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behavioral economics

Questions and Answers of Behavioral Economics

Evaluation of gains Yesterday, you had a decent day: you first 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) = √x/2 for gains and v (x) = −2√|x| 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
Prospect evaluation, cont. This exercise refers to Example 7.7 above. Suppose that your value function v(·) is defined by v (x) = √x/2 for gains (x ≥ 0) and v (x) = −2√|x| for losses (x <
Prospect evaluation Consider the following two problems: (a) In addition to whatever you own, you have been given $1000. You are now asked to choose between (A) a 50 percent chance of winning $1000
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(± 0) and v(–10) or the absolute difference between v(–1000) and v(–1010)?
Curvatures An S-shaped value function v(·) can be defined by an expression that has two components: one corresponding to the realm of gains and one corresponding to the realm of losses. For example:
Pandemic problem 2 Imagine that the US is preparing for the outbreak of an unusual contagious disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been
Pandemic problem 1 Imagine that the US is preparing for the outbreak of an unusual contagious disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been
Misguided criticism Some critics attribute to neoclassical 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
The Precautionary Principle The Precautionary Principle enjoins us to avoid whatever course of action leads to the worst possible outcome. What principle of rational choice introduced in this chapter
The rationality of having children It is sometimes argued that certain decisions cannot be made rationally. Philosopher L. A. Paul, for example, has argued that it is impossible to make a rational
Lotto 6/49, cont. Compute the certainty equivalent of the Lotto 6/49 ticket from Exercise 6.5 if u (x) = √x.
Suppose that your utility function is u (x) = √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
Suppose that your utility function is u (x) = √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
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) =
Compute the certainty equivalent of the gamble in Figure 6.7, using the utility function u(x) = x 2 . We end this section with a series of exercises.
St Petersburg paradox, cont. In Section 6.4 we learned that for an agent with utility function u(x) = log(x), the expected utility of the St Petersburg gamble is approximately 0.602. What is the
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
Certainty equivalent The certainty equivalent of a gamble G is the number CE that satisfies this equation: u(CE) = EU(G).
Attitudes to risk As far as you can tell, are the following people 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 6.7. Now suppose that your utility function is u(x) = x 2 . Unlike the previous utility function, which gets flatter when amounts increase, this
Risk aversion Suppose you own $2 and are offered a gamble giving you a 50 percent chance of winning a dollar and a 50 percent chance of losing a dollar. This decision problem can be represented as in
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
Umbrella problem, cont. This question refers to Table 6.1(b), that is, the umbrella problem from Section 6.2. If the probability of rain is p, what does p need to be for the expected utility of
Pascal’s wager The seventeenth-century French mathematician 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 value and expected utility Assume again that your utility function is u (x) = √x. Compute (i) the expected value and (ii) the expected utility of the following gambles: (a) G: You have a
Expected utility, again Suppose that you are facing three gambles. A gives you a 1/3 probability of winning $9. B gives you a 1/4 probability of winning $16. C gives you a 1/5 probability of winning
Lotto 6/49, cont. Assume still that your utility function is u(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. function is u(x) = x Suppose instead that your utility (a) What is the expected utility of rejecting the gamble? (b) What is the expected utility of accepting the gamble? (c)
Expected utility Consider, again, the gamble from Figure 6.2(c). Suppose that your utility function is u(x)=. Should you accept or reject the gamble? == The utility of rejecting the gamble is EU (R)
Expected utility Given a decision problem like Table 6.4, the expected utility EU(A) of an act A, is given by EU (A.) = Pr (S1) (Ca) + Pr (S2)*u (C2)+...+r (Sn) * u (Cin) Pr (S,)u (Cij) j-1
St Petersburg paradox A gamble is resolved by tossing an unbiased coin as many times as necessary to obtain heads. If it takes only one toss, the payoff is $2; if it takes two tosses, it is $4; if it
Warranties A tablet computer costs $325; the optional oneyear 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. Given what you pay for parking and given what parking fines are in your area, what does the probability of getting a ticket need to be for the expected value of parking legally to
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
Parking, cont. If a parking ticket costs $30, and it costs $5 to park legally, what does the probability of getting a ticket need to be for the expected value of parking legally to equal the expected
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 6.5). 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?
You are offered the following gamble: if a (fair) coin comes up heads, you receive $10; if the coin comes up tails, you pay $10. What is the expected value of this gamble? The expected value of this
Parking You are considering whether to park legally or illegally and decide to be rational about it. Use negative numbers to represent EV (Ai) = Pr(S1) ∗ Ci1 + Pr(S2) ∗ Ci2 + … + Pr(Sn) ∗ Cin
Roulette A roulette wheel has slots numbered 0, 00, 1, 2, 3, …, 36 color-coded in red and black (see Figure 6.4). The players make their bets, the croupier spins the wheel, and depending on the
Expected value For the following questions, refer to Figure 6.2(c): (a) What is the expected value of accepting this gamble? (b) What is the expected value of rejecting it?Exercise 6.9 Expected value
What would you pay to play this gamble? If you are willing to pay to play this game, what do you hope to achieve?
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
Lotto 6/49 Represent the gamble accepted by someone who plays Lotto 6/49 (from Exercise 4.28 on page 82) as in Figure 6.1(a) and (b). Assume that the grand prize is a million dollars.
Harsanyi’s challenge Suppose you live in New York City and are offered two jobs at the same time. One is a tedious and badly paid job in New York City itself, while the other is a very interesting
The dating game under uncertainty Imagine that you are considering whether or not to ask somebody out on a date. (a) Given your utility function, what course of action would be favored by (i) the
Rational choice under uncertainty This exercise refers to the utility matrix of Table 6.2. What course of action would be favored by (a) the maximin criterion, (b) the maximax criterion, and (c) the
The watch Having just bought a brand-new watch, you are asked if you also want the optional life-time warranty. (a) Would a maximin reasoner purchase the warranty? (b) What about a maximax reasoner?
Drawing on your own experience, make up stories like those in Exercise 5.52 to illustrate the various ideas that you have read about in this chapter.
Match each of the vignettes below with one of the following phenomena: availability bias, base-rate neglect, confirmation bias, conjunction fallacy, disjunction fallacy, hindsight bias, and
Schumpeter The Austrian economist Joseph Schumpeter claimed that he had set himself three goals in life: to be the greatest economist in the world, the best horseman in all of Austria, and the
Genetically modified organisms (GMOs) A person opposed to GMOs reads a compelling text about the benefits of such organisms and comes to quite like the thought of them. When asked about the risks, he
Matthew Which heuristic is embodied in this line from Matthew 7:17–18: “So every good tree bears good fruit, but the bad tree bears bad fruit. A good tree cannot produce bad fruit, nor can a bad
Theories, theories Complete this sentence: “If all your observations support your scientific theories or political views, you are (probably) suffering…”
Juan Williams In October 2010, National Public Radio (NPR) fired commentator Juan Williams after he made the following remark on Fox News: “When I get on a plane … if I see people who are in
CIA Intelligence services are deeply interested in how people think, both when they think correctly and when they think incorrectly. The following exercise is borrowed from the book Psychology of
Mandatory drug testing In July 2011, the State of Florida started testing all welfare recipients for the use of illegal drugs. Statistics suggest that some 8 percent of adult Floridians use illegal
IVF In vitro fertilization (IVF) is a procedure by which egg cells are fertilized by sperm outside the womb. Let us assume that any time the procedure is performed the probability of success (meaning
Gender discrimination, cont. In Exercise 4.51 on page 93, we computed the probability that an editorial board of 20 members is all male by chance alone. If the answer strikes a person as low, what
Probability matching Imagine that your friend Anne has a coin that has a 2/3 probability of coming up heads (H) and a 1/3 probability of coming up tails (T). She intends to flip it three times and
Misguided criticism Some critics of the heuristics-andbiases program attack it for saying that human beings are irredeemably stupid. Thus, “the heuristics-and-biases view of human irrationality
Adam Smith, once more What sort of phenomenon might Adam Smith have had in mind when he talked about the “over-weening conceit which the greater part of men have of their own abilities”?
Inevitability People think many things are inevitable. If you search for the expression “it was inevitable that” on Google News, you may get tens of thousands of hits. Which bias is reflected in
Apollo 11 On the 35th anniversary of the moon landing, CNN asked the crew of Apollo 11 what their biggest concern was at the time. Astronaut Neil Armstrong answered: “I think we tried very hard not
Meteorology Evidence suggests meteorologists are well calibrated and therefore an exception to the rule. This will strike many people as literally unbelievable. What heuristic might cause them to
Causes of death According to the World Health Organization, the leading causes of death in the world are ischemic heart disease, stroke, lower respiratory infections, and chronic obstructive lung
Contacts Your optometrist tells you that your new contacts are so good that you can wear them night and day for up to 30 days straight. She warns you that there is some chance that you will develop
CT scans In some populations, brain tumors in children are rare: the base rate is only about 1/10,000. A child with a tumor is very likely to have occasional headaches: 99 out of 100 do. But there
Preventing confirmation bias In matters of politics, philosophy, religion, and so on, do you expose yourself to the ideas of people “on the other side” as you do to the ideas of people “on your
Destroying America Explain how book titles such as Demonic: How the Liberal Mob Is Endangering America and American Fascists: The Christian Right and the War on America contribute to political
Confirmation bias among economists (a) Name two famous economists who in your view are suffering confirmation bias. (b) Reflect upon the people you just named: if both are economists with whom you
Reputation The fact that people exhibit confirmation bias makes it very important to manage your reputation – whether you are a student, professor, doctor, lawyer, or brand. Why? Scientists, by the
The jealous lover From literature or life, you may be familiar with the character of the jealous lover, who refuses to accept any evidence that his or her affections are reciprocated and who
Confirmation bias Imagine that John is suffering from confirmation bias. Which of the curves labeled A, B, and C in Figure 5.4 best represents the manner in which his probabilities change over time
Diagnosticity Let us take it for granted that the behaviordetection test (from Exercise 5.26) is not diagnostic. The test may still be diagnostic in another setting, say, at a checkpoint at the US
Behavior detection The following passage is from USA Today: Doug Kinsey stands near the security line at Dulles International Airport, watching the passing crowd in silence. Suddenly, his eyes lock
Jean Charles de Menezes In the aftermath of the July 21, 2005, terrorist attacks in London, British police received the authority to shoot terrorism suspects on sight. On July 22, plainclothes police
Down syndrome The probability of having a baby with Down syndrome increases with the age of the mother. Suppose that the following is true. For women 34 and younger, about one baby in 1000 is
Iron Bowl At an Auburn–Alabama game, 80 percent of attendees wore Alabama gear and 20 percent wore Auburn gear. During the game, one of the attendees apparently robbed a beer stand outside the
Testimony A cab company was involved in a hit-and-run accident at night. Two cab companies, the Green and the Blue, operate in the city. You are given the following data: 85 percent of the cabs in
Mammograms, cont. Men can get breast cancer too, although this is very unusual. Using the language of “base rates” and “diagnosticity,” explain why men are not routinely tested for breast
Mammograms Doctors often encourage women over a certain age to participate in routine mammogram screening for breast cancer. Suppose that from past statistics about some population, the following is
Private jet shopping Suppose you are fortunate (or delusional) enough to be shopping for a private jet. You have to decide whether to get a jet with one or two engines. Use p to denote the
The preface paradox In the preface to your new book, you write that you are convinced that every sentence in your book is true. Yet you recognize that for each sentence there is a 1 percent chance
The birthday problem Suppose that there are 30 students in your behavioral-economics class. What is the probability that no two students have the same birthday? To make things easier, assume that
What is the probability of drawing at least one ace when drawing cards from an ordinary deck, with replacement, when you draw: (a) 1 card, (b) 2 cards, (c) 10 cards, and (d) 52 cards?
Terrorism Compute the probability that at least one major terrorist attack occurs over the course of the next ten years, given that there are 365.25 days in an average year, if the probability of an
Flooding Imagine that you live in an area where floods occur on average every ten years. The probability of a flood in your area is constant from year to year. You are considering whether to live in
Hiking You plan to go on a hike in spite of the fact that a tornado watch is in effect. The national weather service tells you that for every hour in your area, there is a 30 percent chance that a
Compute the probability of getting at least one six when rolling (a) one die, (b) two dice, (c) three dice, and (d) ten dice. (a) The probability of rolling at least one six when rolling one die

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