeifheorsheistoremainequallywelloff.Part(b)appliestoapersonwhoisonlyslightlyriskaverse:Anincreaseinthestandarddeviationofincomerequiresonlyasmallincreaseinexpectedincomeifheorsheistoremainequallywelloff.RISKAVERSIONANDINDIFFERENCECURVESArebusinessexecutivesmorerisklovingthanmostpeople?Inonestudy,464executiveswereaskedtorespondtoaquestionnairedescribingriskysituationsthatanindividualmightfaceasvicepresidentofahypotheticalcompany.Thepayoffsandprobabilitieswerechosensothateacheventhadthesameexpectedvalue.Inincreasingorderoftheriskinvolved,thefoureventswere:AlawsuitinvolvingapatentviolationAcustomerthreateningtobuyfromacompetitorAuniondisputeAjointventurewithacompetitorThestudyfoundthatexecutivesvarysubstantiallyintheirpreferencestowardrisk.Moreimportantly,executivestypicallymadeeffortstoreduceoreliminaterisk,usuallybydelayingdecisionsandcollectingmoreinformation.EXAMPLE5.2BUSINESSEXECUTIVESANDTHECHOICEOFRISKDiversification●

diversification Practiceofreducingriskbyallocatingresourcestoavarietyofactivitieswhoseoutcomesarenotcloselyrelated.ReducingRisk5.3TABLE5.5INCOMEFROMSALESOFAPPLIANCES($)HOTWEATHERCOLDWEATHERAirConditionersales30,00012,000Heatersales12,00030,000Ifyousellonlyairconditionersoronlyheaters,youractualincomewillbeeither$12,000or$30,000,butyourexpectedincomewillbe$21,000(.5[$30,000]+.5[$12,000]).Ifyoudiversifybydividingyourtimeevenlybetweenthetwoproducts,yourincomewillcertainlybe$21,000,regardlessoftheweather.Iftheweatherishot,youwillearn$15,000fromairconditionersalesand$6000fromheatersales;ifitiscold,youwillearn$6000fromairconditionersand$15,000fromheaters.Inthisinstance,diversificationeliminatesallrisk.●

negativelycorrelatedvariablesVariableshavingatendencytomoveinoppositedirections.THESTOCKMARKET●

mutualfundOrganizationthatpoolsfundsofindividualinvestorstobuyalargenumberofdifferentstocksorotherfinancialassets.●

positivelycorrelatedvariablesVariableshavingatendencytomoveinthesamedirection.InsuranceTABLE5.6THEDECISIONTOINSURE($)INSURANCEBURGLARY(PR=.1)NOBURGLARY(PR=.9)EXPECTEDWEALTHSTANDARDDEVIATIONNo40,00050,00049,0003000Yes49,00049,00049,0000Forarisk-averseindividual,lossescountmore(intermsofchangesinutility)thangains.Arisk-aversehomeowner,therefore,willenjoyhigherutilitybypurchasinginsurance.THELAWOFLARGENUMBERSInsurancecompaniesarefirmsthatofferinsurancebecausetheyknowthatwhentheysellalargenumberofpolicies,theyfacerelativelylittlerisk.Theabilitytoavoidriskbyoperatingonalargescaleisbasedonthelawoflargenumbers,whichtellsusthatalthoughsingleeventsmayberandomandlargelyunpredictable,theaverageoutcomeofmanysimilareventscanbepredicted.ACTUARIALFAIRNESSWhentheinsurancepremiumisequaltotheexpectedpayout,asintheexampleabove,wesaythattheinsuranceisactuariallyfair.●

actuariallyfairCharacterizingasituationinwhichaninsurancepremiumisequaltotheexpectedpayout.Supposeyouarebuyingyourfirsthouse.Toclosethesale,youwillneedadeedthatgivesyouclear“title.”Withoutsuchacleartitle,thereisalwaysachancethatthesellerofthehouseisnotitstrueowner.EXAMPLE5.3THEVALUEOFTITLEINSURANCEWHENBUYINGAHOUSEInsituationssuchasthis,itisclearlyintheinterestofthebuyertobesurethatthereisnoriskofalackoffullownership.Thebuyerdoesthisbypurchasing“titleinsurance.”Becausethetitleinsurancecompanyisaspecialistinsuchinsuranceandcancollecttherelevantinformationrelativelyeasily,thecostoftitleinsuranceisoftenlessthantheexpectedvalueofthelossinvolved.Inaddition,becausemortgagelendersareallconcernedaboutsuchrisks,theyusuallyrequirenewbuyerstohavetitleinsurancebeforeissuingamortgage.Withcompleteinformation,youcanplacethecorrectorderregardlessoffuturesales.Ifsalesweregoingtobe50andyouordered50suits,yourprofitswouldbe$5000.If,ontheotherhand,salesweregoingtobe100andyouordered100suits,yourprofitswouldbe$12,000.Becausebothoutcomesareequallylikely,yourexpectedprofitwithcompleteinformationwouldbe$8500.ThevalueofinformationiscomputedasExpectedvaluewithcompleteinformation: $8500Less:Expectedvaluewithuncertainty(buy100suits): –6750Equals:Valueofcompleteinformation $1750TheValueofInformation●

valueofcompleteinformationDifferencebetweentheexpected

valueofachoicewhenthereiscompleteinformationandtheexpectedvaluewheninformationisincomplete.TABLE5.7PROFITSFROMSALESOFSUITS($)SALESOF50SALESOF100EXPECTEDPROFITBuy50units500050005000Buy100units150012,0006750EXAMPLE5.4THEVALUEOFINFORMATIONINANONLINECONSUMERELECTRONICSMARKETInternet-basedpricecomparisonsitesofferavaluableinformationalresourcetoconsumers.Thevalueofpricecomparisoninformationisnotthesameforeveryoneandforeveryproduct.Competitionmatters.Thesavingsincreasewiththenumberofcompetitors.OnemightthinkthattheInternetwillgeneratesomuchinformationaboutpricesthatonlythelowestpriceproductswillbesoldinthelongrun,causingthevalueofsuchinformationtoeventuallydeclinetozero.Sofar,thishasnotbeenthecase.TherearefixedcostsforpartiestobothtransmitandtoacquireinformationovertheInternet.TheresultisthatpricesarelikelytocontinuetovarywidelyastheInternetcontinuestogrowandmature.EXAMPLE5.5DOCTORS,PATIENTS,ANDTHEVALUEOFINFORMATIONSupposeyouwereseriouslyillandrequiredmajorsurgery.

Assumingyouwantedtogetthebestcarepossible,how

wouldyougoaboutchoosingasurgeonandahospitalto

providethatcare?Atrulyinformeddecisionwouldprobablyrequiremore

detailedinformation.Thiskindofinformationislikelytobedifficultorimpossible

formostpatientstoobtain.Moreinformationisoften,butnotalways,better.Whethermoreinformationisbetterdependsonwhicheffectdominates—theabilityofpatientstomakemoreinformedchoicesversustheincentivefordoctorstoavoidverysickpatients.Moreinformationoftenimproveswelfarebecauseitallowspeopletoreduceriskandtotakeactionsthatmightreducetheeffectofbadoutcomes.However,informationcancausepeopletochangetheirbehaviorinundesirableways.Assets●

asset Somethingthatprovidesaflowofmoneyorservicestoitsowner.Anincreaseinthevalueofanassetisacapitalgain;adecreaseisacapitalloss.●

riskless(orrisk-free)assetAssetthatprovidesaflowofmoneyorservicesthatisknownwithcertainty.RiskyandRisklessAssets●

riskyasset Assetthatprovidesanuncertainflowofmoneyorservicestoitsowner.Assetreturns●

return Totalmonetaryflowofanassetasafractionofitsprice.●

realreturn Simple(ornominal)returnonanasset,lesstherateofinflation.TheDemandforRiskyAssets5.4●

actualreturn Returnthatanassetearns.●

expectedreturn Returnthatanassetshouldearnonaverage.EXPECTEDVERSUSACTUALRETURNSTABLE5.8INVESTMENTS—RISKANDRETURN(1926–2010)AVERAGERATEOFRETURN(%)AVERAGEREALRATEOFRETURN(%)RISK(STANDARDDEVIATION)Commonstocks(S&P500)11.98.720.4Long-termcorporatebonds6.23.38.3U.S.Treasurybills3.70.73.1TheTrade-OffBetweenRiskandReturnLet’sdenotetherisk-freereturnontheTreasurybillbyRf.Becausethereturnisriskfree,theexpectedandactualreturnsarethesame.Inaddition,lettheexpectedreturnfrominvestinginthestockmarketbeRm

andtheactualreturnberm.THEINVESTMENTPORTFOLIO(5.1)(5.2)TheInvestor’sChoiceProblem(5.3)Todeterminehowmuchmoneytheinvestorshouldputineachasset,let’ssetbequaltothefractionofhersavingsplacedinthestockmarketand(1-b)thefractionusedtopurchaseTreasurybills.Theexpectedreturnonhertotalportfolio,Rp,isaweightedaverageoftheexpectedreturnonthetwoassets:Thestandarddeviationoftheriskystockmarketinvestmentis

m.,andthestandarddeviationoftheportfoliois

p,therefore:Howshouldtheinvestorshouldchoosethefractionb?Fromequation(5.2)weseethatb=

p/

m,sothat:RISKANDTHEBUDGETLINE(5.3)●

PriceofriskExtrariskthataninvestormustincurtoenjoyahigherexpectedreturn.Thisequationisabudgetlinebecauseitdescribesthetrade-offbetweenrisk(

p)andexpectedreturn(Rp).Notethatitistheequationforastraightline:BecauseRm,Rf,and

m

areconstants,theslope(Rm

−Rf)/

m

isaconstant,asistheintercept,Rf.TheequationsaysthattheexpectedreturnontheportfolioRpincreasesasthestandarddeviationofthatreturnspincreases.Wecalltheslopeofthisbudgetline,(Rm

−Rf)/

m,thepriceofrisk.RISKANDINDIFFERENCECURVESAninvestorisdividingherfundsbetweentwoassets—Treasurybills,whichareriskfree,andstocks.

Toreceiveahigherexpectedreturn,shemustincursomerisk.Thebudgetlinedescribesthetrade-offbetweentheexpectedreturnanditsriskiness,asmeasuredbythestandarddeviationofthereturn.Theslopeofthebudgetlineis(Rm−Rf)/σm,whichisthepriceofrisk.CHOOSINGBETWEENRISKANDRETURNFigure5.6(1of2)RISKANDINDIFFERENCECURVESCHOOSINGBETWEENRISKANDRETURNFigure5.6(2of2)Threeindifferencecurvesaredrawn,eachshowingcombinationsofriskandreturnthatleaveaninvestorequallysatisfied.Thecurvesareupward-slopingbecausearisk-averseinvestorwillrequireahigherexpectedreturnifsheistobearagreateramountofrisk.Theutility-maximizinginvestmentportfolioisatthepointwhereindifferencecurveU2

istangenttothebudgetline.THECHOICESOFTWODIFFERENTINVESTORSFigure5.7InvestorAishighlyriskaverse.Becausehisportfoliowillconsistmostlyoftherisk-freeasset,hisexpectedreturnRAwillbeonlyslightlygreaterthantherisk-freereturn.HisriskσA,however,willbesmall.InvestorBislessriskaverse.Shewillinvestalargefractionofherfundsinstocks.AlthoughtheexpectedreturnonherportfolioRBwillbelarger,itwillalsoberiskier.BUYINGSTOCKSONMARGINFigure5.8BecauseInvestorAisriskaverse,hisportfoliocontainsamixtureofstocksandrisk-freeTreasurybills.InvestorB,however,hasaverylowdegreeofriskaversion.Herindifferencecurve,UB,istangenttothebudgetlineatapointwheretheexpectedreturnandstandarddeviationforherportfolioexceedthoseforthestockmarketoverall(Rm,σm).Thisimpliesthatshewouldliketoinvestmorethan100percentofherwealthinthestockmarket.Shedoessobybuyingstocksonmargin—i.e.,byborrowingfromabrokeragefirmtohelpfinanceherinvestment.EXAMPLE5.6INVESTINGINTHESTOCKMARKETThe1990s,manypeoplestartedinvestinginthe

stockmarketforthefirsttime.Theshareofwealth

investedinstocksincreasedfromabout26percent

toabout54percentduringthesameperiod.Theadventofonlinetradinghasmadeinvesting

mucheasier.Anotherreasonmaybethe

considerableincreaseinstockpricesthatoccurred

duringthelate1990s,driveninpartbytheso-called“dotcomeuphoria.”Inthelate1990s,manyinvestorshadalowdegreeofriskaversion,werequiteoptimisticabouttheeconomy,orboth.Alternatively,therun-upofstockpricesmayhavebeentheresultof“herdbehavior,”inwhichinvestorsrushedtogetintothemarketafterhearingofthesuccessfulexperiencesofothers.Thepsychologicalmotivationsthatexplainherdbehaviorcanhelptoexplainstockmarketbubbles.EXAMPLE5.6INVESTINGINTHESTOCKMARKETDIVIDENDYIELDANDP/ERATIOFORS&P500Figure5.9ThedividendyieldfortheS&P500(theannualdividenddividedbythestockprice)hasfallendramatically,whiletheprice/earningsratio(thestockpricedividedbytheannualearnings-per-share)rosefrom1980to2002andthendropped.●

bubble Anincreaseinthepriceofagoodbasednotonthefundamentalsofdemandorvalue,butinsteadonabeliefthatthepricewillkeepgoingup.Bubblesareoftentheresultofirrationalbehavior.Peoplestopthinkingstraight.During1995to2000,manyinvestors(perhaps“speculators”isabetterword)boughtthestocksofInternetcompaniesatveryhighprices,pricesthatwereincreasinglydifficulttojustifybasedonfundamentals.TheresultwastheInternetbubble.TheUnitedStatesexperiencedaprolongedhousingpricebubblethatburstin2008,causingfinanciallossestolargebanks.Bytheendof2008,theUnitedStateswasinitsworstrecessionsincetheGreatDepressionofthe1930s.Thehousingpricebubble,farfromharmless,waspartlytoblameforthis.Bubbles5.5EXAMPLE5.7THEHOUSINGPRICEBUBBLE(I)Duringthat8-yearperiodfrom1998to2006,many

peopleboughtintothemyththathousingwasa

sure-fireinvestment,andthatpricescouldonlykeep

goingup.Manybanksalsoboughtintothismyth.Thedemandforhousingincreasedsharply,withsomepeoplebuyingfourorfivehouses.Thisspeculative

demandservedtopushpricesupfurther.By2010,

housingpriceshadfallenover28%fromtheir2007peak.S&P/CASE-SHILLERHOUSINGPRICEINDEXFigure5.10TheIndexshowstheaveragehomepriceintheUnitedStatesatthenationallevel.Notetheincreaseintheindexfrom1998to2007,andthenthesharpdecline.InformationalCascadesThebubblethatresultsfromaninformationalcascadecaninfactberationalinthesensethatthereisabasisforbelievingthatinvestinginthebubblewillyieldapositivereturn.Thereasonisthatifinvestorsearlyinthechainindeedobtainedpositiveinformationandbasedtheirdecisionsonthatinformation,theexpectedgaintoaninvestordownthechainwillbepositive.

However,theriskinvolvedwillbeconsiderable,anditislikelythatatleastsomeinvestorswillunderestimatethatrisk.●informationalcascades Anassessment(e.g.,ofaninvestmentopportunity)basedinpartontheactionsofothers,whichinturnwerebasedontheactionsofothers.EXAMPLE5.8THEHOUSINGPRICEBUBBLE(II)WasitrationaltobuyrealestateinMiamiin2006?

Rationalornot,investorsshouldhaveknownthatconsiderableriskwasinvolvedinbuyingrealestatethere(orelsewhereinFlorida,Arizona,Nevada,andCalifornia).Lookingback,wenowknowthatmanyoftheseinvestorslosttheirshirts(nottomentiontheirhomes).S&P/CASE-SHILLERHOUSINGPRICEINDEXFORFIVECITIESFigure5.11TheIndexshowstheaveragehomepriceforeachoffivecities(innominalterms).Forsomecities,thehousingbubblewasmuchworsethanforothers.LosAngeles,Miami,andLasVegasexperiencedsomeofthesharpestincreasesinhomeprices,andthenstartingin2007,pricesplummeted.Cleveland,ontheotherhand,largelyavoidedthebubble,withhomepricesincreasing,andthenfalling,onlymoderately.Recallthatthebasictheoryofconsumerdemandisbasedonthreeassumptions:consumershaveclearpreferencesforsomegoodsoverothers;consumersfacebudgetconstraints;andgiventheirpreferences,limitedincomes,andthepricesofdifferentgoods,consumerschoosetobuycombinationsofgoodsthatmaximizetheirsatisfaction.Theseassumptions,however,arenotalwaysrealistic.Perhapsourunderstandingofconsumerdemand(aswellasthedecisionsoffirms)wouldbeimprovedifweincorporatedmorerealisticanddetailedassumptionsregardinghumanbehavior.Thishasbeentheobjectiveofthenewlyflourishingfieldofbehavioraleconomics.BehavioralEconomics5.6Herearesomeexamplesofconsumerbehaviorthatcannotbe

easilyexplainedwiththebasicutility-maximizingassumptions:Therehasjustbeenabigsnowstorm,soyoustopatthehardwarestoretobuyasnowshovel.Youhadexpectedtopay$20fortheshovel—thepricethatthestorenormallycharges.However,youfindthatthestorehassuddenlyraisedthepriceto$40.Althoughyouwouldexpectapriceincreasebecauseofthestorm,youfeelthatadoublingofthepriceisunfairandthatthestoreistryingtotakeadvantageofyou.Outofspite,youdonotbuytheshovel.Tiredofbeingsnowedinathomeyoudecidetotakeavacationinthecountry.Ontheway,youstopatahighwayrestaurantforlunch.Eventhoughyouareunlikelytoreturntothatrestaurant,youbelievethatitisfairandappropr