Deck 29: Behavioral Economics

Question 1

Using lessons learned from behavioral economists, which of the following would be most likely to increase retirement savings?

A) Specifying that all retirement contributions are to be made by personal check only
B) Allowing customers to make contributions of any amount whenever they desire
C) Enabling automatic deductions from paychecks, but allow customers to make as many changes to the amount as they like without cost or obligation
D) Allowing customers to commit to an increasing portion of their paycheck being automatically deposited in retirement savings in future years
E) Charging service fees for contributions under $100

Answer 1

D

Question 2

An article in the October 15, 2005, edition of the Wall Street Journal described the popularity with New York lawyers and stock brokers of a new gym that hires ex-Marines as fitness trainers. The gym is run with a boot camp motif. Which of the following behavioral economic concepts would help explain the existence of this gym?
A) Time inconsistency between desires when purchasing gym membership and desires when it is time to work out
B) The effect of spurious information on decision making
C) Increasing the cost of deviating from self control
D) Positive framing
E) a. and c.
A) Time inconsistency between desires when purchasing gym membership and desires when it is time to work out

A) and
B) The effect of spurious information on decision making
C)
C) Increasing the cost of deviating from self control

Answer 2

E

Question 3

A house was for sale for 9 months with no offers at $350,000. It was taken off the market, and relisted 1 month later at $399,500 and sold in 2 weeks. Which of the following behavioral economic concepts could explain this scenario?

A) Hyperbolic discounting of housing values
B) Time inconsistency of preferences
C) Spurious information
D) Framing effects
E) Fairness norms

Answer 3

D

Question 4

In a study by financial economists Brad Barber and Terrance Odeank of stock portfolio management techniques and returns, men trade more frequently on average than women, and as a result of more active management, men's portfolios grow at a higher rate of return than women's.

Question 5

Nash equilibria can be used to make predictions about human behavior in noncooperative games. Behavioral game theory studies actual human interaction, and has found inconsistencies between observed human behavior and Nash-predicted behavior. Which of the following is NOT an inconsistency pointed out by behavioral economists?

A) In ultimatum games, proposers should always offer to give responders the minimum possible split, regardless of whether it is perceived as "unfair" or not.
B) In ultimatum games, offers perceived as "unfair" are frequently rejected.
C) In ultimatum games, responders are less likely to turn down "unfair" offers if the dollar amount is large.
D) Third party observers of ultimatum games will frequently punish what they perceive as "unfair" divisions, even at a cost to themselves.
E) In ultimatum games, men tend to receive more favorable divisions, particularly when divisions are proposed by women.

Question 6

If a coin is tossed, and the results are 6 consecutive tails (TTTTTT), this is conclusive evidence that the coin is not a fair coin.

Question 7

People who have recently become unemployed often believe the national unemployment rate is higher than it actually is. Behavioral economists would attribute this to

A) the anchoring effect.
B) the law of small numbers.
C) time inconsistency of preferences.
D) fairness norms.
E) hyperbolic discounting.

Question 8

Which of the following are examples of the framing effect?

A) Campus "Public Interest Research Groups" receive more operating funds from student registration fees when the default choice is to contribute but a box must be checked to opt out versus a default of not contributing but checking a box to contribute.
B) Shoppers often purchase extended service and warranty plans even though expected losses are much smaller than the cost of the plans.
C) In a repeated classroom experiment, half the class was randomly picked to receive an iPod Shuffle of music from the 1970s. The average value placed on the Shuffle is consistently higher for students who received the Shuffle than for those who didn't.
D) A busy executive who wants to exercise more joins a bicycling club where fellow members will exert pressure upon him if he doesn't go biking.
E) All of the above.

Question 9

Professor Bob has an incredibly messy office, and really wants to change but just can't. Professor Bob just read his first book about behavioral economics. To help him keep his office more neat, Professor Bob could hire

A) an expensive office consultant to set up an organizational scheme. Because the consultant's visit was so expensive, Professor Bob will not want to lose his investment.
B) a very expensive custodial service that will clean and bill Professor Bob only when his office needs cleaning.
C) somebody to clean his office once a week for the entire year whether it needs it or not.
D) a sarcastic graduate student to make fun of him when his office becomes messy.
E) All of the above would be equally effective in changing Professor Bob's behavior.

Question 10

In practice, people tend to accept too many large risks (such as forgoing life insurance) and avoid too many small risks (such as losing or breaking a cell phone).

Question 11

A couple planning to get married wants to do all that they can to make their marriage last. To help, they should consider having

A) a very lavish and expensive wedding.
B) a prenuptial agreement specifying how assets will be divided among them in case of divorce.
C) an agreement in which all jointly held assets are donated to charity in case of divorce.
D) an inexpensive wedding in Las Vegas.
E) an Elvis impersonator marry them in Las Vegas.

Question 12

People find it easier to commit to saving for retirement from next year's salary as opposed to current salary. This behavior is consistent with hyperbolic discounting of income.

Question 13

Which of the following is NOT an example of the anchoring effect (i.e., choices are affected by spurious information)?

A) The French and British governments completed construction of the Concorde because they had so much money tied up in research and development that would have been wasted if the project were cancelled.
B) People are reluctant to sell stock they have received as a gift even if they would not have chosen to purchase the stock.
C) Investors purchase shares of a stock on plausible rumors of increased future earnings.
D) Investors liquidate common stock and hold cash because they fear that the stock market will fall because the American League won the World Series.
E) a. and c. are correct.

Question 14

Psychologists and behavioral economists argue that preferences are "discovered," as opposed to a preexisting guide to choice.

Question 15

In the movie The Hunt for Red October, Captain Ramius (Sean Connery) leaves a letter for the Soviet Navy announcing that he intends to defect to the United States. As a result, the Soviet Navy launches a massive effort to find and sink Ramius's ship, the Red October. In announcing that he was intending to defect, Capt. Ramius's actions could be explained as

A) an act of irrationality.
B) a step to remove the option of return to the Soviet Union, thereby increasing the likelihood of a successful defection to the West.
C) a spurious piece of information that might affect behavior.
D) part of the process of discovering his preferences.
E) an attempt at randomizing behavior to make his adversaries less certain of his true intentions.

Question 16

If a tennis player were truly randomizing over which half of the court to serve to, she would never serve to the same side of the court 5 times in a row.

Question 17

Under hyperbolic discounting, a person discounts the long term future more heavily than the near term future.

Question 18

The following statement is a defense of conventional models of consumer behavior against the objections of behavioral economists: Even if many participants in a market do not behave rationally, those who consistently maximize utility will have the greatest effect on market prices and outcomes.

Question 19

Deb plans and prepares her meals 1 month in advance. Scott eats out for lunch every day. According to observations from behavioral economics, Scott will eat more varied meals than Deb.

Question 20

According to behavioral economists, rational consumers are able to make decisions when faced with many choices because preferences are complete.

Question 21

In an experiment on risk aversion and inconsistency, a group of people were given the option to accept or reject the following gamble: 50% chance to win $150, 50% chance to lose $100. Which of the following scenarios is most accurate and would most likely occur?

A) A majority accepted the gamble. People who chose the gamble can expect to gain from it.
B) A majority rejected the gamble. People who chose the gamble can expect to gain from it.
C) A majority accepted the gamble. People who chose the gamble can expect to lose from it.
D) A majority rejected the gamble. People who chose the gamble can expect to lose from it.
E) People were evenly split between accepting and rejecting the gamble. Expected winnings from the gamble are zero.

Question 22

According to a recent New York Times article, "Bank of America debit card customers can agree in advance to round up their purchases to the next dollar, putting the extra cents into a savings account." Why might customers want to commit to this mechanism rather than make deposits to their savings accounts on their own?

Question 23

With several additional mutations, the bird flu, whose victims to date are mostly poultry, could become a global epidemic. Suppose there are 2 possible courses of action public health officials could take. For treatment A, the lives of 1 million people out of the 10 million affected would be saved. For treatment B, 90% of those infected would not be helped and would die. If infected persons were given a choice between treatments A and B, which of the following scenarios would most likely occur?

A) Treatment A is more effective than treatment B. More people will choose treatment A.
B) Treatment A is less effective than treatment B. More people will choose treatment A.
C) Treatment A is more effective than treatment B. More people will choose treatment B.
D) Treatment A and treatment B are equally effective. More people will choose treatment A.
E) Treatment A and treatment B are equally effective. Equal numbers of people will choose each treatment.

Question 24

Suppose you and a complete stranger must split $100 in even dollar increments. You propose a split, and the stranger with whom you are splitting the $100 either accepts or rejects. If she rejects, you both receive nothing.
a. What is the Nash equilibrium for this game?
b. The Nash equilibrium solution is not frequently observed in practice. Explain why.

Question 25

In the 1960s dark comedy classic Dr. Strangelove, the Soviet Union constructs a Doomsday Machine that will destroy all life on earth automatically if the Soviet Union is attacked. The Doomsday Machine can never be turned off or disabled. Which of the following would best explain why the Soviets would build the Doomsday Machine?

A) This is a completely irrational action.
B) This is an example of the use of spurious information to influence outcomes.
C) This is an example of the negative framing effect.
D) By removing the choice of whether or not to retaliate, the Soviets increase the chance that the United States will not attack.
E) The Soviets would gain utility from destroying all life on earth.

Question 26

In a study of individually held stock portfolios over time, gains were much more likely to be realized than losses. Fifteen percent of all gains were realized in the time period, while only 10% of losses were. Subsequently, the rising stocks that were sold outperformed the losing stocks that were held. Behavioral economists would explain this as

A) aversion to losses.
B) overconfidence as exhibited in excessive trading.
C) the framing effect (losses vs. gains).
D) a departure from sound financial practices.
E) All of the above.

Question 27

In an experiment on risk aversion and inconsistency, a group of people were given the following choice: A) Lose $100 with certainty, or B) 50% chance to win $50, 50% chance to lose $200. Which of the following scenarios is most accurate and would most likely occur?

A) A majority chose option A. Option A has a lower expected loss.
B) A majority chose option B. Option A has a lower expected loss.
C) A majority chose option A. Option B has a lower expected loss.
D) A majority chose option B. Option B has a lower expected loss.
E) Roughly equal numbers chose A and B, because they have equal expected losses.

Question 28

A stingy health maintenance organization (HMO) gives its customers diagnosed with cancer a choice between surgery and radiation therapy, but not both. The brochure they send to their customers describes surgery as 80% successful, but says that 2 out of 10 patients who choose radiation will die. If customers were given a choice between surgery and radiation therapy, which of the following scenarios would most likely occur?

A) Surgery is more effective than radiation. More customers will choose surgery.
B) Surgery is less effective than radiation. More customers will choose surgery.
C) Surgery is less effective than radiation. More customers will choose radiation.
D) Surgery and radiation are equally effective. More customers will choose surgery.
E) Surgery and radiation are equally effective. Equal numbers will choose each treatment.

Question 29

A substantial majority of Americans have inadequate retirement savings. Behavioral economists attribute this to
A) time inconsistency of preferences.
B) lack of self-control.
C) preferences between current and future consumption that are still being discovered.
D) framing effects.
E) a. and b. are both correct.
A) time inconsistency of preferences.

A) and
B) lack of self-control.
B) are both correct.
C) preferences between current and future consumption that are still being discovered.

Question 30

John is doing very well in Intermediate Micro economics, but hires a graduate student to spend 1 hour a week with him to do workbook problems together. John always gets every problem correct without help from the graduate student, but he insists on continuing the relationship. Is there a behavioral economic explanation of why this is rational? Explain.

Question 31

In an experiment on risk aversion, a group of people were given the following choice: A) Lose $100 with certainty, or B) 50% chance to win $50, 50% chance to lose $200. An overwhelming majority chose option B. This can be best explained by which of the following?

A) People have a greater aversion to loss than to risk.
B) Option B has a smaller expected loss than option A.
C) This behavior is consistent with risk aversion with losses.
D) Option B has an expected gain as opposed to certain loss with option A.
E) This behavior violates the Weak Axiom of Revealed Preference.

Question 32

Consider 2 identical twins, Scott and Rich. Scott is a professional wrestler who will earn lots of income when he is young and will retire by age 40. Rich is a manager who expects to earn high income in his 50s and 60s. The life cycle theory of savings would predict that Scott should save while he is young to smooth consumption over his lifetime, and Rich should borrow against his future earnings when he is young. If Scott and Rich are typical savers, which of the following scenarios is most likely to be observed?

A) Scott will save a substantial portion of his wrestling income but Rich will not borrow against future earnings to boost consumption when he is young.
B) Scott will save a substantial portion of his wrestling income and Rich will borrow against future earnings to boost consumption when he is young.
C) Scott will spend his wrestling income when he is young and Rich will not borrow against future earnings to boost consumption when he is young.
D) Scott will spend his wrestling income when he is young and Rich will borrow against future earnings to boost consumption when he is young.
E) There are no typical patterns of saving.

Question 33

A new DVD of lectures on the topic of macro economics and personal hygiene is being marketed on the Internet as a remedy for insomnia. As an experiment, the marketing firm wants to direct half of Web hits to a page that advertises the DVD as 90% successful in inducing sleep while the other half are directed to a page that advertises the DVD as failing to induce sleep 10% of the time. Would you expect equal numbers of sales from the 2 advertising approaches? Explain.

Question 34

If Fred were to consume $1,050 1 year from now, he would consider this as good as spending $1,000 today. He would consider $1,628.89 of consumption 10 years into the future equivalent to $1,000 of consumption today. If the interest rate is 5%, Fred preferences

A) are consistent with exponential discounting.
B) are consistent with hyperbolic discounting.
C) are consistent with geometric discounting.
D) are inconsistent.
E) violate the Weak Axiom of Revealed Preference.