Question 1

A default option is the option that is selected when the decision-maker is indifferent between choices.

Accepted Answer

A default option is the pre-selected choice that will be followed if no alternative is specified, not necessarily when the decision-maker is indifferent.

Question 2

The rational model predicts that if an individual has complete preferences over a set of goods, then the fact that one of the goods is the default option should have no impact on his choices.

Accepted Answer

The rational model assumes that individuals make decisions based solely on their preferences and available information, without being influenced by the default option.

Question 3

In the experiment discussed on page 5 of Chapter 4 , the researchers could have suggested any number to the participants. For example, the researchers could have suggested the number given by the subjects' arrival to the experiment instead of the last two digits of the social security number.

Accepted Answer

The order of arrival is not random. If the order of arrival is correlated with an unobservable characteristic that makes those who arrive first state a lower price than the person who arrived $20^{\text {th }}$ then the data is biased. The magnitude of the last two digits of the social security number is random.

Question 4

The policy implication of the default option bias is that policy-makers can set a desired choice as the default option. If the default option bias is present then this increases the likelihood that the government's choice is implemented.

Accepted Answer

The default option bias refers to the tendency of individuals to stick with a given option when it is presented as the default, thus policy-makers can leverage this bias by setting a desired choice as the default to increase the likelihood that it is chosen, effectively guiding public behavior in a preferred direction.

Question 5

The default option bias implies that the default option is specified by an outsider, whereas the status quo bias does not have this implication.

Accepted Answer

The default option bias refers to the tendency to choose an option that is pre-selected by someone else (an outsider), while the status quo bias is a preference for the current state of affairs, regardless of whether it was chosen by an outsider or not.

Question 6

The status quo bias is necessarily inconsistent with the rational model.

Accepted Answer

An individual may choose to stick with the status quo instead of looking or a new good may simply be averse to the uncertainty or because preferences are stable over time and what was chosen before should still be utility maximizing today.

Question 7

There are three bundles of goods: $x, y, z$. A consumer has preferences such that $x \geqslant$ $y, y \geqslant z$. If $x \sim z$ then the consumer's preferences cannot be described as transitive.

Accepted Answer

Remember, if $x \geqslant y$ and $y \geqslant x$, then $x \sim y$ and if $y \geqslant z$ and $z \geqslant y$ then $y \sim z$. If this is true, then $x \sim z$ does not violate transitivity.

Question 8

A preference reversal is a violation of transitivity.

Accepted Answer

Preference reversal occurs when an individual's preference between two options changes when the method of evaluation changes, which can violate the transitivity principle in decision-making.

Question 9

If there is a violation of transitivity or completeness then a standard utility function cannot represent the individual's preferences.

Accepted Answer

A standard utility function requires that preferences be complete and transitive to represent an individual's choices consistently. Violations of these conditions mean preferences cannot be accurately depicted by a utility function.

Question 10

Standard utility maximization cannot be used to describe preference reversals.

Accepted Answer

Preference reversals occur when individuals change their preference between options when the method of evaluation changes, which standard utility maximization, assuming consistent and stable preferences, cannot account for.

Question 11

Consider two bundles $x$ and $y$ and a reference point $r$. If $x \sim_{r} y$ then it must also be true that $x \sim r$ and $r \sim y$.

Accepted Answer

The notation $x \sim_{r} y$ indicates that bundle $x$ is considered equivalent to bundle $y$ when evaluated from the perspective of reference point $r$, but it does not imply that $x$ is directly equivalent to $r$ or that $r$ is directly equivalent to $y$. The relations $x \sim r$ and $r \sim y$ would require separate evaluations.

Question 12

Diminishing Sensitivity implies that when there are two goods (i \& j) and when I expect less of good i, then to give up a set amount of good i, I need to be compensated with less j THAN when I am initially expecting more of good i.

Accepted Answer

Diminishing sensitivity implies that as the initial amount of good i decreases, the marginal rate of substitution between goods i and j decreases. This means that to give up a set amount of good i, you need to be compensated with less j when you are initially expecting less of good i.

Question 13

Consider the constant loss aversion utility function in 4.1. This function creates a kink in the value function whenever $\lambda_{i}>0$.

Accepted Answer

$\lambda_{i}>1$.

Question 14

If the amount of utility I receive from a good is the same amount of utility I would lose if the good was taken away then I'm willing to pay the same amount to acquire the good as I would be to sell the good.

Accepted Answer

This statement ignores the endowment effect, which suggests that people often value a good more once they own it, leading them to demand more to give it up than they would be willing to pay to acquire it.

Question 15

The endowment effect is only an "anomaly" if utility is linear.

Accepted Answer

The endowment effect is the tendency for people to place a higher value on things they own than on things they do not own. This is considered an anomaly because it violates the assumption of rational behavior, which states that people should be indifferent between two options that offer the same utility. However, if utility is linear, then the endowment effect is not an anomaly, because it can be explained by the fact that people experience diminishing marginal utility from additional units of a good.

Question 16

The endowment effect can be explained by loss aversion.

Accepted Answer

The endowment effect, where people ascribe more value to things merely because they own them, can be explained by loss aversion, as people tend to prefer avoiding losses to acquiring equivalent gains.

Question 17

A difference in willingness to pay and willingness to accept mean there is an endowment effect.

Accepted Answer

The answer of A difference in willingness to pay and...

Question 18

An individual must choose between 4 insurance policies, $x_{1}, x_{2}, x_{3}, x_{4}$, where $x_{1}$ is the company's default option. The utility the individual receives from each option is ordered the following way: $u\left(x_{3}\right)>u\left(x_{1}\right) \geq u\left(x_{2}\right)>u\left(x_{4}\right)$. Which option does the individual choose?
A) $x_{1}$
B) $x_{2}$
C) $x_{3}$
D) $x_{4}$

Accepted Answer

Given the utility ordering $u(x_{3}) > u(x_{1}) \geq u(x_{2}) > u(x_{4})$, the individual will choose $x_{3}$ because it provides the highest utility.

Question 19

A preference for the default option is called:
A) Indifference bias.
B) Default option bias.
C) Loss aversion.
D) Indecisive bias.

Accepted Answer

The preference for the default option is known as the "default option bias," where individuals are more likely to choose an option that is pre-selected or presented as the standard choice.

Question 20

Anne and Jim participated in an experiment about the willingness to pay for a set of head phones. Jim is suggested a price of $\$ 13$ and Anne is suggested a price of $\$ 22$. The experimenters conclude that both Anne and Jim use the anchoring and adjustment heuristic to arrive at a final willingness to pay. What are possible values of their willingness to pay:
A) Anne: $\$ 15$. Jim: $\$ 30$.
B) Anne: $\$ 30$. Jim: $\$ 30$.
C) Anne: $\$ 13$. Jim: $\$ 13$.
D) Anne: \$25. Jim: \$15.

Accepted Answer

The anchoring and adjustment heuristic suggests that people start with an initial anchor (suggested price) and adjust from there. Anne's willingness to pay is likely to be around her anchor of $22, and Jim's around his anchor of $13.

Quiz 4: Status Quo Bias and Default Options

A default option is the option that is selected when the decision-maker is indifferent between choices.

The rational model predicts that if an individual has complete preferences over a set of goods, then the fact that one of the goods is the default option should have no impact on his choices.

In the experiment discussed on page 5 of Chapter 4 , the researchers could have suggested any number to the participants. For example, the researchers could have suggested the number given by the subjects' arrival to the experiment instead of the last two digits of the social security number.

The policy implication of the default option bias is that policy-makers can set a desired choice as the default option. If the default option bias is present then this increases the likelihood that the government's choice is implemented.

The default option bias implies that the default option is specified by an outsider, whereas the status quo bias does not have this implication.

The status quo bias is necessarily inconsistent with the rational model.

There are three bundles of goods: $x, y, z$ . A consumer has preferences such that $x \geqslant$ $y, y \geqslant z$ . If $x \sim z$ then the consumer's preferences cannot be described as transitive.

A preference reversal is a violation of transitivity.

If there is a violation of transitivity or completeness then a standard utility function cannot represent the individual's preferences.

Standard utility maximization cannot be used to describe preference reversals.

Consider two bundles $x$ and $y$ and a reference point $r$ . If $x \sim_{r} y$ then it must also be true that $x \sim r$ and $r \sim y$ .

Diminishing Sensitivity implies that when there are two goods (i \& j) and when I expect less of good i, then to give up a set amount of good i, I need to be compensated with less j THAN when I am initially expecting more of good i.

Consider the constant loss aversion utility function in 4.1. This function creates a kink in the value function whenever $\lambda_{i}>0$ .

If the amount of utility I receive from a good is the same amount of utility I would lose if the good was taken away then I'm willing to pay the same amount to acquire the good as I would be to sell the good.

The endowment effect is only an "anomaly" if utility is linear.

The endowment effect can be explained by loss aversion.

A difference in willingness to pay and willingness to accept mean there is an endowment effect.

A preference for the default option is called:

Quiz 4: Status Quo Bias and Default Options

A default option is the option that is selected when the decision-maker is indifferent between choices.

The rational model predicts that if an individual has complete preferences over a set of goods, then the fact that one of the goods is the default option should have no impact on his choices.

In the experiment discussed on page 5 of Chapter 4 , the researchers could have suggested any number to the participants. For example, the researchers could have suggested the number given by the subjects' arrival to the experiment instead of the last two digits of the social security number.

The policy implication of the default option bias is that policy-makers can set a desired choice as the default option. If the default option bias is present then this increases the likelihood that the government's choice is implemented.

The default option bias implies that the default option is specified by an outsider, whereas the status quo bias does not have this implication.

The status quo bias is necessarily inconsistent with the rational model.

There are three bundles of goods: x,y,zx, y, zx,y,z . A consumer has preferences such that x⩾x \geqslantx⩾ y,y⩾zy, y \geqslant zy,y⩾z . If x∼zx \sim zx∼z then the consumer's preferences cannot be described as transitive.

A preference reversal is a violation of transitivity.

If there is a violation of transitivity or completeness then a standard utility function cannot represent the individual's preferences.

Standard utility maximization cannot be used to describe preference reversals.

Consider two bundles xxx and yyy and a reference point rrr . If x∼ryx \sim_{r} yx∼r​y then it must also be true that x∼rx \sim rx∼r and r∼yr \sim yr∼y .

Diminishing Sensitivity implies that when there are two goods (i \& j) and when I expect less of good i, then to give up a set amount of good i, I need to be compensated with less j THAN when I am initially expecting more of good i.

Consider the constant loss aversion utility function in 4.1. This function creates a kink in the value function whenever λi>0\lambda_{i}>0λi​>0 .

If the amount of utility I receive from a good is the same amount of utility I would lose if the good was taken away then I'm willing to pay the same amount to acquire the good as I would be to sell the good.

The endowment effect is only an "anomaly" if utility is linear.

The endowment effect can be explained by loss aversion.

A difference in willingness to pay and willingness to accept mean there is an endowment effect.

A preference for the default option is called:

There are three bundles of goods: $x, y, z$ . A consumer has preferences such that $x \geqslant$ $y, y \geqslant z$ . If $x \sim z$ then the consumer's preferences cannot be described as transitive.

Consider two bundles $x$ and $y$ and a reference point $r$ . If $x \sim_{r} y$ then it must also be true that $x \sim r$ and $r \sim y$ .

Consider the constant loss aversion utility function in 4.1. This function creates a kink in the value function whenever $\lambda_{i}>0$ .