Question 1

People are willing to buy insurance because of:

Accepted Answer

Risk aversion refers to an individual's willingness to pay to avoid risk. Insurance provides a sense of security and protection against financial loss, which appeals to individuals who are risk-averse. Therefore, people are willing to buy insurance because of risk aversion.

Question 2

If a decision maker chooses an option that leaves him or her worse off than choosing another available option,he or she is:

Accepted Answer

Choosing an option that leaves the decision maker worse off than choosing another available option is an irrational decision because it goes against the goal of decision making – to choose the option that maximizes the decision maker's overall utility or satisfaction. Choosing such an option may be due to a lack of information, flawed reasoning or biases, which are all examples of irrational decision making.

Question 3

Sally must submit a form to enroll in her company's flexible medical benefits program.Although she has been employed over a year,she has yet to complete the form.Which type of irrational behavior does this represent?

Accepted Answer

Sally's behavior represents a status quo bias, which is the tendency to stick with the default or current option, even if it's not the best choice. In this case, Sally may be hesitant to enroll in the program because she's used to not having it, or simply because she hasn't taken the time to fill out the form. This is a common behavior that can lead to missed opportunities or suboptimal choices.

Question 4

Mary goes ahead and buys a new car because she expects to receive a 10% increase in her salary next year.What type of behavior does this BEST represent?

Accepted Answer

Mary's decision to buy a new car based on the expectation of a future salary increase suggests overconfidence. She is assuming that her salary will actually increase, which may not be a reliable assumption. Additionally, even if her salary does increase, she may have other financial obligations or unexpected expenses that she has not considered. This decision is not necessarily based on a careful consideration of opportunity costs or risk aversion.

Question 5

Lucy bought some stock 10 years ago that has been priced at half of her purchase price for the past 5 years.However,Lucy refuses to sell the stock,thinking that,if she waits long enough,she will recover her investment.What type of behavior does this represent?

Accepted Answer

This behavior represents loss aversion, where Lucy is unwilling to sell the stock at a loss and is holding onto it in hopes of recovering her initial investment.

Question 6

Which type of behavior is a systematic mistake that leads to irrational decisions?

Accepted Answer

Overconfidence is a systematic mistake where individuals overestimate their knowledge or abilities, leading to irrational decisions.

Question 7

If a person engages in mental accounting,he or she:

Accepted Answer

Mental accounting refers to the tendency of individuals to assign different values to the same amount of money depending on how and where they received it or how they plan to spend it. This means that someone may value $100 earned from a bonus more than $100 earned from regular work due to the perception of it being "extra" money. Therefore, choice B is the correct answer.

Question 8

When making decisions,a person should consider only costs that actually involve an explicit money outlay.This is because such costs actually have to be paid,whereas implicit costs are only notional or hypothetical.

Accepted Answer

When making decisions, a person should consider both explicit and implicit costs. Implicit costs refer to the opportunity costs of the next best alternative foregone and can have a significant impact on decision-making. While implicit costs do not involve an explicit money outlay, they are still relevant and should be considered in decision-making.

Question 9

Joshua is tired of school as well as his part-time job and decides on the spur of the moment to take a weekend trip to Cabo San Lucas.He pays for it with his credit card,rather than with money from his checking account.Which type of irrational behavior does this BEST represent?

Accepted Answer

Joshua is exhibiting mental accounting because he is treating the credit card as a separate account from his checking account, even though it will still require payment later on. He is not considering the long-term consequences of using credit card debt to pay for expenses in the short-term.

Question 10

If a star college quarterback turns down a multimillion-dollar offer from the NFL to return for his senior year of college,he may be exhibiting:

Accepted Answer

The quarterback may be misperceiving the opportunity costs of returning to college for his senior year. While he may enjoy the experience and potentially improve his draft stock for the following year, he is passing up a guaranteed multimillion-dollar contract and the opportunity to start his professional career early. This decision could be a result of not fully understanding the value of the opportunity cost or being biased towards staying in his familiar college environment.

Question 11

Cindy just graduated from college and started working at a large accounting firm.Although the firm will match her contributions to a retirement account,Cindy wants to wait several years before participating since there are so many things she needs to buy right now.What type of behavior does this represent?

Accepted Answer

Cindy's decision to delay retirement contributions reflects unrealistic expectations about the future, as she assumes she will have more resources or time to save later, potentially underestimating the benefits of starting early.

Question 12

A person who is oversensitive to loss and is unwilling to recognize the loss and move on has:

Accepted Answer

Loss aversion refers to the tendency to feel the pain of losses more than the pleasure of gains. In this case, the person is oversensitive to loss, which means they are experiencing the pain of the loss more intensely than others might. This can make it difficult for them to move on from the loss and may cause them to hold onto things or situations that are no longer beneficial for them. They may also be more risk-averse because they are afraid of experiencing further losses.

Question 13

Star athletes,singers,and actors often start their career very young,forgoing a college education.This is an example of poor decision making since a college education provides benefits that will be invaluable later in their lives.

Accepted Answer

Many star athletes, singers, and actors who start their careers young and forgo a college education do so because they are pursuing unique opportunities in their fields that may not be available later. Success in these areas often requires early and intense dedication, and the benefits and opportunities they gain can be equivalent to or surpass those provided by a traditional college education. Additionally, some eventually return to complete their education or pursue alternative forms of continued learning and personal development.

Question 14

A decision maker who is irrational:

Accepted Answer

An irrational decision maker makes illogical, inconsistent or contradictory choices that may go against their own interest or objectives. Therefore, such a decision maker is likely to choose an option that makes him or her worse off, rather than choosing a better available option.

Question 15

Most economic models:

Accepted Answer

Most economic models assume that people behave rationally. While this assumption is not always accurate, it allows for the creation of simple and predictive models of human behavior. It also serves as a useful starting point for understanding economic phenomena.

Question 16

Which type of behavior is NOT a common mistake that leads to irrational decisions?

Accepted Answer

Risk aversion is a natural, rational behavior where individuals prefer to avoid losses rather than acquiring equivalent gains. It's a fundamental aspect of human decision-making, unlike the other options which can lead to irrational decisions.

Question 17

Because resources are scarce,the true cost of anything is its opportunity cost.

Accepted Answer

Opportunity cost is the value of the next best alternative forgone when a choice is made. Since resources are scarce, choosing to use them for one thing means giving up the opportunity to use them for something else, and that is the true cost of the choice.

Question 18

The habit of mentally assigning dollars to different accounts so that some dollars are worth more than others is:

Accepted Answer

This is the definition of mental accounting, where individuals treat money differently depending on the account it is assigned to, rather than viewing it as a single pool of funds.

Question 19

A person with loss aversion:

Accepted Answer

Loss aversion refers to the tendency for people to feel loss more strongly than gain. As a result, someone with loss aversion may have a hard time recognizing losing investments and cutting their losses since they feel the loss more strongly than they would feel the gain from a profitable investment.

Question 20

The tendency to avoid making a decision is:

Accepted Answer

The tendency to avoid making a decision is known as status quo bias. This bias refers to individuals' preference for maintaining the current state of affairs instead of making a change, even if the change may be more beneficial in the long run. It is a cognitive bias that affects decision-making and can lead to missed opportunities and suboptimal outcomes. Bounded rationality refers to the limitations of human decision-making, loss aversion is the tendency to avoid losses more than acquiring gains, and mental accounting refers to the tendency to treat money differently based on its source or intended use.

Quiz 9: Decision Making by Individuals and Firms