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behavioral economics

Questions and Answers of Behavioral Economics

Latte discounts Many coffee shops give customers a small discount if they bring their own reusable mug. The coffee shops could equiva lently lower all prices and add a small penalty to the bill of
The tax cut Suppose Alex and Bob are loss averse, so that their value function is v (x) 5 x/2 for gains and v (x) 5 2x for losses. Because of an upcoming election, politician R promises a tax cut
Thievery A thief steals $100 from a victim. Let us suppose that the thief and victim have the same value function over money: v (x) 5 x/2 for gains and v (x) 5 2x for losses.(a) How much, in value
The stock market Alicia, Benice, and Charlie own stock in the same company. When they bought the stock, it was worth $10. It later rose to$17, but then dropped to $12 before they sold it. The three
The bond market An ill-fated investment of yours in the junk bond market just decreased from $1 to $0. Your value function is v (x) 5 x/2 for gains and v (x) 5 2x for losses.(a) Suppose, first, that
Having and losing In fact, it is possible to be worse off in value terms even if you are better off in dollar terms. Working with the same value func tion, compute the net effect in value terms of
Toy Yoda, cont. Suppose that the same value function cap tures the waitress’s value function over cars in Example 3.34. What is the total change in value she experiences after she gains a car and
Third-party candidates, cont. Suppose that politician A in E 3.29 above wanted to win elections instead by harnessing the power of the compromise effect. What sort of platform must the third-party
Speed vs. safety, cont. Suppose that you want to harness the power of the compromise effect to sell more Bugattis (see Exercise 3.26). What sort of vehicle would you need to introduce to do so?
Wingmen and wingwomen To improve your chances on the dating scene, you have decided to recruit a wingman or wingwoman.(a) How, in general terms, should you choose your wingman or wingwoman?(b)
Third-party candidate Politician A has decided to run for polit ical office on a platform promising lower taxes and cuts in public services. His opponent B promises higher taxes and more funding for
Decoy effect For this question, refer to Figure 3.8. (a) If you are in charge of marketing the target product, in what area would you want to put the decoy?(b) Assuming the decoy works as
Revenge When wronged, many people feel a strong urge to take revenge. Assuming revenge is costly, would not a revenge simply be a matter of honoring the sunk cost of whatever injury they have already
Course selection Students at an expensive liberal arts col lege may take courses at a nearby public university at no additional charge.One of their professors tells them that it would make no sense
The fridge When cleaning out your fridge, you find some food obviously rotting in the back. You have no trouble throwing away the cheap mass-produced cheese somebody gave you, but you just cannot
Sunk costs Draw decision trees for people who (a) hold on to failed investments and (b) stay in bad relationships, in such a way that it becomes clear that the people in question are committing the
The opportunity cost of an economics education What is (or would be) the opportunity cost, for you, of taking a course in behavioral eco nomics? Upon reflection, is it (or would it be) worth it?
War or terror Imagine that a new terrorist group is threat ening the lives of innocent civilians, and that all things equal, it would be a good thing if the group vanished. Does this necessarily make
Advertising campaigns Your latest efforts to boost revenue led to an advertising campaign that turned out to be hugely successful: an investment of $1000 led to a $5000 boost in revenue. Does this
Whatever it takes Politicians sometimes promise to do “what ever it takes” to eliminate poverty, defeat terrorism, etc. Use the concept of opportunity cost to explain why that is not be the best
Room service Suppose that you are staying at an expensive hotel that offers in-room dining for $60. Ordinarily you would not pay that kind of money for a meal, but you say to ourself: “I already
Opportunity costs, cont. Using the language of opportunity cost, explain why highly paid people are less likely than poor people to mow their own lawns, clean their own houses, maintain their own
Opportunity costs What is the opportunity cost of (a) staying in an unfulfilling relationship, (b) pursuing a course of study that does not excite you, and (c) sleeping until noon?The concept of
Opportunity costs This exercise refers to Figure 3.3. Suppose that a fifth act (call it a5 ) becomes available. Assume that a5 has a utility of 9. (a) What would the tree look like now? (b) What
Investment problem (a) Draw a decision tree illustrating this decision problem. (b) What is the opportunity cost of buying real estate? (c) What is the opportunity cost of buying bonds?
Irrationality Explain (in words) why each of the charac ters below is irrational according to the theory you have learned in this chapter.(a) In the drama Sophie’s Choice, the title character finds
As part of your answer to the following questions, make sure to specify what the universe is.(a) Give an example of a relation that is complete but not transitive.(b) Give an example of a relation
More properties of the preference relation Here are two relations: “is married to” and “is not married to.” Supposing the universe is the set of all living human beings, which of these
For each of the relations and properties in Table 2.1, use a check mark to identify whether or not the relation has the property.Table 2.1 Properties of weak preference, indifference, and strong
Misguided criticism Many criticisms of standard economics are quite mistaken. Explain where the following critics go wrong. (a) An otherwise illuminating article about behavioral economics in Harvard
Prove Proposition 2.34(ii).
Budget sets Suppose that your budget is $12. Use a graph to answer the following questions:(a) What is the budget set when apples cost $3 and bananas cost $4?(b) What is the budget set when apples
The menu, cont. If you can also choose to eat an appetizer only, or an entrée only, or nothing at all, what would the new menu be? There is no assumption that a menu is small, or even finite, though
Indifference curves Represent the following sets of indiffer ence curves graphically.(a) Suppose that an apple for you is always as good as two bananas.Heavenly Bliss Coke Pepsi Eternal Suffering(b)
Cycling preferences, cont. By contrast, it is possible for the weak preference relation to cycle. This is to say that there may well be an x, y, and z such that xfy & yfz & zfx. If this is so, what
Cycling preferences Using the definitions and propositions discussed so far, show that it is impossible for a rational strict preference rela tion to cycle. To do so, suppose (for the sake of the
Tea cups Imagine that there are 1000 cups of tea lined up in front of you. The cups are identical except for one difference: the cup to the far left (c1 ) contains one grain of sugar, the second from
Vacations Suppose that you are offered two vacation pack ages, one to California and one to Florida, and that you are perfectly indif ferent between the two. Let us call the Florida package f and the
Negative transitivity Prove the following two principles. You might already have been tempted to invoke these two in your proofs. But remember that you may not do so before you have established
Prove that if x , y and y , z, then ¬ x s z.
Establish the following important and intuitive principles.(For the record, some of them are logically equivalent.)(a) If x s y then x f y(b) If x s y then ¬ y f x(c) If x f y then ¬ y s x(d) If x
Prove the following principle: x s y & yfz S xsz (for all x, y, z). Notice that this proof has two parts. First, prove that xfz; second, prove that ¬ zfx.
Prove Proposition 2.16(iii). Prove it by contradiction, by first assuming that there is an x such that x s x.
Iterated transitivity In this exercise you will prove the follow ing principle in two different ways: x , y & y , z & z , p S x , p.(a) First prove it by applying the transitivity of indifference
Prove the following principle: xfy & y , z S xfz.In your various proofs, it is always acceptable to rely on propositions you have already established. The following exercise shows how useful this can
Preferences and the universe Use your understanding of transitivity and completeness to answer the following questions.(a) If the universe is {apple, banana, starvation}, what does the transitivity
Assuming the universe is the set of all natural numbers, mean ing that U 5 {1, 2, 3, 4, …}, are the following relations transitive? Are they complete?(a) “is at least as great as” ($)(b) “is
The enemy of your enemy Suppose it is true, as people say, that the enemy of your enemy is your friend. What does this mean for the transitivity of “is the enemy of”? (Assume there are no true
Assuming the universe is the set of all people – past, present, and future – are the following relations transitive? Are they complete? (a) “is the mother of” (b) “is an ancestor of” (c)
Preferences Suppose d denotes “enjoying a cool drink on a hot day” and r denotes “getting roasted over an open fire.”(a) How would you state your preference over these two options?(b) How
The universe Suppose we are talking about all countries that are members of the United Nations. How would that be written?
Relations Assume that f denotes France and n denotes Norway, and that B means “is bigger than.” (a) How would you write that France is bigger than Norway? (b) How would you write that Norway is
Numeracy In a recent study on financial decision-making, peo ple’s answers to three quick mathematics questions were strong predictors of their wealth: households where both spouses answered all
Descriptive vs. normative Which of the following claims are descriptive and which are normative? (Answers to this and other exercises can be found in the Appendix.) (a) On average, people save less
Be able to prove important principles of probability, including Bayes’s theorem, on the basis of fundamental rules of probability.
Know the theory of probability
Apply the (normative) theory of rationality in the real world – but also appreciate how demanding the theory is.
Know some building blocks of the (descriptive) behavioral theories, including the biases-and-heuristics program and prospect theory.
Be able to identify common behavior patterns that violate the theory of rational choice under certainty.
Appreciate the variety of methods used by behavioral economists.
Understand how behavioral economics differs from standard (neoclassical) economics – and why.
Know the difference between descriptive and normative theories of decision.
Be able to prove theorems on the basis of axioms and definitions.
Understand the concept of rationality built into this theory.
Know the theory of choice under certainty.
Understand how analytical game theory can be used for descriptive and normative purposes – and what its limitations are.
Be able to find Nash equilibria (and some refinements) in a variety of games.
Know the difference between parametric and strategic decision-making.
Identify three features of your car, computer, or any other device that constitute nudges
Google Google wants to encourage its employees to eat healthily. Fast Company reports: “In pursuit of that healthiness, happiness, and innovation, the software giant has turned to ‘nudges’:
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
Kong Ming The Game Theorist’s Guide to Parenting, by Paul Raeburn and Kevin Zollman, may be the most useful parenting book of all time. In passing, it tells the story of famed Chinese military
The watch collection In the interest of acquiring yet another hobby you cannot afford, you have decided to start collecting fine Swiss watches. You find that there are some watches that you like and
That fridge There’s a fridge in the office that needs to be cleaned out once a week. Nobody does, though, and you hate it. You do not hate it enough to clean it every week yourself. But you would
In the volunteer’s dilemma, at least one person has to volunteer to provide some good in order for everyone to enjoy it. For example, in order for you and your friends to have snacks while watching
Egoists, utilitarians, and enviers Consider the game in Table 11.3, expressed in dollar terms.(a) Suppose, first, that this game is played by two egoists, for whom u(x, y) = x. Compute all Nash
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
Explain how positive offers in the ultimatum game are consistent with Nash-equilibrium predictions. (There are many misconceptions about this, so it is good to make sure you understand.)
Rock-paper-scissors, cont. The game rock-paper-scissors has a unique Nash equilibrium, in which both players randomize with probability 1/3, 1/3, and 1/3, and in which both players have an equal
Investment decisions Suppose that you have the opportunity to invest in a promising business venture, but that you have no way to recover your expenses in case your business partner turns out to be
The Stora Rör Swimming Association The Stora Rör Swimming Association is a non-profit organization teaching open-water swimming skills and water safety to kids in the Baltic. The Association is
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) = √x. (b) Two utilitarians, for whom u
Altruism and the ultimatum game Imagine the ultimatum game from Figure 11.1 played by two utilitarians with u (x, y) = √x + √y. Find the unique subgame-perfect equilibrium in this game. The
Charitable donations One example of a dictator game played in the real world involves a person’s decision about whether to give money to charity. Whenever you walk by a beggar, for example, you are
Dividing the cake When two children have to divide a cake, they sometimes follow a procedure in which the first child splits the cake in two and the second chooses first. Given that Kid II will
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
Find all subgame-perfect equilibria in the game in Figure 10.6. The game has two players and three stages. Player I moves at the first and third stages, and Player II moves at the second stage.
For each of the games in Table 10.14, identify the Nash equilibria in mixed strategies (if any). Assume Player I plays U with probability p and Player II plays L with probability q.
Which of the Nash equilibria in pure strategies are Pareto-optimal outcomes in the relevant game?
Which of the Nash equilibria in pure strategies are trembling-hand perfect (if any)?
For each of the games in Table 10.14, identify the Nash equilibria in pure strategies (if any).
Lunch date Suppose you have to meet a friend at noon tomorrow somewhere in your town, but you forgot to specify the exact location. Where would you go? Ask your friends where they would go. Would you
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
Subgame perfection Use backward induction to find the unique subgame-perfect equilibrium in the game in Figure 10.4. Recall that a strategy is a complete plan of action, which means that a strategy
MAD Mutually assured destruction (MAD) is a military doctrine according to which two superpowers (such as the US and the USSR) can maintain peace by threatening to annihilate the human race in the
Subgame-perfect equilibrium A subgame-perfect equilibrium is a strategy profile that constitutes a Nash equilibrium in each subgame.
Credible versus non-credible threats Consider a game with two stages. In the first stage, Player I plays U or D. If Player I plays D, both players get a payoff of 2. If Player I plays U, it is Player
Trembling-hand perfection Find (a) all Nash equilibria in pure strategies in Table 10.12 and (b) identify which of them are trembling-hand perfect.Substituting the concept of trembling-hand-perfect

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