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behavioral economics

Questions and Answers of Behavioral Economics

Salary comparisons Insofar as you use other people’s salaries as a reference point, what does the theory seem to say about maximizing value in your life?
Exam scores Assume that Alysha and Billy have the following value function over exam scores: v(x) = x/2 for gains and v(x) = 2x for losses. Both of them use the expected exam score as their reference
Bonuses Draw a graph that illustrates how a person who gets a five percent raise can be elated if she did not expect a raise at all, but feel cheated if she expected a ten percent raise.
Latte discounts Many coffee shops give customers a small discount if they bring their own reusable mug. The coffee shops could equivalently 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) = x/2 for gains and v(x) = 2x for losses. Because of an upcoming election, politician R promises a tax cut which
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) = x/2 for gains and v(x) = 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) = x/2 for gains and v(x) = 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 function, compute the net effect in value terms of
Toy Yoda, cont. Suppose that the same value function captures 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
Losses and gains Use the value function above to answer the following two questions: (a) What is the increase in value you would experience if you found $10? (b) What is the decrease in value you
WTA vs. WTP In the presence of loss aversion, your willingness-to-accept (WTA) does not in general equal your willingnessto-pay (WTP). When eliciting your WTA, you are asked to imagine that you have
Third-party candidates, cont. Suppose that politician A in Exercise 3.29 above wanted to win elections instead by harnessing the power of the compromise effect. What sort of platform must the
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 political office on a platform promising lower taxes and cuts in public services. His opponent B promises higher taxes and more funding for
Real-estate sales Suppose that you are a real-estate agent showing two properties to potential customers. The one is in good shape but far from the clients’ office; the other is only in decent
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
Speed vs. safety Imagine that you are in charge of selling a car that is very fast but not very safe. Let us call it a “Bugatti.” (When people complained about the poorly designed brakes of his
Expansion condition If x is chosen from the menu {x, y}, assuming that you are not indif erent between x and y, you must not choose y from the menu {x, y, z}.
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
The F-35 The F-35 is the US military’s next-generation fighter jet. Plagued with technical difficulties, the project was $160 billion over budget already by early 2014. Critics argue that the
Course selection Students at an expensive liberal arts college 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
Reading habits According to a survey administered by Goodreads. com, 38.1 percent of readers say they will finish a book they started reading no matter what – even if they hate it. This behavior
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 basketball game Imagine that you paid $80 for a ticket for a college basketball game to be played about an hour’s drive away. The ticket cannot be sold. On the day of the game, there is a freak
The opportunity cost of an economics education What is (or would be) the opportunity cost, for you, of taking a course in behavioral economics? Upon reflection, is it (or would it be) worth it?
War or terror Imagine that a new terrorist group is threatening 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
One day at a time The field study mentioned in Section 1.3 found that New York City cab drivers who set their own hours ignore opportunity costs in a big way. The study found that cab drivers
Whatever it takes Politicians sometimes promise to do “whatever it takes” to eliminate poverty, defeat terrorism, etc. Use the concept of opportunity cost to explain why that is not 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 yourself: “I already
shows. A person who ignores the opportunity cost of a bad relationship, for example, could miss out on a lot. If you were surprised by the opportunity costs of watching the “Gangnam Style” video,
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
ai is a rational choice ⇔ u(ai ) ≥ c(ai )Example 3.5 Gangnam Style By mid-2014, the goofy music video “Gangnam Style” became the most watched YouTube clip of all time. According to a review
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
Opportunity cost c (ai) = max {u (a1), u (a2), …, u (ai−1), u (ai+1), …, u (an)}
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?
Consumer-choice theory and indifference curves For each of the sets of indifference curves in Figure 2.9, what assumption rules it out?
Consumer-choice theory Do the following quotations agree or disagree with the assumptions of consumer-choice theory (see box on page 28)? (a) “Variety is the spice of life” – William Cowper.
Irrationality Explain (in words) why each of the characters 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 is...
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). It is easy to confirm that the proposition is true of the utility function from Figure 2.7. One important point to note is that utility functions are not unique. The
Properties of u(·) Given a utility function u(·) representing the preference relation the following conditions hold: (i) x ≻ y ⇔u(x) > u(y) (ii) x ~ y ⇔ u(x) = u(y)
Representation theorem If the set of alternatives is finite then ≽ is a rational preference relation just in case there exists a utility function representing ≽.
Definition of u(·) A function u(·) from the set of alternatives into the set of real numbers is a uti/ity function representing the preference relation ≽ just in case x ≽ y ⇔ u(x) ≥ u(y)
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
Example 2.29 The menu If a restaurant offers two appetizers (soup and salad) and two entrées (chicken and beef) and you must choose one appetizer and one entrée, what is your set of alternatives?
Indifference curves Represent the following sets of indifference curves graphically: (a) Suppose that an apple for you is always as good as two bananas. (b) Suppose that one apple is always as good,
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 x ≽ y & y ≽ z & z ≽ x. If this
Cycling preferences Using the definitions and propositions discussed so far, show that it is impossible for a rational strict preference relation to cycle. To do so, suppose (for the sake of the
Teacups 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 packages, one to California and one to Florida, and that you are perfectly indifferent 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 them.
Prove that if ¬ x ~ y and y ~ z, then ¬ x ≻ z.
Establish the following important and intuitive principles. (For the record, some of them are logically equivalent.) (a) If x ≻ y then x ≽ y (b) If x ≻ y then ¬ y ≽ x (c) If x ≽ y then ¬
Prove the following principle: x ≻ y & y ≽ z → x ≻ z (for all x, y, z). Notice that this proof has two parts. First, prove that x ≽ z second, prove that ¬ z ≽ x.
Prove Proposition 2.16(iii). Prove it by contradiction, by first assuming that there is an x such that x ≻ x.
on page 15. In future exercises, you will see just how useful proofs by contradiction can be.
The enemy of your enemy, cont. Use a proof by contradiction to establish that “is the enemy of” is not transitive, as in
Using the definitions and propositions discussed so far, complete the first part of the proof of Proposition 2.16(i). Notice that the proofs of Proposition 2.16(i) and (ii) involve constructing
Iterated transitivity In this exercise you will prove the following principle in two different ways: x ~ y & y ~ z & z ~ p → x ~ p. (a) First prove it by applying the transitivity of indifference
Prove the following principle: x ≽ y & y ~ z → x ≽ z. In your various proofs, it is always acceptable to rely on propositions you have already established. The following exercise shows how
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, meaning that U = {1, 2, 3, 4, …}, are the following relations transitive? Are they complete? (a) “is at least as great as” (≥) (b)
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? A universe may have infinitely many members, in which case simple
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 2010 study on financial decision-making, people’s answers to three quick mathematics questions were strong predictors of their wealth: households where both spouses answered all three
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
“Banking inefficiency and the excessive regulation of the banking sector and interest rates in some of the LDCs have proved to be highly detrimental to their growth rates.” Can this be explained
LDCs have at times resorted to high money growth rates to finance their development efforts in an attempt to push up their growth rates. What is the theoretical analysis to support this policy? Was
“Central bank policies that produce low inflation increase long-run economic growth.”Present the relevant theories and empirical evidence on this proposition.
How would you test for the contribution of (a) the quantity of money, (b) the financial sector, to growth for a selected group of countries? Specify your variables, estimating equations and the
What is the empirical evidence on the contribution of (a) the quantity of money, (b) the financial sector, to growth? Cite at least one study on each of these. Compare their findings and explain the
Should a distinction be drawn between the growth rate of fiat money provided by the central bank and that of inside money provided by private commercial banks for the proper analysis of money in
“It is vital for understanding the contribution of money to growth that we distinguish between the quantity of money and the size and efficiency of the financial sector.”Discuss.
“Given that saving is positively related to the rate of interest and that an increase in the rate of inflation will increase the rate of interest, both saving and the growth rate of the economy
“Rapid increases in the money stock cause inflation and inflation raises interest rates, so that investment is reduced by the rapid increases in the money stock. Consequently, high rates of money
Is there room for considering changes in the structure and efficiency of the financial sector in the traditional neoclassical growth theories with money? If so, how would you modify the standard
In the context of the endogenous growth theories with money, is the money growth rate neutral for the steady state and the pre-steady states of the economy? Explain your answer.
In the context of the traditional neoclassical growth theories with money, is the money growth rate neutral for the steady state and the pre-steady states of the economy? Explain your answer.
Set up an OLG model with two lifestages, an indirect MIUF approach with a Cobb–Douglas transactions technology and an indirect MIPF with a unit elasticity of substitution between labor, capital and
Set up an OLG model with two lifestages, a Cobb–Douglas production function with capital and labor but without money, and a Cobb–Douglas transactions technology that uses both capital and labor
Set up an OLG model with two lifestages, a utility function without money in it and a Cobb–Douglas transactions technology for making payments to complete purchases of commodities. Make any other
Discuss the different parts of the following statement: “For the modern economy, the theory of the speculative demand for money has come to the conclusion that there is no longer an asset demand
If currency (a fiat money) is intrinsically useless for firms and households, are demand/checking deposits also intrinsically useless for them? Why, then, do they hold these when there are other
Why does the W–M–M theorem hold in the analysis of Chapter 22 but not in the analysis presented in this chapter? What is the critical difference in the assumptions that changed this finding and
What is the meaning of utility in microeconomic theory? In answering this question, consider the following. Why are goods that seem to harm the individual’s physical or mental wellbeing placed in
Given the stylized facts on money in Chapter 21, how far does the MIUF approach(i) without time and overlapping generations, (ii) with overlapping generations, satisfy the items in the list (a) that
Some economists have claimed that the OLG model of fiat money includes what is essential for a good theory of money and that it should be recognized as the best available one. Draw up a list of (a)
Which of the following approaches to money demand do you prefer: (a) MIUF,(b) indirect MIUF, (c) cash-in-advance, or (d) pure OLG models of money? Why?

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