Investor Choice

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En provenance du cours de University of Rochester

The Power of Markets I: The Basics of Supply and Demand and Consumer Behavior

76 notes

University of Rochester

The Power of Markets I: The Basics of Supply and Demand and Consumer Behavior

76 notes

This opening module of the Power of Markets course covers the basic assumptions about market participants made by economists, the concept of opportunity cost, and the key determinants of supply and demand. We will then learn how to use the supply-demand framework to explain and predict market outcomes and to show how government policies affect those market outcomes. We will look at how quantity demanded and supplied respond to their key determinants in quantitative (elasticity) as well as qualitative terms. The last two weeks of the first module will investigate consumer behavior more closely and show how consumer choices are driven by the interplay of preferences and budget constraints. We will employ the consumer choice framework to examine investor choice as well as policies such as ObamaCare and school choice. Finally, we will also address the concept of how to distribute a given amount of goods across a society’s consumers in the most efficient manner.

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Week 4 - Consumer Choice and the Benefits of Exchange

Using Consumer Choice Theory to Analyze Investor Choice as well as Policies Such as ObamaCare and School Choice. Promoting Efficiency in the Distribution of Goods.

Investor Choice 4:54

Efficiency in the Distribution of Goods 7:41

Rencontrer les enseignants

Mark Zupan
Professor of Economics and Public Policy
Simon School of Business

Another important application of consumer choice theory is

looking at investor choice. How investors park

their money across different assets. And to motivate this if you look at

a portfolio of common stocks, and when people have analyzed this going back

to the early 1800s, the annual average rate

of return on common stocks has averaged 6%, per year.

By contrast, treasury bills have an average annual rate

of return, over that same time period, of point 6%.

So why would any investor in his or her

right mind put money in treasury bills versus common stocks?

Another perspective on this, had you put a dollar in common stocks, as

of 1802, today that dollar in real terms would be worth

$500,000. Had you put that same dollar in

treasury bills that same dollar would be worth only $350 today, in real terms.

So why would you sacrifice such a potential gain as an investor?

The reason you might, is your tolerance for risk.

While it's true common stocks have an average annual rate of return of 6%, they

also have much more variation year-to-year in those returns.

That 6% rate of return may be arrived at by an 18% increase one year

coupled with a 6% decline the next year, and the average over the two

year period being 6%.

Whereas, the return on treasury bills are very predictable and much less risky.

At least until later in 2013, there was no

talk about a government potential default on its payment.

So treasury bills were an incredibly secure asset.

And let's look at how that translates into thinking

about how investors should position their, should allocate their wealth.

There's a return-risk tradeoff that'll determine an investor's

appetite for how much do I want to put

into stocks, how much do I want to put in treasury bills and other forms of assets.

Risk is bad.

Whereas returns on the vertical axis are good.

These indifference curves in this type of setting have an upward slope to em.

So to take on additional risk from point A to point B, for the investor to remain

on the same indifference curve she has to be

compensated with a higher return to stay on U2.

So if we're going to add from risk 1 to risk 2 additional risk to their portfolio,

we have to add additional return to compensate.

The more averse you are to risk, the more steeply

sloped your indifference curves will be relating return to risk.

You have to be compensated with more return, if you're more risk-averse,

to take on that same additional risk from risk 1 to risk 2.

So when people are advising or making

their own asset allocation decisions, fundamentally, underneath it

they're thinking about these risk return trade

offs, and how they're portrayed by indifference curves.

And then one other example, when we

look at entrepreneurs versus non-entrepreneurs, nowadays seven

out of ten high school students indicate

they eventually want to start their own business.

It's been growing over time.

One of the fundamental insights of entrepreneurs

is that they're willing, they have more

of an appetite for risk, they're more tolerant of risk for the same return.

let's see an example of this. in figure 5.14, we show an entrepreneur's

indifference curve map relating return to risk versus a non entrepreneur.

For the same increase in return, from return 1 to return 2, an entrepreneur

is willing to take on my risk, from risk 1 E to risk 2 E,

a greater horizontal distance for that same increase

in return than a non-entrepreneur's willing to take on.

so folks that are more averse to risk and taking chances, the advice

is an entrepreneurial career is less likely to be a good fit for your future.

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