The Price Point

As Stuyvesant students prepare to enter the world, understanding the economy becomes an essential skill. In today’s society, knowledge of economics provides us with a foundation for navigating financial issues, understanding the effects of public policy on the market, and making informed decisions about our own personal finances.

End of Government Shutdown Brings Valuable Information

After six weeks, the longest government shutdown in the country’s history has ended and federal economic data is once again available. On November 20, the Bureau of Labor Statistics released the September monthly job report, which was delayed due to the government shutdown; the report showed an unexpected 119,000 new jobs in September. However, many exhibit cautious optimism of this reading—for example, unemployment increased to 4.4 percent. The hospitality and healthcare industries recorded the most growth, but, concerningly, sectors tied with producing goods shed jobs due to decreased imports. This was coupled with weak growth in the service sector and government firings, as part of the current administration’s agenda. Overall, this economic picture can be summed up in one word that many investors do not like: uncertainty.

AI Investment Panic Causes Severe Market Downturn

This past week marked a terrible one for investors in the stock market. Key indicators such as the Dow Jones Industrial Average were down $1,470 (-3.11 percent); the S&P 500 was down $133 (-2.00 percent); and the NASDAQ was down $466 (-2.07 percent), as compared to the past five days at closing on Thursday evening. This downturn is attributed to the uncertainty of AI technologies and their valuation, prompting investors to seriously consider if we are in an AI bubble; a weakening labor market; and rampant inflation. The last two contribute to uncertainty over the Federal Reserve’s actions at its next meeting and thus this downslide in stocks.

Economics Concept of the Issue

Prospect Theory - The Value Function

In prospect theory, the value function describes how individuals evaluate the values of different outcomes. It takes the piecewise form shown above with different equations for gains and losses.

• Reference Dependence: Outcomes are valued as changes relative to a reference point instead of absolute wealth—the function models outcomes based on changes, not absolute values.

• Diminishing Sensitivity: Absolute wealth value’s diminishing to marginal utility of wealth as well as changes in wealth in both gain and loss domains—shown by the curved nature of the graph on both gains and losses.

Ex: The difference in happiness between gaining $10 and $20 is greater than the difference between gaining $1,010 and $1,020.

• Loss Aversion: Losses have a larger psychological impact than gains—expressed via the lambda term (greater than 1) in the loss function, which amplifies negative value.

Ex: A loss of $10 hurts more than a gain of $10 feels good.

• Gain Concavity (Risk Aversion) and Loss Convexity (Risk Seeking): Individuals exhibit risk-averse behavior in the gain domain and risk-seeking behavior in the loss domain—the function is concave (concave down) in the gain domain and convex (concave up) in the loss domain. This is due to diminishing sensitivity, since the possibility of worsening the loss has a smaller impact than improving it, so individuals are willing to take the gamble; the opposite is true for gains.

• Reference Point Kink: Near the reference point (origin), small losses are much worse than small gains are good—the function exhibits a sharp bend (kink) at the reference point.