398 ❖ Chapter 22/Frontiers of Microeconomics
D. The Median Voter Is King
1. Example: A society is deciding how much money to spend on a public good. Each voter has a
2. Definition of median voter theorem: a mathematical result showing that if voters
median voter.
b. On Figure 1, the median voter wants a budget of $10 billion.
3. One implication of the median voter theorem is that if two political candidates are each trying
voter.
4. Another implication of the median voter theorem is that minority views are not given much
weight.
E. Politicians Are People Too
1. Politicians may be self-interested.
2. Some politicians may be motivated by desire for reelection and others may be motivated by
greed.
III. Behavioral Economics
insights of psychology.
.
B. Behavioral economics is a relatively new field in economics where economists make use of basic
psychological insights into human behavior.
C. People Aren’t Always Rational
1. Economists assume that human beings are always rational.
a. Firm owners maximize profit.
b. Consumers maximize utility.
all costs and benefits.
Figure 1
Chapter 22/Frontiers of Microeconomics ❖ 399
2. Real people are often more complex than economists assume.
b. These imperfections suggest that humans should not be viewed as rational maximizers
3. Studies of human decision making have found several systematic mistakes that people make.
a. People are overconfident.
c. People are reluctant to change their minds.
4. Case Study: Left-Digit Bias
b. An irrational focus on the left-most digit is called
left-digit bias
.
D. People Care about Fairness
1. Example: the ultimatum game.
b. The game begins with a coin toss, which is used to assign the volunteers to the roles of
Player A and Player B.
d. After Player A makes his proposal, Player B decides whether to accept or reject it.
2. Conventional economic theory suggests that Player A should know that if he offers $1 to
4. Knowing this, people in the role of Player A often offer a more substantial portion of the
money to Player B.
5. This implies that people may be driven by a sense of fairness.
E. People Are Inconsistent over Time
1. Many times in life, people make plans for themselves but then fail to follow through.
2. The desire for instant gratification can induce a decisionmaker to abandon his past plan.
400 ❖ Chapter 22/Frontiers of Microeconomics
3. An important implication is that people will try to find ways to commit their future selves to
following through on their plans.
F.
In the News: Can Brain Science Improve Economics?
1. A new branch of economics examines the biology of the brain to understand economic
behavior.
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
Moral hazard is the tendency of a person who is imperfectly monitored to engage in
dishonest or otherwise undesirable behavior. After purchasing insurance, an insured person
may engage in riskier behavior than do people who are not insured.
A life insurance company can mitigate moral hazard by trying to monitor behavior better and
charging higher rates to those who engage in risky behavior (such as smoking). It can
mitigate adverse selection by trying to collect better information on applicants; for example,
it may require that all applicants submit to a medical examination before issuing insurance.
3. Human decision making can differ from the rational human being of conventional economic
theory in three important ways: (1) people aren’t always rational, (2) people care about
fairness, and (3) people are inconsistent over time.
Questions for Review
Chapter 22/Frontiers of Microeconomics ❖ 401
2. Adverse selection is the tendency for the mix of unobserved attributes to become undesirable
from the standpoint of an uninformed party. Examples of markets in which adverse selection
3. Signaling is an action taken by an informed party to reveal private information to an
uninformed party. Job applicants may use a college diploma as a signal of ability. Screening
is an action taken by an uninformed party to induce an informed party to reveal information.
A life insurance company may require applicants to submit to a health examination so that
4. Condorcet noticed that the majority rule will fail to produce transitive properties for society.
5. The median voter’s preferences will beat out any other proposal in a two-way race because
the median voter will have more than half of the voters on his side.
6. Two volunteers are chosen and a coin toss determines which volunteer is Player A and which
is Player B. Player A proposes a split of a sum of money and then Player B decides whether
to accept or reject the proposal. If Player B accepts, the sum of money is divided as outlined
in the proposal. If Player B rejects the proposal, each player gets nothing.
Conventional economic theory predicts that Player A will offer only $1 to Player B and keep
the remainder for himself. This is predicted to occur because Player A knows that Player B
will be better off with $1 than with $0. However, in reality, Player B generally rejects small
proposals that he considers unfair. If Player A considers this, he will likely offer Player B a
more substantial amount.
Quick Check Multiple Choice
1. b
2. a
3. d
4. b
5. a
6. c
Problems and Applications
b. The stockholders of the firm (the owners) are the principals and the top executives are
the agents. The firm’s owners do not know in advance how well the top executives will
perform their duties. Tying some of the executives’ compensation to the value of the firm
provides incentive for the executives to work hard to increase the value of the firm.
402 ❖ Chapter 22/Frontiers of Microeconomics
installing anti-theft equipment are more likely to take good care of their vehicles.
Offering a discount on insurance premiums will induce car owners to install such devices.
3. Saying “I love you” is likely not a good signal. To be an effective signal, the signal must be
costly. In fact, the signal must be less costly, or more beneficial, to the person with the
higher-quality product. Simply professing one’s love does not meet this requirement.
HIV-positive), increasing the adverse selection problem. The number of individuals without
health insurance would likely rise as a result.
5. Ken is violating the property of independence of irrelevant alternatives. Adding a choice of
and prefer chocolate.
6. a. If the three friends use a Borda count, the Chinese restaurant gets the most votes (10);
the Italian restaurant gets 9 votes; the Mexican restaurant gets 7 votes; and the French
restaurant gets 4 votes.
c. This voting violates the assumption of independence of irrelevant alternatives. The
presence of the Mexican and French restaurants should not alter the group’s preferences
between the Italian and Chinese restaurants.
7. a. There would be a tie between the three television shows, with 6 votes each.
b. In a vote between
NCIS
and
Glee
,
NCIS
would win. In a vote between
NCIS
and
Homeland
,
Homeland
would win. Thus, Monica’s first choice (
Homeland
) would win.
competing in a second vote with
NCIS
. That way, his preferred choice (
NCIS
) would win.
d. If Chandler says he prefers
Glee
over
NCIS
,
Glee
will then compete in a vote against
preferred show (
Homeland
).
8. a. The efficient number of DVDs is three. Total surplus would be the sum of the roommates’
willingness to pay (38 + 26 + 18 = 82) minus the cost of the DVDs (15 + 15 + 15 = 45)
which is 37.
Chapter 22/Frontiers of Microeconomics ❖ 403
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b. Quentin would want 4 DVDs; Spike would prefer 3; Ridley wants 2; Martin wants 1; and
Steven does not want to buy a DVD.
c. The preference of the median roommate (Ridley) is 2 DVDs.
2 DVDs.
e. No. Any other option besides 2 DVDs would get fewer votes.
9. More than likely, the two stands will locate at the center of the beach. Thus, they will always
be closest for at least half of the beach goers. This is related to the median voter theorem.
than the possibility of the needy person spending the cash on drugs or alcohol, the
government can be certain the needy person is getting food from the soup kitchen.