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behavioral economics

Questions and Answers of Behavioral Economics

The Bloomberg ban As part of a 2013 public-health initiative spearheaded by then-mayor Michael Bloomberg, New York City banned the sale of sodas larger than 16 ounces (or about 0.5 liters) in
Apples or fries? US hamburger chains have started serving apple slices instead of French fries with their “meal” options. Fries are still available, but the customer has to ask to have fries
Traffic signals What kind of policy is represented by (a) a stop sign; (b) a lane-ending sign; (c) a red light; (d) a yellow light; (e) a parking meter labeled “¢25 per hour”; and (f) a
Gandhi A leader of India’s independence movement and advocate of non-violent social change, Mahatma Gandhi is supposed to have said: “The true measure of any society can be found in how it treats
Social preferences and the prisoners’ dilemma Find the Nash equilibria in pure strategies in Table 11.2, when played by:(a) Two egoists, for whom u(x, y)5 !x.(b) Two utilitarians, for whom u(x, y)5
Altruism and the ultimatum game Imagine the ultimatum game from Figure 11.1 played by two utilitarians with u(x, y)5 !x1 !y. Find the unique subgame-perfect equilibrium in this game.One important
Paradoxes of rationality Experimental economists have invited students with different majors to play prisoners’ dilemma games against each other. In an experiment pitching economics majors against
The centipede game The centipede game has four stages (see Figure 10.5). At each stage, a player can Take, thereby ending the game, or Pass, thereby increasing the total payoff and allowing the other
Battle of the sexes, cont. Are the two pure-strategy equilib ria in the battle of the sexes (Table 10.8) trembling-hand perfect?
The stag hunt This game is due to Jean-Jacques Rousseau, the eighteenth-century French philosopher. Rousseau describes a scenario in which two individuals go hunting. The two can hunt hare or deer
Chicken The game of chicken was popularized in the 1955 f ilm Rebel Without a Cause, starring James Dean. The game is played by two peo ple who drive cars straight at each other at high speed; the
Rock-paper-scissors (a) Draw the payoff matrix for the game rock-paper-scissors. Suppose that a win gives you 1 utile, a tie 0, and a loss −1. (b) What is the unique Nash equilibrium in this game?
Pure vs. mixed equilibria Find all Nash equilibria (in pure and mixed strategies) in the games depicted in Table 10.9.
Mixed-strategy equilibrium Find the mixed-strategy Nash equilibria in Tables 10.4(a) and (b).
Nash equilibrium in pure strategies Find all Nash equilibria in the games in Table 10.4, where Player I chooses between Up (U), (Middle (M)), and Down (D) and Player II chooses between Left (L),
Match each of the vignettes below with one of the fol lowing phenomena: hyperbolic discounting, preference over profiles, and choosing not to choose. If in doubt, pick the best fit.(a) Allie goes to
Weights and shackles Seneca offered the following advice:[Reflect] that prisoners at first find the weights and shackles on their legs hard to bear, but subsequently, once they have determined to
Addiction Suppose that life has three periods: youth, middle age, and old age. In every period you decide whether to do drugs(“hit”) or not (“refrain”). The utility of hitting depends on
Retirement savings When young, many people fully intend to save for retirement. However, when they start making money after college, they are often tempted to spend it immediately. Assume that Ximena
Happiest professions Table 9.3 shows the result of a recent survey about the happiness of people in various professions: the middle col umn lists the five happiest professions, and the right-hand
Buffet lines Perhaps you too have the following experience when picking up dinner from a buffet, where you can serve yourself exactly what kind of food you want. At the end of the meal, people find
Sidgwick What kind of misprediction is described in the following passage, by the nineteenth-century moral philosopher Henry Sidgwick?
College Many adults will tell you that their college years were the best years of their lives. This is puzzling since actual college students are not, on the average, fantastically happy. Use the
The peak–end rule, cont. This exercise refers to Figure 9.6.Would a person who follows the peak–end rule choose the episode repre sented by the solid line or the episode represented by the dashed
The peak–end rule Suppose you add a pleasant tail to an already pleasant episode. If people assess the episode as a whole in accord ance with the peak–end rule, will this make people think of the
Cleaning the house It is Sunday morning (t 5 0), and you are determined to accomplish two things today: cleaning the apartment and going to the movies. You can either clean during the morning (at t 5
Johnny Depp 2 This exercise refers to Example 9.10. Suppose instead that you can only watch one of the four movies. Will you watch a the mediocre, b the good, c the great, or d the fantastic movie?
Wicksteed’s blanket The theologian and economist Philip Wicksteed offers the following observation: “[We] lie awake (or what we call awake next morning) half the night consciously suffering from
Suppose that you discount the future hyperbolically. Assume that both b and d are strictly greater than zero but strictly smaller than one. At t 5 0, you are given the choice between the following
Suppose that you discount the future hyperbolically. Assume that both b and d are strictly greater than zero but strictly smaller than one. At t 5 0, you are given the choice between the following
Suppose that you discount the future hyperbolically, that is, in accordance with the beta–delta function, and that from the point of view of Thursday you are indifferent between options a (1 utile
Cancer screening Most colon cancers develop from polyps. Because early screening can detect polyps before they become cancerous and colon cancer in its early stages, many doctors advise patients over
Impulsivity and impatience Suppose you are offered the choice between option a (8 utiles on Thursday) and b (12 utiles on Friday). (a) Assume that b 5 1 and that d 5 5/6. From the point of view of
The beta–delta function Suppose that you are facing a utility stream of 1 utile at t 5 0, 3 utiles at t 5 1, and 9 utiles at t 5 2. For each of the following parameter values, apply the
Time discounting and interest rates Whether you should spend or save will depend not just on your time preference, but on the interest you can get when putting your money in a savings account.Suppose
Credit scores A study in the journal Psychological Science by two economists from the Federal Reserve Bank in Boston found a connection between people’s discount factor d and their credit score.A
Youth sports In a 2014 interview, basketball star Kobe Bryant discussed the importance of making sports fun for young people. “It’s hard to tell a kid that you need to get out there and compete
Suppose instead that the utility function is u (x) 5 x2. What would Table 8.4(b) look like, and what would d be?Table 8.4 Time-discounting problem (in dollars and utiles) t 5 0 t 5 1 a b $9 $1 $4 $25
As a financial advisor, you offer your clients the possibility to invest in an asset that generates a utility stream of 1 utile this year (t 5 0), 0 utiles next year (t 5 1), and 1 utile the year
For each of the three decision problems in Table 8.3, compute d on the assumption that a person is indifferent between a and b at time zero.Table 8.3 Time-discounting problems t 5 0 t 5 1 ab 35
This exercise refers to the utility streams in Table 8.2. For each of the following people, compute d.(a) At t 5 0, Ahmed is indifferent between utility streams a and b.(b) At t 5 0, Bella is
Use Figure 8.3 to answer the following questions:(a) If d , 1/3, what would the curve look like?(b) What if d . 1/3?
A stitch in time “A stitch in time saves nine,” people say when they want you to do something now rather than later. But not everyone will be swayed by that sort of concern. Suppose that you can
The impartial spectator Adam Smith’s Theory of Moral Sentiments made a big deal of the differences between an “impartial specta tor” and our actual selves. An impartial spectator, Smith wrote,
Discount factors For each of the following, identify whether the person’s d is likely to be high (as in close to one) or low (as in close to zero):(a) A person who raids his trust fund to purchase
The ant and the grasshopper According to the fable, the grasshopper chirped and played all summer while the ant was collecting food. When winter came, the ant had plenty of food but the grasshopper
Exponential discounting, cont. Suppose instead that d 5 0.1. (a) Compute the utility of each of the four utility streams from the point of view of t 5 0. (b) What would you choose if given the choice
Payday loans, cont. Imagine that you borrow $61 from a pay day loan establishment. After one week, it wants the principal plus 10 percent interest back. But you will not have that kind of money; so,
Savings Suppose that you put $100 into a savings account today and that your bank promises a 5 percent annual interest rate.(a) What will your bank’s liability be after 1 year?(b) After 10
Payday loans Payday loan establishments offer short-term loans to be repaid on the borrower’s next payday. Fees fluctuate, but such an establishment may offer you $400 on the 15th of the month,
Cost of credit, cont. What would it cost to borrow $1000 for one year using one of the other credit cards in Table 8.1? What if you need$100 or $10,000?Fees and APRs fluctuate; never make decisions
Lotto 6/49, cont. What is the expected value of a Lotto 6/49 ticket, if the grand prize is a million dollars?We know from Exercise 4.28 that the ticket is a winner one time out of 13,983,816. The
Match each of the vignettes below with one of the follow ing phenomena: ambiguity aversion, cancellation, certainty effect, competence hypothesis, silver lining, and mental accounting. If in doubt,
Life coaching Life coaches are people whose job it is to help you deal with challenges in your personal and professional life.(a) If you spend too much money, life coaches will sometimes suggest that
Zero expected value Prospect theory is consistent with the result that people frequently reject gambles with an expected value of zero. Suppose you are facing a gamble G with a 1/2 probability of
Savings decisions You are lucky enough to have a million dollars in the bank. You have decided that there are only three serious investment options: putting it in your mattress, investing in stocks,
Lotteries as rewards Behavioral economists have found that using lotteries is an effective way to incentivize behavioral change. Thus, a person may be more likely to fill in a survey or take a pill
Nevada’s boom and bust Las Vegas entrepreneur Andrew Donner does not gamble at the casinos. Instead, he invests in real estate in the city’s downtown. Interviewed on Marketplace, Donner said:
Tennis You have been invited to bet on one of three tennis games. In game 1, two extraordinarily good tennis players are up against each other. In game 2, two extraordinarily poor tennis players are
The coins Suppose that you have the opportunity to bet on the outcome of a coin toss. If the coin comes up heads, you win; if it comes up tails, you lose. Suppose also that you are ambiguity averse.
Certainty effect, cont. Show that it is a violation of expected-util ity theory to choose (A) over (B) and (D) over (C) in Example 7.23. Notice that (C) and (D) can be obtained from (A) and (B) by
Sure-thing principle, cont. Suppose that you face the options in Table 7.2(c) and that you must choose first between (1a) and (1b), and sec ond between (2a) and (2b). What choice pattern is ruled out
Sure-thing principle(a) Suppose that you face the options in Table 7.2(a). Which state of the world does the sure-thing principle tell you to ignore?(b) Suppose that you face the options in Table
Silver linings For this question, suppose your value function is v(x)5 !x/2 for gains and v(x)5 22!0x0 for losses. Last night, you lost $9 in a bet. There was a silver lining, though: on your way
The pain of paying taxes The previous paragraph suggests that how you feel about paying your taxes will depend on whether you inte grate that cost with the money you made or not. (a) If you are a
Evaluation of losses Yesterday, you had a terrible day: you got a $144 speeding ticket on your way to the opera, and then had to pay $25 for a ticket you thought would be free. Suppose your value
Air fares If you are old enough, you may remember the good old days when all sorts of conveniences were included in the price of an air line ticket. Under pressure to reduce the sticker price of
The opposite arrangement Suppose that the opposite were true: whenever you purchase something, you have to pay cash on the spot, but your purchases are not delivered until the end of the month in a
Evaluation of gains Yesterday, you had a decent day: you f irst received a $48 tax refund, and then an old friend repaid a $27 loan you had forgotten about. Suppose that your value function v(·) is
Relative income It is well known that poor people, who can least afford to play the lottery, are most likely to do so. In a 2008 study, researchers wanted to know whether manipulating people’s
Another person with the same value function is facing the choice between a sure $2 and a 50–50 gamble that pays $5 if he wins and $1 if he loses.(a) If he takes the worst possible outcome as his
A person’s value function is v (x) 5 !x/2 for gains and v (x) 5 22!0x0 for losses. The person is facing the choice between a sure $2 and a 50–50 gamble that pays $4 if she wins and $0 if she
Prospect evaluation, cont. This exercise refers to Example 7.7 above. Suppose that your value function v(?) is defined by: v(x)5 !x/ 2 for gains (x $0) and v(x)5 22!0x0 for losses (x , 0) (a) Draw
The ostrich farm Jen and Joe have an ostrich farm. They have just learned that the farm has been struck by an unusual virus. According to their vet, if they do nothing only 200 of the 600 animals
Jacket/calculator problem, again Consider again the classic jacket/calculator example from Section 3.2. Recall that many people were willing to make the drive when they could save $5 on a $15
Curvatures, cont. Given the same value function, which is greater: the absolute difference between v (60) and v (210) or the absolute dif ference between v (21000) and v (21010)?
Misguided criticism Some critics attribute to neoclassi cal economists the view that human beings have the ability to compute solutions to every maximization problem, no matter how complicated, in
The humiliation show You are on a game show where people embarrass themselves in the hope of winning a new car. You are given the choice between pressing a blue button and pressing a red button.(a)
Deal or No Deal, cont. You are on Deal or No Deal again, and you are facing three boxes. One of the three contains $1,000,000, one contains $1000, and one contains $10. Now the dealer offers you
Lotto 6/49, cont. Compute the certainty equivalent of the Lotto 6/49 ticket from Exercise 4.28 if u(x)5 !x.
Suppose that your utility function is u(x)5 !x, and that you are offered a gamble which allows you to win $16 if you are lucky and $4 if you are not.(a) Suppose that the probability of winning $16 is
Suppose that your utility function is u(x)5 !x, and that you are offered a gamble which allows you to win $4 if you are lucky and $1 if you are not.(a) Suppose that the probability of winning $4 is
Suppose that you are offered the choice between $4 and the following gamble, G: 1/4 probability of winning $9 and a 3/4 probability of winning $1.(a) Suppose that your utility function is u(x)5 !x .
Compute the certainty equivalent of the gamble in Figure 6.8, using the utility function u(x) 5 x2.We end this section with a series of exercises.
Certainty equivalents Demonstrate how to find the certainty equivalent of the same gamble in the case when the utility function bends upwards. Confirm that the certainty equivalent is greater than
Attitudes to risk As far as you can tell, are the following peo ple risk prone, risk averse, or risk neutral? (a) People who invest in the stock market rather than in savings accounts. (b) People who
Risk proneness Consider, again, the gamble in Figure 6.8.Now suppose that your utility function is u (x) 5 x2. Unlike the previous utility function, which gets flatter when amounts increase, this
Indifference This question refers to Table 6.2. Let p denote the probability that S1 obtains. (a) If an expected-utility maximizer is indifferent between A and B, what is his p? (b) If another
Pascal’s wager The French seventeenth-century mathemati cian and philosopher Blaise Pascal suggested the following argument for a belief in God. The argument is frequently referred to as Pascal’s
Thanksgiving indecision Suppose you are contemplating whether to go home for Thanksgiving. You would like to see your family, but you are worried that your aunt may be there, and you genuinely hate
Hearing loss A patient with hearing loss is considering whether to have surgery. If she does not have the surgery, her hearing will get no better and no worse. If she does have the surgery, there is
Expected utility, again Suppose that you are facing three gam bles. A gives you a 1/3 probability of winning $9. B gives you a 1/4 probabil ity of winning $16. C gives you a 1/5 probability of
Lotto 6/49, cont. Assume still that your utility function is u(x)5 !x, that the probability of winning at Lotto 6/49 is one in 13,983,816, and that the prize is a million dollars.(a) What is the
Expected utility, cont. Suppose instead that your utility func tion is u(x) 5 x2. (a) What is the expected utility of rejecting the gamble? (b) What is the expected utility of accepting the gamble?
Warranties A tablet computer costs $325; the optional one year warranty, which will replace the tablet computer at no cost if it breaks, costs $79. What does the probability p of the tablet computer
Lotto 6/49, cont. Suppose a Lotto 6/49 ticket costs $1 and that the winner will receive $1,000,000. What does the probability of winning need to be for this lottery to be actuarially fair, that is,
Parking, cont. Assume that the cost of parking legally is still $5. (a) If the parking ticket costs $100, what does the probability need to be for the expected value of parking legally to equal the
Deal or No Deal You are on the show Deal or No Deal, where you are facing so many boxes, each of which contains some (unknown)amount of money (see Figure 6.6). At this stage, you are facing three
Suppose somebody intends to roll a fair die and pay you $1 if she rolls a one, $2 if she rolls a two, and so on. What is the expected value of this gamble?
Parking You are considering whether to park legally or ille gally and decide to be rational about it. Use negative numbers to represent costs in your expected-value calculations. (a) Suppose that a

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