FHCE 4270E Final Exam Study Guide

Modules 5-7

. . O $500 Colonoscopy Schedule But Not Show Up Payment Upon Scheduling Loss Aversion Dan Ariely Revised And Expanded Edition Nw More Bilen Predictably 1Vnojivi The Hidden Forces Thar Sharp Our Decisions Dan Ariely Hip Dan Ariely New York Times Bestselling Author Of Pretody Rasial The Upside Of Irrationality The Unexpected Benefitsof Defying Logic At Work And At Home Exercise - Clothes Passive Barriers • Foo Dhealthier Options Inve Stingautomate Studying - Distraction Free Area . - Chapter 14: Selfishness And Altruism Summer 2021 People Are Selfish. For Simplicity, Most Economic Models Assume That Rational Humans Care Only About Their Own Well Bein Gbut Then How Does This Explain Altruism, Volunteerism, And Other Socially Generous Behavior That Several Of Us Participate In And Enjoy? Practically, We Define Altruism As Behavior That Aids Others For No Apparent Practical Gain. Example 2: Using Others As A Referencepoint Finding (Frank) Design: •Scenario A: You Save Enough To Support A Comfortable Standard Of Living In Retirement, But As A Trade-Off Your Children Have To Attend A School Whose Students Score In The 20Th Percentile On Standardized Tests In Reading And Math •Scenario B: You Save Too Little To Support A Comfortable Standard Of Living In Retirement, But As A Trade-Off Your Children Attend A Private School Whose Students Score In The Top 80Th Percentile On Standardized Tests In Reading And Math. Positional Externality • A Positional Externality Is An Other-Regardingpreference Where My Utility Depends On My Position Relative To Others In Terms Of Consumption Many 'Altruistic' Parents Derive Greater Happiness By Choosing Scenario 'B'. . Happiness Is Relative Findings (Easterlin Paradox) • High Correlation With Income Within Countries, But Low Correlationwith Income Across Countries. Suggesting That It's The Relative Ordering Within A Country That Matters More Than Total Money People Are Happy With Low Income As Long As Their Friends And Neighbors Also Have Low Income, But People Become Unhappy When They Earn Less Relative To Their Immediate Social Group That Theyidentify With Finding Sa Woman's Decision To Work Is Highly Correlated With The Difference Between Her Brother In Law's Income And Her Own Husband's Income. Question: What Does This Mean? . History And Notes Altruism Has Also Been Studied Extensively In Evolutionary Biology. Some Argue That Altruism Evolved Due To Kin Selection, What's Good For My Family Is Goodfor Me. • Others Argue That Altruism Evolved As Asignaling Mechanism To Impress Others. Chapter 16: Trust And Reciprocity Summer 2021 Nobel Laureate Amartya Sen's Rationalfools... While Identity Theft Is A Real Concern, The Perpetrator Is Usually Not Some Stranger But A Friend Or Family Member Whom We Trust In Everyday Economic Interactions, We Trust Mechanics Or Doctors Or Waiters To Fix Our Cars, And To Provide Care Chapter Overview: Trust And Reciprocity Relationships Are Central To How An Economyfunctions, But Were Historically Neglected In Economic Analyses. Other-Regarding Preferences Are Often Most Important In The Context Of A Relationship. Of Trust And Trustworthiness • Trust Surveys Asked People "Generallyspeaking, Would You Say That Most People Can Be Trusted Or That You Can't Be Too Careful In Dealing With People?" Possessing Social Capital Seemed To Increase Trust And Perhaps Trustworthiness What Is Trust Trust Is Tied Up With Risk. Those Who Are More Risk Tolerant Also Would Be Happy To Trust More However, Trust Is Tied Up In A Complex Social Relationship And Thus No Model Of Trust Has Become Standard Example: Keep On Smiling Experiment (Scharlemann) •Design: Played A Take It Or Leave It Game With A Picture Of The Opponent. Sometimes The Picture Was Smiling, Sometimes The Picture Was Straight Faced. •Results: Participants Were 13% More Likely To Trust If The Partner Was Smiling. Difference Was Much Larger For Men (80% To 59% For Men, Compared To 58% To 52% For Women). Sincerity Of Smiles Also Mattered. Example: Economic Conse Quences O Ftrust Finding (Knack And Keefer) •In A Survey Of 21 Countries, Measures Of Trust And Social Capital Are Associated With Faster Gdp Growth. Reciprocity Fehr And Gachter Point Out Subtle Things Create Trust •A Waitress Who Smiles Gets More Tips •A Supermarket That Gives Free Samples Gets More Business Example 6 Reciprocity As D Istinct Fro Mfairness Here, Fairness Is Defined As Rewarding Intentions To Be Kind And Punishing Intentions To Be Cruel. Reciprocity Rewards Actions That Are Kind And Punishes Actions That Are Cruel E • The Legal Code Often Has Punishments For Bad Behaviors Even If Intentions Were Not Example 7 Reciprocity As A Busines Smodel • Consider The Case Of Open Source Software Or Crowdsourcing And Wikipedia - Wikipedia For Example Provides Information Forfree To Its Readers - In Reciprocity Wikipedia Receives Generousdonations From People Who Support Wikipedai, Whitout Which Wikipedia Would Not Be Able To Exist As A Free Open Resources Chapter Su Mmary: Trust An Dreciprocity Relationships Are Essential To The Economy. Relationships Are Governed By Trust. • Trust And Reciprocity Are Related To Risk Andfairness, But Depend Far More On The Social Context. Risk Tolerance Summer 2021 What Is Risk? The Possibility That Something Bad Or Unpleasant Will Happen Is Risk Important?- Making Housing Decisions - Financial Decisions - Personal Economic Decisions Is Risk Good Or Bad? Why? • How Does It Relate To Investments? Does Our Risk Tolerance Matter? Then Are We More Risk Tolerant? Then Facing A Profitable Situation? Or "Hen Facing A Loss Making Situation? Hat Is The Theory We Studied That Explains Nis? The Concept Of Risk Capacity The Ability To Take Risk Whether An Individual Has The Resources To Take The Amount Of Risk That Her Risk Tolerance Suggests The Difference Between Risk Capacityand Risk Tolerance: Risk Tolerance—The Willingness To Take Risk Risk Capacity-The Ability To Take Risk Measuring Risk Tolerance Many Different Scales Examine Two In Detail Most Widely Us Ed Measure Of Ris Ktolerance Barsky, R. B., Juster, F. T., Kimball, M. S., & Shapiro, M. D. (1997). Preference Parameters And Behavioral Heterogeneity: An Experimental Approach In The Health And Retirement Study. The Quarterly Journal Of Economics, 112(2), 537-579. Question 1 Suppose That You Are The Only Income Earner In The Family, And You Have A Good Job Guaranteed To Give You Your Current (Family) Income Everyyear For Life. • You Are Given The Opportunity To Take A New Andequally Good Job, With A Fifty-Fifty Chance It Will Double Your (Family) Income And A Fifty-Fifty Chance That It Will Cut Your (Family) Income By A Third. Would You Take The New Job? Follow Up Question If You Answered 'Yes' To The First Question: Suppose The Chances Were Fifty-Fifty That It Would Double Your (Family) Income, And Fifty-Fifty That It Would Cut It In Half. Would You Still Take The New Job? If You Answered 'No' To The First Question: Suppose The Chances Were Fifty-Fifty That It Would Double Your (Family) Income And 5050 That It Would Cut It By 20 Percent. Would You Then Take The New Job? Follow Up Question You Answered 'No' To Both Questions 1 And : Suppose The Chances Were Fifty-Fifty That It Would Double Your (Family) Income And 50-50 That It Would Cut It By 10 Percent. Would You Then Take The New Job? Scoring Your Risk Tolerance You Answered 'No' For All Three Scenarios Then Your Core Is 'O' F You Answered 'No' For The Questions 1 And 2 But 'Yes' Or The Third Question Then Your Score Is '1' F You Answered 'No' For The First Question But 'Yes' For Che Second Question Then Your Score Is '2' F You Answered 'Yes' For The First Question But 'No' For The Second Question Then Your Score Is '3' If You Answered 'Yes' For The First Question And 'Yes' For The Second Question, Then Your Score Is 4 Es What Does Your Score Mean? O'—Very Risk Averse '1'—Somewhat Risk Averse '2'— Risk Neutral '3'—Somewhat Risk Taking '4'— Very Risk Taking Why Is Inves Tment Risk Toleranc Erelevant? Securities & Exchange Commission (Sec) Requirement: Http://Www. Sec. Gov/Answers/Suitability. Htm Http://Www. Sec. Gov/Investor/Pubs/Roadmap/ Isk. Htm Issues With Risk Tolerance He Market Crisis Of 2008-2009 - Many Investors Were Assessed With High Risktolerance In 2007 — However, After The Market Crash They Dumpedtheir Stocks And Sued Their Financial Planners For Appropriately Allocating Them In Assets That Were Too Risky (Pan & Statman, 2012) At Else Do We Need To Know Beyondrisk Tolerance? Dividuals Have Multiple Perceived Risk Lerances Why? Blame Thi S On Mental Accountin Ginvestor's Risk Tolerance Corresponds To Their Goals Kisting Questionnaires Do Not Follow Any Direct Nkage Between Risk Tolerance Scores Derived Om The Questionnaires And Portfolio Asset Locations Nvestor's Risk Tolerance Varies By Circumstance Nd Associated Emotions Examples During Periods Of Extraordinarily High Returns On Asset Classes - Dotcom Stocks Of 1999 - Gold Returns Of 2011-2012Oil Prices Of 2007-2008 Risk Tolerance Asked After Periods Of Market Boom Results In Investors Reporting Higher Risktolerance - The Opposite Happens In Periods Following Amarket Crash Isk Perceptions And Risk Toleranc A Wealthy Individual Might Have The Same Risk Tolerance As A Poorer Individual But The Perceptions Of Risk Tolerance May Be Different Perception Of Winning Or Losing $1000 Might Be Different For A Wealthier Individual Than For A Poorer Individual Risk Perceptions And Risk Tolerance • A Wealthy Individual Might Have The Same Risktolerance As A Poorer Individual But The Perceptions Of Risk Tolerance May Be Different Perception Of Winning Or Losing $1000 Might Be Different For A Wealthier Individual Than For A Poorer Individual . Goals & Mental Accounts • What Are Mental Accounts?- Shefrin & Statman (2000) - Mental Accounting Refers To The Tendency Forpeople To Separate Their Money Into Separate Accounts Based On A Variety Of Subjective Criteria, Like The Source Of The Money And Intent For Each Account. Hp Goals & Mental Accounts • What Are Mental Accounts? - Shefrin & Statman (2000) - Mental Accounting Refers To The Tendency Forpeople To Separate Their Money Into Separate Accounts Based On A Variety Of Subjective Criteria, Like The Source Of The Money And Intent For Each Account. Leveraging Mental Accounting • 401K Automatic Contributions • Do No T Spend Gifts Immediatelytake Ownership Of Money First Pay Down Expensive Debt Be Careful With Windfalls, Raises, Or Major Changes In Income . Example Of An Investment Pyramid Financial Health Spectrograph Contact: John Smi Th Portfolio: My Portfoli Ospeculative 1. Metals/Gems/Art/Collectibles 2. Options/Futures 3. Commodities Growth 4. Partnerships & Venture Capital 5. Growth Stocks/High-Yield Bonds 6. Growth Mutual Funds 7. Variable Life & Annuities Report Date: 7/24/2008 Both Preand Post-Retirement Report Spec Ulative Growth Secure Sec Urefoundation B. Investment Real E State 9. Conservative Equ Itiesinvestment Pyramid 10. Corporate Bonds 11. Government Bon D Fundsspectrograph Provided By Fhain Fhrim Is Not A Brokor/Dealer Or R Egistered Investment Advi Sor Underunited States Federal Securities Law Or Securities Laws Of Other Jurisdictions, And Does Not Advise Individuals 12. Residential Real Estateas To The Advisability Of Investing In Purchasing Or Selling Securities Or Other Financial Products. The Content, Calculations, And Sorvices Provided By Fhrim Does Not Constitute An Offer Or Solicitation To Buy Or Sell Any Guaranteedsecurity, Fhri" Doos Not Endorse Or Recommend Any Securities Or Other Financial Products. Nothing Contained In The Fhri Site Is Intended To Constitute Investment, Legal, Tax, Accounting Or Other Professionaladvice, And You Should Not Rely Solely On The Reports, Data, And Other Information Provided To You As Part Of 13. Equity Indexed Annuities The Fhi Products And Services In Making Financial Decisions. You Should Consult With An Appropriato 14. Fixed Annuitiesprofessional For Specific Advice Tailored To Your Situation And Verify The Accuracy Of Information Provided To 15. Cash Value Life Insurance You Before Making Any Investment Decis On 16. Muni Bonds 17. Government Bills/Bonds/Notes Information Appearing And Calculations Provided By Fhri Are Believed To Be Accurate, But Neither Fhri 18. Cd'snor Its Suppliers Warrant Or Guarantee Such Accuracy. You Should Independently Venty All Relevantinformation And Calculations Prior To Making Any Investment Decisions Based On Such Information. Fhri" 19. Money Marketmay Change, Update Or Correct All Or Any Portion Of The Fhm Products And Services And The Information 20. Checking/Savingsand Calculations Contained Therein At Any Time 2008 The Financial Health Research Instituto All Rights Reserved. Patent Pending . . The Mental Accounting Of Jobs An Dportfolios Jobs Provide Downside Protection Portfolios Provide Upside Potential - Case In Point The Barksy Et Al. Scale Overconfidence • What Is Overconfidence? - Perceive Themselves To Be More Risk Tolerance Than They Actually Ar Emarket Crashed - Framing (1 Mil, 90K Or 9%) • Does Human Capital Play A Role?- False Confidence - Regret, Luck, And Skill Investors With A High Degree Of Regret Might Be Very Demanding When It Comes To Their Required Return (Schwartz Et Al. 2002) - Propensity Maximization - Atrait Seen In The Most Demandingcustomers/Clients/Consumers • Some People Believe In Luck. These Individualsare Likely To Be More Risk Tolerance Skill-Self Efficacy, Experience - How Does This Impact Financial Risk Tolerance? . Exuberance Fear And Risk Tolerance • What Is Irrational Exuberance? - Irrational Feeling Of Invincibility And Feeling Of Successduring Periods Of Stock Market Rise. People Tend To Ignore The Probabilities And Become Overconfident • Warren Buffett • Networth: $72.3 Billion - "Be F Earful When Others Are Greedy And Greed Ywhen Others Are Fearful" Social Norms Vs. Market Norms Summer 2021 Social Norms And Market Norms • We Live In Two Worlds;- One Where Social Norms Prevail, Andanother Where Market Norms Make The Rules. • Social Norms Such As Reciprocity Are Warm Andfuzzy, And Altruistic • Market Norms Are Explicit And Hard--You Getwhat You Pay For Social Norms And Market Norms Examples: You Can't Mix Social And Market Norms - After Thanksgiving Dinner At Your Mother-In-Law's House, You Pulled Out Your Wallet And Asked, "How Much Do I Owe You?" - You Cannot Tell Someone You Are Dating That, "You Know, This Relationship Is Costing Me A Lot Of Money." • But You Can Tell The Employer That You Are Being Paidtoo Little • Or You Can Tell Your Financial Planner That You Are Nothappy With The Fee He Or She Is Charging Dan Ariely (Predictively Irrational) Social Norms And Market Norms: Experiment • I N An Experiment, The Rewards Were A Box O Fgodiva Chocolates (Worth $5), Snickers Bars (Worth $1), And Zero Bars (Worth $1)$5 (Godiva): 169 Circles - $0.50 (Snickers): 162 Circles - Zero: 168 Circles - Conclusion: Small Gifts Don't Constitute A Marketnorm, And Keep Things In The Social Realm "People Like To Volunteer Or Help, And They Are Willing To Work For A Reasonable Wage, But Offer Them A Payment And Many May Walk Away." O - Market Norms Drive Out Social Norms • The Aarp Asked Lawyers Whether They Wouldoffer Their Services To Needy Retirees For A Discounted Price Of $30/Hour. - Nobody Agreed To Do So. - When The Program Manager Instead Asked Ifthey'd Offer Their Services For Free, The Lawyers Overwhelmingly Said They Would Participate. Market Norms Drive Out Social Norms Gneezy And Rustichini Studied The Effect Of Fining Parents Who Picked Up Their Children From Daycare Late Imposing A Fine Had Long-Term Negative Effects. - Without A Fine, Parents Felt Guilty About Being Late - Imposing A Fine Inadvertently Replaced Social Normswith Market Norms. - Parents Decided That, Since They Were Being Fined, They Could Decide Whether Or Not To Be Late, And Frequently Chose To Be Late. Social Norms In Business Corporations Are More Productive When Social Norms (Such As The Excitement Of Building Something Together) Are Stronger Than Market Norms (Such As Salaries S Tepping Up With Each Promotion). - Nonprofitsstartup Firms - If Corporations Started Thinking In Terms Of Socialnorms, They Would Realize That These Norms Build Loyalty And--More Important--Make People Want To Extend Themselves To Be Flexible, Concerned, Andwilling To Multi-Task. • That's What A Social Relationship Delivers. Social Norms In Business - What Motivates The Police Officers To Risk Theirlives And Fight Crimes Everyday? - Police Officers, Firefighters, Soldiers--They Don't Workonly For Their Pay. It's The Social Norms--Pride In Their Profession And A Sense Of Duty--That Will Motivate Them To Give Up Their Lives And Health. Money, As It Turns Out, Is Very Often The Most Expensive Way To Motivate People. Social Norms Are Not Only Less Expensive, But Often More Effective As Well. More On Market Norms The Power Of Free! Rational Thinking Goes Away When Something Is Offered To Us For 'Free' The Ability To Make Intelligent Exchanges Deteriorates When The Price Of A Good Orservice Is Dropped To Zero - The "Free" Option Becomes The Preferredoption Even When It Is Clearly Inferior To Other Options Experiments With Candies Students Were Offered The Opportunity To Buyone Chocolate Per Person At Reduced Prices - Here Are The Results: Lindt Truffles Hersheys Kisses Situation A Price $ Quantity % 0.15 0.01 73 27 Situation B Price $ 0.14 0.00 Quantity % Discounted Target Gift Cardsexperiment One Gift Card Per Person Offer 1: $20 Gift Card At A Price Of $7 Offer 2: $10 Gift Card For Free Guess Which One Was The Overwhelming Favorite! Discounted Target Gift Cardsexperiment One Gift Card Per Person Offer 1: $20 Gift Card At A Price Of $7 Offer 2: $10 Gift Card For Free Guess Which One Was The Overwhelming Favorite! The Case Of Amazon. Com In France For Some Reason, Amazon. Com In France Was Not As Successful As It Was In All Other Countries It Turned Out That All Other Countries Had Free Shipping While There Was A One Franc (About20 Cents) Shipping Fee In France - When Shipping Became Truly Free In France, Sales Quickly Jumped Up To The Levels In Other Countries Social Norm Or Market Norm? Http://Finance. Yahoo. Com/News/No-Best-Buydidnt-Mean-201912325. Html Diversification Good Or Bad? Diversification Diversification, If Done To Reduce Risk In One's Wealth Portfolio, Can Be A Great Idea - Good Financial Planning Requires Each Individualto Use His/Her Wealth To Buy A Sensible Mix Of Different Assets, Such As Stocks, Bonds, Real Estate, Etc. • But Naïve Diversification That Is Done Simplybecause One Is Overwhelmed By A Complex Choice Can Cause Serious Problems The Problem With Naïve Diversification When We Face A Complicated Choice From A Multi-Item Menu, We Often Rely On A Rule-Ofthumb Called The Diversification Heuristic: When In Doubt, Diversify. - An Extreme Form Of This Is The 1/N Heuristic: When Faced With N Options, Choose Equal Amounts Of Each Option Diversification Experiment University Employees Were Asked How They Would Invest Their Money If They Had Only Two Mutual Funds To Choose From - Some Mutual Funds Invest In Stocks, Some In Bonds, Some In Real Estate, Etc. Diversification Experiment Group 1 Could Invest In: A M Utual Fund That Invested Only In Stocks, And/Ora Mutual Fund That Invested Only In Bonds · Group 2 Could Invest In:- A Mutual Fund That Invested Only In Stocks, And/Or - A "Balanced" Mutual Fund That Invested Half Instocks And Half In Bonds The Results Confirmed The 1/N Heuristic Diversification Experiment • Group 1 Could Invest In:- A Mutual Fund That Invested Only In Stocks, And 5 - A Mutual Fund That Invested Only In Bonds 5 Group 2 Could Invest In: - A Mutual Fund That Invested Only In Stocks, And/O - A "Balanced" Mutual Fund That Invested Half Instocks And Half In Bonds . • The Results Confirmed The 1/N Heuristic Diversification Experiment • Group 1 Could Invest In:- A Mutual Fund That Invested Only In Stocks, And 50 - A Mutual Fund That Invested Only In Bonds 50 Group 2 Could Invest In: - A Mutual Fund That Invested Only In Stocks, And - A "Balanced" Mutual Fund That Invested Half In 5Stocks And Half In Bonds The Results Confirmed The 1/N Heuristic Diversification Experiment Group 3 Could Invest In: - A Mutual Fund That Invested Only In Bonds, And/Or - A "Balanced" Mutual Fund That Invested Half Instocks And Half In Bonds, And/Or • Guess What Group 3 Decided? Diversification Experiment One Study Examined Employee Behavior In Theretirement Saving Plans Of 170 Companies - It Found That The More Stock Mutual Funds Aplan Offered, The Greater Was The Percentage Of Employees' Money That Was Invested In Stocks Revisiting The Heuristics Bias When Choices Are Complex, People Rely Onrules-Of-Thumb Or Heuristics - This Leads To Bad Decisions • In These Cases, Some Persuasion May Benecessary • Policies Can Help By Forcing People To Makesensible Choices Irrational Choice? Ou Are Trying To Guess The Color Outcomes Of A Oulette Wheel Spin Where 60% Of Slots Are Red And 40% Are Black. To Maximize Your Payoff, What Color Should You Pick? Irrational Choice? You Are Trying To Guess The Color Outcomes Of A Roulette Wheel Spin Where 60% Of Slots Are Red And 40% Are Black. To Maximize Your Payoff, What Color Should You Pick On The Second Spin? Irrational Choice? You Are Trying To Guess The Color Outcomes Of A Roulette Wheel Spin Where 60% Of Slots Are Red And 40% Are Black. To Maximize Your Payoff, What Color Should You Pick On The Third Spin? Outcome Of The Roulette Whee Lexperiment Most People Chose Red For The First Spin (75%)Many Chose Black For The Second Spin (40%) - Even More Chose Black For The Third Spin (55% Cards Experiment Five Cards Are Chosen Randomly From A Deck Of 100 Colored Cards: 36 Green, 25 Blue, 22 Yellow And 17 Brown. Choose, In Advance, The Predicted Color Of The First Five Cards. You Receive A Prize For Each Correct Prediction. What Is The Best Prediction? Brown17 Yellow,22 Blue, 25 Green,36 - Rubinstein (Princeton), 2002, Irrational Diversification In Multiple Decision Pro Raia 46 1369-1878. Cards Experiment E Cards Are Chosen Randomly From A Ck Of 100 Colored Cards: 36 Green, 25 Ue, 22 Yellow And 17 Brown. Brown , 17 Yellow, Hat Is The Best Prediction?22 5 Greens 5 Blues2 Greens, 1 Blue, 1 Yellow, 1 Brown :)) 2 Greens, 2 Blues, 1 Yellow -) 3 Greens, 2 Blues Blue, 25 Greer Cards Experiment Five Cards Are Chosen Randomly From A Deck Of 100 Colored Cards: 36 Green, 25 Blue, 22 Yellow And 17 Brown. Chose, In Advance, The Predicted Color Of The First Five Cards. You Receive A Prize For Each Correct Prediction. In A Test Of 74 College Students, What Percentage Selected All Greens? Brown17 Yellow,22 Blue, 25 38% Green36 -. Rubinstein (Princeton), 2002, I Rrational Diversification In Multiple Decision Pr Oeconomic Review 161369-1 378 Diversification Bias: Why? • The Fear Of Losing Choices, Even When They Are Ba Dones: The Love For Diversification Even When It Ispointless And Costly • We Avoid Focusing Even When It Is The Only Correctchoice • We Worry About Losing Future Options The Argument For Social Norms Economics 101: Higher Income Means Greater Consumption And Therefore Greater Utility Andsatisfaction Satisfaction In China As Average Real Income Rises By 250 Percent Ell, How Satisfied Or Dassatisfied Are You With The Way Things Are Going In Your Life A You Say You Are Very Satisfied, Somewhat Satisfied, Somewhat Dissatisfied, Tasfied? Percentage Satisfied Or Dissatisfied 100% 90% 50% 70% 60% 30% 40% 80% 90% 10% 09 1661 1995 9661 1997 Satisfied Dissatisfied 2005 2001 2003 2002 2001 2000 1999 8661 Aniel Kahneman (Princeton) And Alan B. Krueger (Princeton), 2006, Developments In Measurement Of Subjective Well-Being, Journal Of Economic Perspectives, 20(1), 3-24 101 10 100 - Real Home Repita 1009 100 3 40,00 30.00 + 90.00 100 Manne 1. Happiness And Real Income Le Capita In The United States 1973_2004 World Database Of Happiness And Lemn World Tables Happiness Is The Average Reply To The Mon: "Taken All Together How Would Wow Say Things Are These Days. Would Yow Www That Yow Amses Are Coledas () Very Happx @ Meta Happy And (0) Not Too Happy Happiness Data Ar The General Social Surve Clark, R Friters, And M. Shield, 2008, Relative Income, Happiness, And Utility: An Exple The Easterlin Paradox And Other Puzzles, Journal Of Economic Literature, 46(1), 95144 Vhy Don't We See Perceived National Well-Being Risingwith National Income? Level Of Satisfaction Depends Upon Relative Consumption V. Those In The Immediate Comparison Group Me Goods Are More "Indicative Of Stat Goods Where Relative Evel Is Key - Cars • Houses • Attire • Income Vacation Goods Where Basic Satisfaction Level Is Key . . Health Safety Relationships J. Solnick (U. Vermont) & D. Hemenway (Harvard), 2005. Are Positional Concerns Strong Ome Domains Than In Others? American Economic Review, 95, 147-151 Me Goods Are More "Indicative Of Sta Goods Where Relative Level Is Key • Cars • House Sattire • Income • Vacation Good S Where Basic Satisfaction Level Is Key • Health • Safetyrelationships . 5. J. Solnick (U, Vermont) & D. Hemenway (Harvard), 2005. Are Positional Concerns Stror Some Domains Than In Others? American Economie Reviews 95, 147-151 Conspicuous Consumption Thorstein Veblen - Theory Of The Leisure Class (1899) • The 'Want To Prefer A Good Because It Is More Expensive. -The Display Of The Item Projects Relative Standing. Relative Context If You Graduate From College And Your Income Changes From $0 To $29,000. Your Friends All Get Jobs Making $50,000. How Would You Feel? Relative Context If You Graduate From College And Your Income Changes From $0 To $29,000. Your Friends All Get Jobs Making $50,000. How Would You Feel? Relative Income And Life Satisfactio Study: A Panel Study Of About 10,000 People In 965 Differe Neighborhoods Question: Comparing Individuals With The Same Income, C They Feel Worse When Others Around Them Have More Income? What Do Youthink? A) People Feel Less Happy When The Income Of Those Arathem Goes Up. B) People Feel More Happy When The Income Of Those Arothem Goes Up. C) People Are Unaffected By What Those Around Them Ea Luttmer, E. (Harvard), 2005, Neighbors As Negatives: Relative Earnings And Well-Being Journal Of Economics, 120(3), 963-1002. Peer Effects Revisited - If We Are Doing Well Compared To Thosearound Us We Tend To Be Satisfied Andcomplacent. • If We Are Doing Poorly Compared To Thosearound Us, We Tend To Be Dissa Tisfied And Driven To Action. Sisters & Relative Happines Sexperiment Fone Woman's Husband Makes Less Money Than Her Sister's Husband, Does This Make Her A) Less Likely To Be Employed Outside The Home B) More Likely To Be Employed Outside Thehome? C) No Impact Eumark, D. (Michigan State) & Postlewaite, A. (U. Penn), 1998, Relative Income Concer Me Rise In Married Women's Employment. Journal Of Public Economics, 70, 157-183. The Outcome Among Married Women With A Sister Who Wa Not Employed, The Probability Of The Woman' Own Employment Rises 16-25% If Her Sister's Husband Makes More Than Her Husband. Eumark, D. (Michigan State) & Postlewaite, A. (U. Penn), 1998, Relative Income Concern He Rise In Married Women's Employment. Journal Of Public Economics, 70, 157-183. The Outcome Among Married Women With A Sister Who Was Not Employed, The Probability Of The Woman's Own Employment Rises 16-25% If Her Sister's Husband Makes More Than Her Husband. Umark, D. (Michigan State) & Postlewaite, A. (U. Penn), 1998, Relative Income Concerns E Rise In Married Women's Employment. Journal Of Public Economics, 70, 157-183. Why Do We Volunteer? By Focusing On Those In Need Through Volunteering, Philanthropy, Or Compassion, We Reshape Our Personal Environment Of Relative Standing Volunteers Report Higher Well-Being Scores Than Non-Volunteers; They Are Less Depressed, And Their Mortality Rate Is Lower Than Average Er, S. (Harvard), 2006, The Economics Of Non-Selfish Behavior. Edward Elgar Publishing: Thampton, Ma. P. 43 (Hp

Gambler's Fallacy; Hot Hand Theory

A study of nearly 1800 daily drawings between 1988 and 1992 in a New Jersey lottery showed that after a number came up a winner, bettors appeared to avoid

Modules 4-5

Chapter 11: Disagreeing With Ourselve Sprojection And Hindsight Biases Fhce 4270E 6270E Blinded In The Rec Room Why Do People Spend $3,000 To $10,000 For A Pool Table They Hardly Ever Use? Ex: Mple 1: Adapting To Chronic Kidn E Ydisease Experiment (Sackett And Torrance) •Design: Surveyed People On The Quality Of Life (On A Scale Of 0 To 1) Before And After Chronic Kidney Disease •Results: Predicted Quality Of Life 0.32. Actual Quality Of Life 0.52 Experiment (Ubel Lowenstein And Jepson) •Design: Did The Same Survey But Asked People To Think About How They Might Adapt •Results: The Gap Between Predicted And Actual Quality Of Life Decreased. Example 2: Choosing A College Basedon Weather Finding (Simonsohn) Design: Looked At Matriculation Decisions To An Elite School Based On Weather Of The Day Of Visit. Results: Increased Cloud Cover By 1 Point On A Scale Of 1 To 10 Increases Matriculation By 0.02 To 0.03 Argues It Is Because Sunny Days Makes People Aware Of The Lack Of Recreational Activities. . Making Decisions For Our Future Self : Projection Bias Projection Bias Supposes That Individuals Believe They Will Value Options In The Future The Way They Value Them Today. Making Decisions For Our Future Self: Projection Bias (Con't) • At The Elite School - U(Recreate Prestige, Sunny)>U(Study/Prestige, Sunny) • U(Recreate Prestige, Cloudy)<U(Study/Prestige, Cloudy) Making Decisions For Our Future Self: Projection Bias (Con't) - At A Party School - U(Study/Party, Sunny) < U(Recreate/Party, Cloudy)<U(Study Party, Cloudy)< U(Recreate/Party, Sunny) Projection Bias Utility • Assume L Of All Days Are Sunny And 72 Arecloudy N U(Prestige) = Zu(Studylprestige, Cloudy) + 2? Fu(Recreate Prestige, Sunny) . The Nu(Party) = Zu(Study Party, Cloudy) +Żu(Recreate|Party, Sunny) • And N N N • We Can Use These To Derive Conditions Onwhich School Is Better. Projection Bias Utility (Con't)) That Is How A Rational Agent Would Decide. However, A Projection Biased Agent May Decide Based Only On The Day Of The Visit, Comparing - Nu(Study/Prestige, Cloudy) With Nu(Study Party, Cloudy) Or - Nu(Recreate/Prestige, Sunny) With Nu(Recreate|Party, Sunny) Or - Ample 1: Shopping While Hungry Experiment (Gilbert, Gill, Wilson) Design: Asked Shoppers At A Grocery Store What They Intended To Buy. Some Were Given A Muffin Before Shopping, Others Were Given The Muffin To Eat After Shopping Results: Receipts Were Collected. Those Who Were Hungry Made 51% Unplanned Purchases Compared To The Not-Hungry Group (34%). Example 2: Impulse Buyi Ng An Dcatalog Purchases Finding (Conlin, O'donoghue, Vogelsang) Design: Looked At 2 Million Catalog Sales Of Cold, Snowy, Rainy Gear. Results: If The Temperature Is 30 Degrees Cooler, Then Are 4% More Likely To Return It When They Receive It. Similarly, More Snowfall Leads To A Higher Probability Of Returning Snow Gear. Role Of Emotions And Visceral Factorsin Choice Lowenstein Calls Visceral Factors Emotions (Embarassment, Fear, Anger, Jealousy, Etc.) As Well As Physical Feelings (Hunger, Weather)That Affect Choice. - We Say Someone Is In A Hot State When Avisceral Factor Is Active. And In A Cold Statewhen It Is Not. • Projection Bias Causes A Hot-Cold Empathygap. Example 3 Raging Suburban Mothers • A Case Of Road Rage Between Two Suburban Mothersthat Ends With A Shooting. • A Fight Between Two Brothers That Quickly Escalates. Both Examples When A Time-Out Would Be Helpful. Itwould Have Helped In Bringing The Parties Involved Back Down To Their Cool State. Questio Nwhat Other Examples Of The Hot-Cold Empathy Gap? What Other Policy Recommendations . Example 4: An Obvious Pitch In Order To Receive A Patent, It Must Be Non-Obvious (Consider The Recent Patent For "The Refreshing Of Bread Through The Application Of Heat" (I. E. Toast)) Experiment (Mandel) •Design: Asked Law Students If A Patent Idea For Teaching Baseball Pitches Was Obvious. One Group Was Told The Solution And Then Asked. The Other Was Asked And Then Told The Solution. •Results: 76% Who Were Told The Solution First Thought It Was Obvious Compared To 24% Of The Other Group. Hindsight Bias And Th E Curse O Fknowledge • Hindsight Bias Is Like Projection Bias, But Insteadof Predicting The Future, It Is The Bias Of Remembering What My Beliefs Were In The Past. Related, Is The Curse Of Knowledge, People Think Other People Have The Same Knowledge As Mysel - I. E. This Is Often Experienced In A Classroom, Where Arexperienced Professor Fails To Explain Concepts To The Students Assuming That Students Already Know The Concept. . Ha Experiment On Hindsight Experiment (Camerer, Loewenstein, Weber) -Design: Participants Were Asked To Predict Company Stock Performance. Some Were Given The Actual Performance Of Those Companies. All Were Asked To Predict The Predictions Of Others. •Results: Those Who Knew The Actual Performance Based Their Predictions On The Actual Performance, And Therefore Did Worse. Hp Hapter 12: Naïve Procrastination Fhce 4270E 6270E A Taxing Problem Most Us Taxpayers Have All The Forms They Need By Mid February, Yet Every Year 40 Million Wait Until The Very Last Week Before They Are Due On April 15Th Why? Food Stamp Findings <Periment (Usda) Design: Randomly Assign Some People To Food Stamps Ome People To Cash Result: People On Food Stamps Ate 100 To 200 More Alories. Contradicting The Fact That People On Food Camps Still Supplement With Cash. Inding (Parke And Ranney) Design: Studies Patterns Of Eating Over A Month Result: People Spent $5 Per Day In The First Two Days, In Ontrast With $2 For The Rest Of The Month. Calories Drop Y 10% In The Last Week. Modeling Food Stamps Since People Should Optimally Equalize Marginal Utility Across Days, Optimal Consumption Across Two Days J And K Should Be Relatively Close. (Although The Further Apart The Two Days Are, The Greater The Consumption In The Earlier Day.) Consuming The Same Across Days Is Called Consumption Smoothing. Using The Model Experiment (Thaler) Would You Rather Have One Apple Today Versus Two Tomorrow? Would You Rather Have One Apple In A Year Versus Two Apples In One Year And One Day? Under The Stationarity Property, Both Should Just Depend On 8. •Compareu(1) > Su(2) Hence Majority Chose The Apple Today Versus(1) > Slu(2) Which Reduces To The Same Thing. But Since A Year Is Such A Long Time, People Appeared To Be More Rational When Making A Long Term Decision And Chose The Two Apples After One Year And One Day' Instead Of Choosing One Apple 'A Year From Today! Re Onciling Discounting In Gains Versuslosses • The Data Suggests That People On Average Are Indifferent - Age Of $40 Togey End 52 Ma Year - A Loss Of $40 Toney And A Loss Of Stema Year These Two Imply Afterent Empirical Discount Rates Fon Gains • Perhaps This Could Be Explained By Diminishing Marginalutility • But Diminishing Marginal Utility Would Predict The Opposite Therefore, We Conclude People Discount Future Losses Lessthan They Discount Future Gains. Example: Now Or Later Experiment (Loewenstein) •How Much Would You Have To Be Paid To Not Use A $100 Gift Certificate For 6 Months- The Average Was $23.85 •How Much Would You Pay To Get A Gift Certificate You Would Be Getting In 6 Months, Now- The Average Was $10.17 Example: Now Or Later (Con't) •In A Fully Addictive Mode, These Two Should Be Equivalent. Thus We Have Asymmetry. Chapter Su Mmary: Naïv Eprocrastination If Our Discount Factor Declines With Time, Then We Will Procrastinate. Models Of Procrastination Can Be Combined With Prospect Theory To Account For Differences In Discounting Gains Versus Losses. (Hp Other Findings • People Generally Procrastinate When Theyhave To Make An Important Decision Based On Asymmetric Or Incomple Te Informatio Nnot Because They Are Lazy Mental Inertia Or Status Quo Bias Also Plays A Role In Peoples' Procrastination To Make A Decision Especially If The Outcome May Have Significant Consequences Gambling Vs. Speculation, Framing Effects And Salience Module 5 Recap From Day 1 Anchoring • Status Quo & Endowment Effec Tchoices & Default Effect • Narrow Framing: $10 Bil L & Theater T Icketexample Gambling Speculation Gambling • There May Be A High Probability Of Losing Themoney, And A Low Probability Of Winning • The Gambler Is Always At A Slight Disadvantage Because The Agency Ensures That In The Long Run, It Profits Speculation Speculation Is Taking A Calculated Risk - You May Speculate That If You Buy A Certainstock, Its Price Will Increase. Gambling Or Speculation • You Offer $122 For A Stock Of Mgm Mirage? • You Offer $122 To Play In A Slot Machine I Nmgm Mirage? The Assumpt Ions Of Utility Drive Neconomics - An Individual Will Only Speculate If Theexpected Utility Of Outcome Is Greater Than The Utility Derived From Holding Current Assets Alone • All Individuals Are Rational And Informed • Risk Averseness Prospect Theory - Daniel Kahnema Namos Tversky - Econometrica (1979) Examples Of Rationality Example 1: 53% Chance To Win $2500 56% Chance To Win $2400 % Chance Of Winning $0 B Sure Income Of $ 2400 Example 2 А A - 33% Chance Of Winning $2500 - 67% Of Winning $0 • B • 34% Chance Of Winning $240066% Chance Of Winning $0 Example 3 A $4000 (80% Chance) $0 (20% Chance) - В$3000 - 100% Chance Hp A Example 4 20% Chance Of Winning $4000 80% Chance Of Winning $0 - В - 25% Chance Of Winning $3000 - 75% Chance Of Winning $0 Reflection Effect Example 5: A 33% Chance To Losing $2500 66% Chance To Losing $2400 1% Chance Of Losing $0 B Sure Loss Of $ 2400 Example 6 • A33% Chance Of Losing $2500 • 67% Of Losing $0 • B • 34% Chance Of Losing $240066% Chance Of Losing $0 Op Example 7 • A • $4000 (90% Chance) • $0 (10% Chance) • B$6000 45% Chance Ор) Example 8 • A • .002% Chance Of Losing $3000 • B • .001% Chance Of Losing $6000 O The Certainty Effect Problem 1: 82% Chose B • Problem 2: 83% Chose A • Problem 3: 80% Chose B . Problem 4: 65% Chose A The Reflection Effect Problem 5: 82% Chose A Problem 6: Indifferent • Problem 7: 80% Chose B • Problem 8: 70% Chose A Loss Behavior Is A Mirror Image Of Gain Behavior The Isolation Effect • In A Two Stage Game Following Are The Possibleoutcome Options: • Stage Ia Probability Of 75% To End Game Without Reaching Secondstage. A 25% Probability Of Reaching Second Stage • Stage 2- (4000,80%) Or (3000,100%) Choice Must Be Made Before The First Stage Has Began . Revisit Example 4 - Α - 20% Chance Of Winning $4000 - 80% Chance Of Winning $0 • B • 25% Chance Of Winning $3000 • 75% Chance Of Winning $0 Calculation Chance To Win $4000: - .25*.8=20% - Chance To Win $3000 ? - .25*1.0= 25% What Is Isolation Effect? People Disregard The Similarities And Focus On Differences Between The Choices When Making A Decision Real World Consequence - When Investing In Stocks, People Often Focus Onthe Past Performance Of The Company, While Completely Ignoring The Performance Of Its Industry Or The Economy Implications For Risk - Risk Aversion In The Domain Of Likely Gains - Risk Seeking In The Domain Of Unlikely Gains - Risk Seeking In The Domain Of Likely Losses - Risk Aversion In The Domain Of Unlikely Losses Summary • Risk Averse In Gains; Risk Taking In Losses A Person Facing The Prospect Of A Loss Is More Likely To Take Gambles, Otherwise Unacceptable • Prospect Curve More Hyperbolic Than Concaveas Suggested By Utility Theory • Must Reads Applications Prospect Theory In The Wild: Evidence From The Field (Camerer, 1998) Pplications Of Prospect Theory In Rea Lworld Assumption Of Selfis H Profit Maximizing Householdreality: Negative (Kahneman, 2003) - Rational Ity - Reality: Not Always T Ruein A Survey Of Investors, All Traders Believe They Areabove Average (Odean, 1998) • Traders Are Myopic And Loss Averse (Benartzi & Thaler,1995) O Applications Equity Premium (Benartzi & Thaler, 1997) - Stocks Have More Price Changes (Are More Volatile) Thanbonds - To Compensate For This Risk, The Average Return On Stocksare Higher - The Premium Is Disproportionately High Prospec T Theory Explains This Conundru Minvestors Dislike Loss - Investors Prefer Short Time Horizons - In Short Time Horizons Stocks Are More Volatile - To Compensate For This The Prospect Return Of Stocks Andbonds Will Be Equal Only If Stocks Return 8% More Than Bonds Applications Stock Market Vs Housing Market(Case, Quigley & Shiller, 2001) Households View Wealth In Different Asset Classes Differently Households Assign Greater Utility To Wealth Thanwealth Households With Higherwealth Demonstrate Greater Consumption. Applications Disposition Effect (Shefrin & Statman, 1985) - Investors Take Risky Positions To Get Rid Of Theirlosses - This Drives Them To Hold On To Loss Making Stocks Fortoo Long - Investors Are Risk Averse In Gains - This Causes Them To Sell Stocks Too Early Applications New York City Cab Driver Experiment (Camerer, Babcock, Loewenstein & Thaler, 1998) - Drive Long Hours On Bad Days• Thus Lowering Their Wage/Hr Rate And Burning Up Gas. • Waste Resources On A Down Day• Risk Taking In Loss - Drive Till They Have Made Up Their Target Income• Drive Short Hours On Good Days • Selling Out Too Early Applications Status Quo Bias (Samuelson & Zeckhauser, 1988) Harvard Health Care Plan Harvard University Revamped Their Health Insurance Plan In The Late 1980S. The New Plan Had Greater Coverage And Less Expensive. The Older Faculty Still Preferred The Earlier Plan Sexaggerated Choice For Default Option (Status Qu O Effect) The Concept Of Salience O Rrecency Bias The Salience Or Saliency Of An Object Or Event Refers To Its Prominence In Our Perceptions Relative To Other Objects Or Events. Salience Is A Cognitive Consequence Of Framing Events Relative To Each Other. Behavioral Economists Such As George Akerlof [Nobel Prize 2002] Identify Salience Or Non-Salience As Reasons For Decisions To Be Less Than Perfectly Rational. Decision Makers Tend To Overemphasize Recent Events That Have Occurred With Greater Than Normal Frequency Or Amplitude, And Consequently Overweigh The Probability That Such Events Will Recur, While Placing Inadequate Weight On The Likelihood Of Events That Have Recently Occurred Less Frequently Or Less Intensely Than Usual. Salience Imagine A Disease Is Expected To Kill 600 People - Und Er Program A, 200 People Will Be Save Dunder Program B, There Is A 1/3 Probability That 600 People Will Be Saved And A 2/3 Probability That Nopeople Will Be Save D - Under Program C, 400 People Wil L Dieunder Program D, There Is A 1/3 Probability That No One Will Die And A 2/3 Probability That 600 People Willdie 72% Prefer A To B And 78% Prefer D To C Heuristics In Decision Making Thinking Through Every Alternative For Complex Economic Decisions Is Difficult Many Rely On Simple Heuristics (Mental Shortcuts) That Ha Ve Served Well In The Past Example: Savin Gin Financial Planning Finding The Best Rate Of Savings Involves Complex Calculations In Practice People Seem To Follow Conventional Rules Such As 10% Of Income These Rules Appear To Ignore Factors That Theory Says One Should Consider Factors Such As Expected Future Income 13-34 Heuristics Continued Popular Rules May Be Choices That Are Nearly Optimal, Using One Is Not Necessarily A Mistake Maximizing Vs. Satisficing Example Individual Vs. Group Managed Mutual F Unds Rate Of Time Preference & Intertempora Ldecision Making When Making Financial Decisions Involving Different Points In Time, Individuals Demonstrate Several Patterns Of Behavior In Their Financial Decision Mak Ingpreferences Over A Set Of Alternatives Available At A Future Date Are Dynamically Inconsistent If The Preferences Change As The Date Approaches The Sunk Cost Fallacy Is The Belief That, If You Paid More For Something, It Must Be More Valuable To You Projection Bias Is The Tendency To Evaluate Future Consequences Based On Current Tastes And Needs High Rate Of Time Preference Thought To Reflect A Bias Towa Rd Immediate Gratification, Know As Present Bia Sa Person With Present Bias Often Suffers From Lapses Of Self-Control Laboratory Experiments Have Documented The Existence Of Present Bias Precommitment Is Useful In Situations In Which People Don't Trust Themselves To Follow Through On Their Intentions Pre Commitment Is A Choice That Removes Future Opti Onsexample: A Student Who Wants To Avoid Driving While Intoxicated Hands His Car Keys To A Friend Before Joining A Party The Other Side Of Pre-Commitment Table 13.6 The Cost To Members Of Going To The Gym Months After Enrollment 1 2 3 4 5 6 Nonmembers Average Priceper Month $55.1 $30.5 $700 $81.7 $81.9 $81.9 Average Attendanceper Month 3.45 5.45 4.97 4.61 4.43 4.32 Average Priceper Visit $16.0 $14.8 $14.1 $12.7 $18.5 $18.9 $10 Scurce: Stefano Della Vigna And Utrike Malmedier, Paying Not To Go To The Gyn," American Econorte Review 99, Jane 2006. Pp. 694-719 Projection Bias In Forecasting Futuretastes And Needs Hungry Shoppers Tend To Buy More Than Sated Shoppers When Shopping For The Week Ahead Sunk Costs Table 13.7 Effect Of Sunk Costs On Theater Attendance Season Ticket Discount None S2St Difference Statistically Significant? Attendance, First Plays 3.32 329 Yes Attendance, Last 5 Plays 2.28 1.84 2.18 No Source: Hal. Artes And Catherine Blumet "The Psychology Of Sunk Cost," Organizational Betuvior And Marsan Dech Sion Process 35. February 1985. Pp. 124-149. The Subjects Were Season Ticket Holders For The Ohio University Thastot Trouble Assessing Probabilities Repend Make Specific Errors In Assessing Prebabilitieseng Olacy Is The Belief That Once An Event Has Oc Curred Several Pimesinaronitis More Likely To Repea Taries When People Can Easily Invent Explanations For Streaks, Eg, Basketball Come Qulacy Is The Belief That Once An Event Has Occurred It Is Less Arise When People Can Teasily Invent Explanations For Streaks Ego State Balacies Have Important Implications For Financial Planning Behavior, Est Dear Relevant In Context Of Investing Drengendence Causes People To: - Orerstand The Likelihood Of Favorable Events - Ungerstate The Uncertainty Involved Gambler's Fallacy A Study Of Nearly 1800 Daily Drawings Between 1988 And 1992 In A New Jersey Lottery Showed That After A Number Came Up A Winner, Bettors Appeared To Avoid It Overconfidence In One Study Of Us Students With An Average Age Of 22, 82% Ranked Their Driving Ability Among The Top 30% Of Their Age Group In The Manufacturing Sector, More Than 60% Of New Entrants Exit Within Five Years; Nearly 80% Exit Within Ten Years Low Probability Events Grab All Theattention Option A: Win $2,500 Option B: Win $5,000 With 1/2 Probability Most Choose Option A Over B, Suggesting Riskaverse Preferences Option C: Win $5 Option D: Win $5,000 With 1/1000 Probability A Sizable Majority Picks Option D Over C, Which Is Puzzling Because The Choice Sug Gests Risk-Loving Preferences Framing - Framing Effectsframing Is The Combination Of Beliefs, Values, Attitudes, Mental Models, And So On Which We Use To Perceive A Situation. Kahneman And Tversky Defined A Decision Frame As 'The Decision-Maker's Conception Of The Act, Outcomes And Contingencies Associated With A Particular Choice.' When Would A Person Trust Her Or His Money With This Financial Planner? The Financial Planner Tells Them "90% Of His Clients Have Increased Orretained Their Wealth After 5 Years And Met Their Financial Goals." - "10% Of Patients Lost A Huge Chu Nk Of Their Fortune In 5 Years." Framing Framing Effect Sframing Is The Combination Of Beliefs, Values, Attitudes, Mental Models, And So On Which We Use To Perceive A Situation. Kahneman And Tversky Defined A Decision Frame As 'The Decision-Maker's Conception Of The Act, Outcomes And Contingencies Associated With A Particular Choice. When Would A Person Trust Her Or His Money With This Financial Planner? The Financial Planner Tells Them "90% Of His Clients Have Increased Or Retained Their Wealth After 5 Years And Met Their Financial Goals." "10% Of Patients Lost A Huge Chunk Of Their Fortune In 5 Years." Prospect Vs. Expected Utility Theory Expected Utility Theory Suggests That Individuals Can Determine Expected Values Of Risky Prospects And Make Choices Consistent With Utility Maximization, Prospect Theory-People Are Not Good Intuitive Statisticians - Furthermore, People Often Behave As If Extremelyunlikely, But Still Possible, Outcomes Have No Chance Whatsoever Of Occurring. Perceptual & Contrasting Effects When We Make Decisions, We Tend To Do It By Contrasting Between The Decision Item And Reference Items. When Two Things Appear Close To One Another, We Will Tend To Evaluate Them Against One Another More Than Against A Fixed Standard. - To Make Something Look Good, First Showsomething Of Inferior Quality. Or, To Get Someone To Buy Something Expensive, First Show Them Something Even More Expensive. Time Inconsistency Hyperbolic Discounting-People Generally Prefer Smaller, Sooner Payoffs To Larger, Later Payoffs When The Smaller Payoffs Would Be Imminent; But When The Same Payoffs Are Distant In Time, People Tend To Prefer The Larger, Even Though The Time Lag From The Smaller To The Larger Would Be The Same As Before. When Given A Choice, Some People Would Prefer $50 Today To $100 One Year From Now, But Would Choose $100 Six Years From Now Versus $50 Five Years From Now. Time Inconsistency Lots Of People Want The Irs To Withhold More Than They Owe In Taxes So They Get A Big Refund Check. This Behavior Amounts To Giving The Irs An Interest Free Loan. School Teachers Who Work 9 Months Are Given The Option Of Receiving Their Salary Over 9 Months Or Over 12 Months. Many Choose The 12 Monthly Checks Because They Don't "Trust" Themselves. They Lose Interest Income. Recency Bias Pay More Attention To Newsworthy Events People Often Rate The Chance Of Death By Plane Crash Higher After Plane Crashes, And Death By Natural Disaster As Too Likely Only Because These Events Are Reported More Often Than Common Causes Of Death. People Tend To Believe That Stocks Of Corporations That They Are Familiar With Are Better Confirmation Bias Confirmation Bias-People Look For Examples And Anecdotes That Confirm Their Prior Beliefs. After People Buy A New Car They Eagerly Read The Advertisements For That Car - The Ads, Of Course, Confirm That Their Purchase Was A Good One Self-Control & Availability Bias Fhce 4270E And 6270E Defining Self-Control Restraint Exercised Over One's Own Impulses, Emotions, Or Desires Is It Important? Self-Control • Self-Esteem - A Feeling Of Having Respect For Yourself And Yourabilities Self-Efficacy - An Individual's Belief In His Or Her Capacity To Executebehaviors Necessary To Produce Specific Performanceattainments Self-Regulation - The Ability To Act In Your Long-Term Best Interest, Consistent With Your Deepest Values. . Self-Control Why Do We Lack Self-Control: - Hyperbolic Disc Ounting - Availability Bias Discounting & The Rate Of Tim Epreference • Being Happy In The Present (Today, This Week, This Year) Is Typically More Desirable Than The Prospect Of Being Happy In The Future(Tomorrow, Next Week, Next Year) • The Discount Rate Is The Additional Futurehappiness That Can Compensate For The Loss Of One Unit Of Happiness In The Present - Assuming Happiness Is Measurable Example For Bob, Suppose The Loss Of One Unit Of Present Happiness Can Be Compensated By The Gain Of 1.07 Units Of Future Happiness - Bob's Discount Rate Is 0.07 For Alice, Suppose The Loss Of One Unit Of Present Happiness Can Be Compensated By The Gain Of 1.02 Units Of Future Happiness - Alice's Discount Rate Is 0.02 Who Is More Patient, Alice Or Bob? Discounting Higher The Discount Rate, More Important The Present Is To An Individual (Relative To The Future) - Individuals With Higher Discount Rates Are Usuallymore Impulsive And Impatient Inconsistent Discounting Typically, When We Are Making Financial Plans About Future, We Are Patient - Our Discount Rates Are Low But When The Future Finally Arrives, We Become Impatient And Change Our Plans - Our Discount Rates Spike This Phenomenon Is Called Hyperbolic Discounting Or Time Inconsistency Consequence Of Hyperboli Cdiscounting When We Think About What Our Future Financial Savings Plan, We Tend To Make Well Thought Out Plans But When The Future Finally Arrives, We Give In To Other More Immediate Impulses And Abandon The Savings Plans We Had Made The Cell Phone Question Iphone 6 Plan Unlimited Ta Lk & Text, 5Gb Of Data • Verizon Options : - Postpaid- $199 Fo R Iphone 6, $80 A Month - Prepaid- $649 For Iphone 6, $40 A Month Save More Tomorrow Benefiting From Hyperbolic Discounting 20,000 Participants Wanted To Save Mor Ea: Employer Suggest All Employees To Save Additional 7% Of Inc Omeb: Employe R Suggest Employees Save 8% When They Get At 15% Raise Results Begi Nningnon Smart: 6.6% • Smart: 3 .5% Endnon Smart: 6.6% • Smart: 13.6% . Mancial Consequences Of Hyperboli Cdiscounting Excessive Spending, Inadequate Saving Especially For Retirement), Bankruptcy, And Debt Default Nadequate Personal Investment In Education National Neglect Of Investment On Infrastructure Public Education, Scientific Research Excessive National Spending On Trivial Issues That Have Immediate Appeal Financial Consequences Of Hyperboli Cdiscounting Excessive Spending, Inadequate Saving (Especially For Retirement), Bankruptcy, And Debt Default Inadequate Personal Investment In Education National Neglect Of Investment On Infrastructure, Public Education, Scientific Research Excessive National Spending On Trivial Issues That Have Immediate Appeal The Credit Card Offers: • Borrowers Were Offered Two Types Of Credit Card Contracts. Lew Teaser Interest Rate For First Six Months, Followed By High Interest Rate After The First Six Month Shigher Rate, Followed By Lower Post Teaser Rate • Interest Rate: 1% For 6 Months, 23.95% • Interest Rate: 8.5% • Borrowers Went For The First Contract Even Though, Giventheir Borrowing Behavior, They Would Have Been Better Off With The Second • Ausubel, Lawrence M. 1999, "Adverse Selection I N Thecredit Card Market." . . Availability Bias When An Event Is Easier To Recall, More Importance Is Assigned To It People Remember Painful Experiences More Investors' Perceptions Are Biased By Personal Experiences That Likely Represent Only A Fraction Of The Complete Economic Picture Example: A Person Whose Home Has Lost 20% Of Its Market Value And Whose Spouse Endured A Long Period Of Unemployment Is Less Likely To See Or Feel An Economic Recovery Even While Housing Markets Show Signs Of Recovery And Unemployment Falls. Someone Who Just Landed A Great Job Would Be Inclined To See That As Proof The Economy Is Recovering Those Who Grew Up In The 1930S And 40S Are More Frugal But Very Risk Averse In Their Investment Decisions Many Individuals Continue To Stay Away From The Stock Markets After Losing Money In 2008. Decision Fatigue The Deteriorating Quality Of Decisions Made By An Individual, After A Long Sessionof Decision Making • Understood As One Of The Causes Of Irrational Trade-Offs In Decision Making. Baumeister, Roy F (2003), "The Psychology Of Irrationality", In Brocas, Isabelle; Carrillo, Juan D, The Psychology Of Economic Decisions: Rationality And Well-Being, Pp. 1-1 Example 1 Group Memorizing 2-Digit Number Chose Chocolate Cake41% Of The Time Group Memorizing 7-Digit Number Chose Chocolate Cake63% Of The Time Decision Fatigue • What The Judge Ate For Breakfast? • In Sequential Parole Decisions Made Byexperienced Judges. We Record The Judges' Two Daily Food Breaks, Which Result In Segmenting The Deliberations Of The Day Into Three Distinct "Decision Sessions." We Find That The Percentage Of Favorable Rulings Drops Gradually From -65% To Nearly Zero Within Each Decision Session And Returns Abruptly To -65% After A Break. My Mih Orainal Position Fig. 1. Proportion Of Rulings In Favor Of The Prisoners By Ordinal Position. Circled Points Indicate The First Decision In Each Of The Three Decision Ses Sions Tick Marks On X Axis Denote Every Third Case: Dotted Line Denotes Food Break Because Unequal Session Lengths Resulted In A Low Number Of Cases For Some Of The Later Ordinal Positions The Graph Is Based On The First 95% Of The Data From Each Session National Academy Of Sciences - Danzier, Levax Pesso, Kahneman Flexing Our Self Control • Pre-Commit • Use Rewards • Use Penalties • Reward Substatio N • The Self-Control "Tank" Hp Flexing Our Self Control Sleeping In • Clocky Hp Sel Fcontrol App • Self Control App For Mac Os X - Lets You Block• Access To Distracting Websites • E-Mail Servers • Or Anything Else On The Internet • Set A Time And Push "Start"

Preference Formation, framing, and default option

Contrary to traditional economics which assumes preferences are rational, in fact people may make choices that appear irrational or 'biased'. The default option fills the void when a person is confused about making a decision Experiment (Ariely, Lowenstein, Drazen) •Design: Students were asked to write down the last two digits of their SSN. They were presented with various items with a retail price around $70 (like a bottle of wine). They were first asked whether they would pay more or less than those two digits. Then they were asked using a random device, what they would actually be willing to pay (WTP) •Finding: Students WTP were higher for students with higher SSN •Since SSN are likely to be random, students were likely anchoring and adjusting

Self-control, Hyperbolic Discounting, and Decision Fatigue

Defining Self-Control:Defining Self-Control •Self-Esteem -A feeling of having respect for yourself and your abilities •Self-Efficacy -An individual's belief in his or her capacity to execute behaviors necessary to produce specific performance attainments •Self-Regulation - The ability to act in your long-term best interest, consistent with your deepest values. •Why do we lack self-control: -Hyperbolic Discounting -Availability Bias •Higher the discount rate, more important the present is to an individual (relative to the future) -Individuals with higher discount rates are usually more impulsive and impatient •Typically, when we are making financial plans about future, we are patient -our discount rates are low •But when the future finally arrives, we become impatient and change our plans -our discount rates spike •This phenomenon is called hyperbolic discounting or Time inconsistency Consequence of Hyperbolic Discounting: •When we think about what our future financial savings plan, we tend to make well thought out plans •But when the future finally arrives, we give in to other more immediate impulses and abandon the savings plans we had made Financial Consequences of Hyperbolic Discounting: •Excessive spending, inadequate saving (especially for retirement), bankruptcy, and debt default •Inadequate personal investment in education •National neglect of investment on infrastructure, public education, scientific research •Excessive national spending on trivial issues that have immediate appeal •The deteriorating quality of decisions made by an individual, after a long session of decision making •Understood as one of the causes of irrational trade-offs in decision making. • •In sequential parole decisions made by experienced judges. We record the judges' two daily food breaks, which result in segmenting the deliberations of the day into three distinct "decision sessions." We find that the percentage of favorable rulings drops gradually from ≈65% to nearly zero within each decision session and returns abruptly to ≈65% after a break.

Reciprocity

Fehr and Gachter point out subtle things create trust •A waitress who smiles gets more tips •A supermarket that gives free samples gets more business •Here, fairness is defined as rewarding intentions to be kind and punishing intentions to be cruel. •Reciprocity rewards actions that are kind and punishes actions that are cruel. • •The legal code often has punishments for bad behaviors even if intentions were not. •Consider the case of open source software •Or crowdsourcing and wikipedia -Wikipedia for example provides information for free to its readers -In reciprocity wikipedia receives generous donations from people who support wikipedai, whitout which wikipedia would not be able to exist as a free open resources

The Role of a Reference Point

Finding (Frank) •Design: •Scenario A: You save enough to support a comfortable standard of living in retirement, but as a trade-off your children have to attend a school whose students score in the 20th percentile on standardized tests in reading and math •Scenario B: You save too little to support a comfortable standard of living in retirement, but as a trade-off your children attend a private school whose students score in the top 80th percentile on standardized tests in reading and math.

Happiness

Findings (Easterlin Paradox) •High correlation with income within countries, but low correlation with income across countries. Suggesting that it's the relative ordering within a country that matters more than total money •People are happy with low income as long as their friends and neighbors also have low income, but people become unhappy when they earn less relative to their immediate social group that they identify with Findings •A woman's decision to work is highly correlated with the difference between her brother in law's income and her own husband's income.Question: what does this mean?

Status Quo Bias

Findings (Samuelson and Zeckhauser) •When new insurance plans were introduced at Harvard, only 3% of employee would switch each year, but new employees were very likely to adopt the new plans Rational Explanations for Status Quo Bias •Switching Costs •Exploration Costs •Aversion of the unknown

Selfishness and Altruism

For simplicity, most economic models assume that rational humans care only about their own well being. -But then how does this explain altruism, volunteerism, and other socially generous behavior that several of us participate in and enjoy? -Practically, we define altruism as behavior that aids others for no apparent practical gain.

Hindsight Bias

Hindsight bias is like projection bias, but instead of predicting the future, it is the bias of remembering what my beliefs were in the past •Related, is the curse of knowledge, people think other people have the same knowledge as myself. -i.e. This is often experienced in a classroom, where an experienced professor fails to explain concepts to the students assuming that students already know the concept. Experiment (Camerer, Loewenstein, Weber) •Design: Participants were asked to predict company stock performance. Some were given the actual performance of those companies. All were asked to predict the predictions of others. •Results: Those who knew the actual performance based their predictions on the actual performance, and therefore did worse.

Projection Bias; Sunk costs

Hungry shoppers tend to buy more than sated shoppers when shopping for the week ahead

Mental Accounting Definition

Mental Accounting describes how people simplify the decisions they need to make in life by separating choices into different "accounts" in one's head Related to sunk costs. • Mental Accounts can explain: 1.How income sources affect spending 2.How individuals rationalize bad investments How individuals group events to "balance" accounts 1.Decisions are made as if the budget for different mental accounts are not fungible 2.Losses and Gains relative to a reference point in each account are treated differently according to a value function 3.Individuals receive transaction utility as well as consumption utility •The principle of double-entry accounting is that for every credit to an account, there must be a corresponding debit Similarly in mental accounting, for every credit (to say the food account in the case of food stamps) there must be a corresponding debit (from the food account only

Modules 1-3

Mer 2021 - Profile 1 - Microsoft Edge Fullscreen/35402475/View Module1: Rationality, Irrationalityand Rationalization Textbook Chapter 1 Summer 2021 - Profile 1 - Microsoft Edge 575/Fullscreen/35402475/View Defining Behavioral Economics Definition: Economics Is The Study Of How Resources Are Allocated Given Unlimited Wants Definition: Behavioral Economics Is The Focus Of How Decision Making Resources Are Allocated - Behavioral Economics Focuses O Nsystematic Deviations From The Best Possible Decision - How Observed Behavior Impacts Financial Decisionmaking - The Psychology Behind The Mistakes We Make Whenthe Outcome Is Not Known Immediately. Summer 2021 - Profile 1 - Microsoft Edge 7575/Fullscreen 35402475 View Behavioral Economics And The Ration A Lchoice Model • Rational Choice Model And Utility Theory Aretraditional Microeconomic Theories, Whichposit How People Should Behave. • Behavioral Economics Identifies Thesystematic Deviations From The Rational Choice Model, When Individuals Make Decisions. O Bi Oa W Doll Mmer 2021 - Profile 1. Microsoft Edge 5/Fullscreen/35402475Niew Uses Of Behavioral Economics 1. Behavioral Economics May Be Used Therapeutically Tohelp People Make Better Decisions. A) Example 1: Financial Planners And Financial Counselors Canuse Tools And Techniques Learned From Behavioral Economicsin Helping Clients Make Better Financial Decisions. B) Example 2: Financial Therapists Can Help Clients, Experiencingstress And Anxiety From Their Financial Situations, Improvetheir Overall Subjective Well-Being. 2. Behavioral Economics Provides Students And Scholarswith A Better Understanding Of How Our Society Functions. 3. Alternatively, Corporations And Marketers In The Businessof Selling Goods And Services To Consumers, Can Use Concepts From Behavioral Economics Strategically To Exploit Consumer Biases And Increase Profits And Sales. 07 Doll 2021 - Profile 1 - Microsoft Edge Llscreen/35402475Niew Three Types Of Economic Models . Rational . Behavioral . Procedurally Rational 03 W 9 Doll 2021-Dile Microsoft Edge 5/3540247Snw. Questioning The Assumptions Of Th Erational Model We Typically Assume That People Are Well Informed, And Have Stable Preferences But Then What Is The Role Of Advertising? - People Try To Make The Best Possible Choice Withinthe Constraints Of Their Human Capital And Mental Capacity At That Point In Time (Rational Thinking) But We All Have Made Choices We Regret (Like Studying For A Test Or Eating An Unhealthy Dessert) [Deviation From Rational Thinking] 9 71°F Lan For Fam Summer 2021 - Profile 1 - Microsoft Edge Tent/2307575/Fullscreen/35402475Niew Arch Why We Should Care. • If We Care About The Motivation Of Thefinancial Decision Maker Behind A Certainfinancial Choice Or Decision. • If We Want To Understand Why People Makemistakes And How We Can Improve Their Financial Decision Making. Wl Summer 2021 - Profile 1 - Microsoft Edge 575/Fullscreen 35402475Niew Behavioral Economics In The Real World People Have Argued That Behavioral Economics Is Less Relevant For Firms And Businesses Because Competition Pressures Firms Into Being Disciplined, And Firms That Make Systematic Mistakes Are Forced To Exit The Market. However Studies Have Shown That The Ceos Of Corporations, And Money Managers In Wall Street Are Also Prone To The Same Behavioral Economic Biases As The Rest Of Us. . Example Of Related Research Findings: Malmendier, U., & Tate, G. (2015). Behavioral Ceos: The Role Of Managerial Overconfidence. Journal Of Economic Perspectives, 29(4), 37-60. And Corporate Leaders And Mutual Fund Managers Often Make Cognitive Errors In Their Strategic Decision Making, Which Results In Losses For Shareholders, And Investors (In The Case Of Mutual Funds). Example Of Related Research Findings: Brown, N. C., Wei, K. D., & Wermers, R. (2014). Analyst Recommendations, Mutual Fund Herding, And Overreaction In Stock Prices. Management Science, 60(1), 1-20. . O Be 0 W Del 71°F Cle Or Fam Summer 2021 - Profile - Microsoft Edge 1/2307575/Fullscreen/35402475 View Bounded Rationality And Model Types • The Notion Of Bounded Rationality - Individuals Behave Rationality Within The Constraints Of Theircognitive Ability, And Mental Capacity At A Specific Point In Time. Individuals Simplify Their Problems Bynarrowing The Set Of Possible Choices, - Narrowing The Characteristics They Consider - Simplifying The Relationships Between Choices And Outcomes This Approach Is Called A Heuristic, A Simplification Of The Decision That Often Works In Simplifying Choices. Heuristics Can Often Lead To Erroneous Decision Making. O An To N Domm All Hotel Montage Tent2307575/Fullscreen 351075 View Ch Chapter Summary: Rationality, Irrationality And Rationalization I • Behavioral Economics Is Defined In Relationship Tcthe Conventional Rational Choice Model • The Rational Choice Model Has Normative Benefitsand Offers A Coherent Structure For Economicscience • Behavioral Economics Helps Better Explain Howpeople Actually Behave, And How Firms Can Take Advantage Of Human Biases. Doll Mer 2021 - Profile 1 - Microsoft Edge /Fullscreen/35402492 Niew Chapter 2: Transaction Utili Ty An Dconsumer Pricing O H Module 2 Slides Del 21 - Profile 1 - Microsoft Edge Feen/35402492Niew Chapter 2: Transaction Uti Lity An Dconsumer Pricing О Bi Oy W Module 2 Slides Summer 2021 - Profile 1 - Microsoft Edge 575/Fullscreen/35402492 View A Story Suppose You Just Spent $10 On A Movie Ticket, Walked In And Realized It Was Not The Comedy That You Expected. Instead, It's A Low Budget Slasher Horror Flic, All Things That You Hate. The Rest Of The Audience Walks Out In Disgust. But You Reason, Since You Paid $10 Already, You Are Going To Watch The Whole Thing Even If It's A Waste Of Time. • Questions To Ask Yourself: How Could You Justify Your Actions Using Standardeconomics? - What Else Might Be Going On? O Bi Om W] Or Fam Summer 2021 - Profile 1 - Microsoft Edge 2307575/Fullscreen/35402492/Iew The Principles Of Cost Benefit The Principal Of Cost Benefit Can Be Defined As: •A Choice Should Be Made If The Benefits Outweigh The Costs •If Multiple Options To Choose From, The Choice With The Highest Net-Benefit (Benefits Minus Costs) Should Be Taken Fam Summer 2021 - Profile 1 - Microsoft Edge 2307575/Fullscreen/35402492 View The Principles Of Cost Benefit(Con't) The Application Of This Principle Is Known As Cost Benefit Analysis (Cba) And Is Central To All Of Economics And Policy Analysis. •The Central Idea Of Equating Marginal Cost And Marginal Benefit (As In Supply And Demand) Can Be Thought Of As An Application Of Cba-So Long As Adding One More Unit Of Consumption Has A Higher (Marginal) Benefit Than The (Marginal) Cost Of Adding One Unit Of Consumption, One Should Continue To Consume More Fam Summer 2021 - Profile 1 - Microsoft Edge 307575/Fullscreen/35402492 Niew Chapter Overview: Transaction Utility And Three Behavioral Anomalies • Utility Is Typically Based On How Choices Affect Yourlifetime Wellbeing. • Behavioral Economics Has Noted That People Makechoices Based On Individual Interactions, Perceptions Or Experiences. This Is Known As Transactional Utility. Transaction Utility Can Explain Three Behavioralanomalies: 1. Sunk Cost Fallacy 2. Flat Rate Bias 3. Reference Dependent Preferences Fam Summer 2021 - Profile 1 - Microsoft Edge 2307575/Fullscreen/35402492/View Defining Transaction Utility Nobel Laureate Richard Thaler's Notion Of "Transaction Utility" Is Defined As: •The Utility One Receives For Feeling They Have Received Greater Value In A Transaction Than What They Have Given Away In Paying For The Good Mer 2021 - Profile 1 - Microsoft Edge /Fullscreen/35402492/View Sunk Cost Fallacy The Sunk Cost Fallacy Occurs When - An Individual Tries To Recover Sunk Costs By Continuingan Activity For Which There Is A Negative Return - I. E. Chasing Bad Money With Goo Dafter Losing Bet In A Casino, People Often Double Down On Their Bet, Hoping To Recover Their Loss. Sitting Through Watching A Terrible Movie, Just Because We Have Bought A Movie Ticket. Continuing To Invest In A Business That Has Been Making Loss, With The Hope That It Will Turn Around One Day. Ummer 2021 - Profile 1 - Microsoft Edge "5/Fullscreen/35402492/View Examples Of Sunk Cost Fallacies Richard Thaler, Gave The Following Two Hypothetical Examples Of The Sunk Cost Fallacy: •"A Family Pays $40 For Tickets To A Basketball Game To Be Played 60 Miles From Their Home. On The Day Of The Game There Is A Snowstorm. They Decide To Go Anyway, But Note That Had The Tickets Been Gifted To Them Instead, They Would Have Stayed Home."•Just Because They Paid For The Tickets They Decided To Go To The Game. But Consistent With Other Research Studies On Sunk Cost Fallacy, Were People To Receive These Tickets As Gifts From Someone, They Would Have Chosen To Return Home! •"A Man Joins A Tennis Club And Pays A $300 Yearly Membership Fee. After Two Weeks Of Playing He Develops A Tennis Elbow. He Continues To Play (In Pain) Saying 'I Don't Want To Waste The $300! Plan For Fam Summer 2021 - Profile 1 - Microsoft Edge Ntent/2307575/Fullscreen/35402492/View Example 1: Theater Tickets And Pricin Gprograms Experiment (Arkes And Blumer): •Design: Randomly Offered 60 People Different Prices For Theater Tickets. Some Received A $2 Discount. Others Received A $7 Discount. •Results: Those Who Paid The Higher Ticket Price Attended More Plays. Questions: •What Might Explain Their Results? •Why Is This An Example Of Sunk Cost Fallacy? •What Else Could Explain Their Results? Example 2: The Concor De Paradox An Dpublic Policy Governments Spent Billions Of Dollars In The 1960'S On The Supersonic Concorde That Could Take Passengers Across The Atlantic At Super-Sonic Speeds. Only 14 Were Ever Used. One Famous Politician On Why We Should Explore Mars... "There's Too Much Invested There. There's Infrastructure That's Very Expensive And Very Extensive. Question: - How Is Government Decision Making Different Fromindividual Decision Making? Plan For Fam Summer 2021 - Profile 1 - Microsoft Edge Tent/2307575/Fullscreen/35402492/View Example 3: Pizza Buffets And Pricing Experiment (Just And Wansink) •Design: 66 Individuals At An All You Can Eat Pizza Restaurant Were Given Either A Free Drink Coupon, Or A Coupon For 50% Off And A Free Drink •Results: Those Offered The Half Price Pizza Ate 25% Less Than Those Who Paid Full Prize (Also, Those Who Reported The Pizza As Less Tasty Ate More) Question: •What Are The Implications For Pizza Restaurant Owners? •What Are The Implications For Dieters? For Fam Summer 2021 - Profile 1 - Microsoft Edge /2307575/Fullscreen/35402492 View Example 4: Telecommunications Research Finding (Kridel, Lehman, Weisman) •Only 24% Of Customers Who Switched To The Unlimited Calling Plan Of South Western Bell In Dallas Texas During The Early 2000'S Saved Money. The Rest Would Have Done Better On The Old Rate-Flat Rate Bias: Individuals Prefer To Pay A Flat Rate Or Afixed Rate Over A Variable Rate. Question: •What Would You Do? •Can This Decision Be Rational? Explanations For The Flat-Rate Bias(Cont) Possible To Find Rational Explanations Individuals May Not Know Expected Usage Individuals May Prefer The Flat Rate In Case Of High Use "Emergencies" And Therefore Choose A Flat-Rate Plan For Its Option Value Summer 2021 - Profile 1 - Microsoft Edge 575/Fullscreen/35402492 Niew Example 5: Gym Membership Research Finding (Della Vigna And Malmendier)Analyzing 8000 Gym Records At A Gym That Had Either A $70 Monthly Fee, Or A $10 Per Visit Fee •Average Member Attended 4.3 Times Per Month •But Those Who Were Committed To The Monthly Plan Attended More-Why? Ummer 2021 - Profile 1 - Microsoft Edge 75/Fullscreen/35402492Niew Behavioral Ano Maly #3: Contex Tdependent Preference Individuals Use A Reference Point When Making Decisions For Example, A Hamburger That Normally Costs $5 At A Restaurant, Feels Like A Good Deal If You Were Offered The Same Hamburger For $3. But Would Feel Like A Rip Off If It Normally Costs $2. - The Reference Point Is An Example Of The Context Of Achoice Problem - Choices That Depend On The Context Of The Problem, Are Context Dependent Fam Summer 2021 - Profile 1 - Microsoft Edge 2307575/Fullscreen/35402492Niew Example 5: B Everage Demand An Dreferences Experiment (Thaler): •Design: In A Famous Experiment, The Individuals Are Asked, Either, Your Friend Asks How Much You Would Pay For A Case Of Beverage (To Go) From A Run-Down Grocery Store, Or From A Fancy Resort Hotel During Your Summer Vacation. Your Friend Will Buy It For You If The Price Is Less Than Or Equal To Your Stated Willingness To Pay (Aside: Why Is This Important) - Results: Respondents Were Willing To Pay $2.60 For Thesame Beverage When Bought From The Fancy Resort, Versus $1.50 For The Beverage When Bought From The Nearby Gas Station. Example 6: Internet Auctions Research Results (Dodonova And Khoroshilov) Finding: Higher "Buy Now" Prices In Online Ebay Auctions Increased How Much People Bid O 有 Nel 2021 Profile Microsoft Edge Fullscreen/35402492 New Rational Reasons For Contex Tdependent Preferences The Context May Convey Information? Context Creates The Perception Of Value O En/35423939Niew Chapter 3: Mental Accounting Ов E Fam Summer 2021 - Proble 1 - Microsoft Edge 2307575/Fullscreen 35423939 Niew Example Suppose You Receive A Coupon For An Ice Cream Cone. After Redeeming The Coupon, You Drop - Your Likely Reaction: No Big Loss. It Was Freeanyway Fam Summer 2021 - Profile 1 - Microsoft Edge 307575/Fullscreen/35423939Niew Explanations A The Situation Described In Slide 2 Is Based On A Premise That People Behave In A Predictively Similar Manner Under These Situations We Tend To Value Different Sources Of Income Differently. When We Work For Something To Earn It (Sweat Equity), We Tend To Value That Income Stream More Than If We Receive The Money For Free. Since The Ice Cream Was Bought Using A Free Coupon, The Loss From Dropping It Is Less Painful Than It Would Have Been Had We Bought The Ice Creams Spending Our Own Money. We Attribute These 'Predictively' Irrational Behavior To 'Mental Accounting! O Ri Fam Summer 2021 - Profile 1 - Microsoft Edge 2307575/Fullscreen/35423939Niew Mental Accounting Mental Accounting Describes How People Simplify Thedecisions They Need To Make In Life By Separating Choices Into Different "Accounts" In One's Head Related To Sunk Costs. Mental Accounts Can Explain: 1. How Income Sources Affect Spending 2. How Individuals Rationalize Bad Investments 3. How Individuals Group Events To "Balance" Accounts. - Sommer 2021 - Profil E 1 - Micsun Edge Tra Nthu Defining Mental Accounting Definition: Mental Accounting Is A Theory Of Grouping And Categorizing Money And Transactions So That The Individual May Systematically Evaluate The Potential Tradeoffs. Spending Is Categorized Into Separate Budgets For Various Types Of Items People Put Money Into Different Accounts Like Checking Or Savings, And Start Treating The Money Put In A Savings Account, An Investment Account, Or A Checking Account Differently The Key Is That People Make Decisions As If The Accounts Were Unrelated Stee Bon Summe2007-Pollet-Microsoft Bage Keys To Mental Accounting 1. Decisions Are Made As If The Budget Fordifferent Mental Accounts Are Not Fungible 2. Losses And Gains Relative To A Referencepoint In Each Account Are Treated Differentlyaccording To A Value Function 3. Individuals Receive Transaction Utility As Wellas Consumption Utility M Summer 2021 - Profile 1 - Microsoft Edge 07575/Fullscreen/35423939Niew Relationship To Business Accounting, The Principle Of Double-Entry Accounting Is That For Every Credit To An Account, There Must Be A Corresponding Debit Similarly In Mental Accounting, For Every Credit (To Say The Food Account In The Case Of Food Stamps) There Must Be A Corresponding Debit (From The Food Account Only) Summer 2021 - Profile 1 - Microsoft Edge 575/Fullscreen/35423939Niew Key 1: The Importance Of Beingfungible In Public Finance, We Call Money Fungible When It Can Be Moved Between Different Accounts - For Example, Giving An Autocratic Country Food Aid, Oftenallows That Country To Spend More Money On Weapons Because The Money Is Fungible I The Behavioral Bias That Characterizes Models Of Mental Accounting Is That All Mental Accounts Should Be Fungible, But We Treat Them As Separate Or, Even Though We Can Easily Spend Money Just As Easily From Our Savings Account As From Our Checking Account, Since These Funds Are Fungible, We May Treat The Savings Account As Off Limits Fam Summer 2021 - Profile 1 - Microsoft Edge 307575/Fullscreen/35423939Niew Key 2: Combining Mental Accounts Andprospect Theory People Tend To Characterize All Transactions As Either A Gain Or A Loss • Properties Of A Prospect Theory Curve- Diminishing Sensitivityi. E. Diminishing Marginal Utility In Gains, But Also Diminishing Marginal Pain From Losses - Loss/Risk Aversioni. E. The Kink At The Origin Means Marginal Losses Are More Painful Than Marginal Gains Ri Summer 2021 - Profile 1 - Microsoft Edge 75/Fullscreen/35423939Niew Key 3: Transaction Utility As Well Asconsumption Utility In Each Transaction Within An Account, People Receive Both Consumption Utility In Terms Of Gains And Losses To The Value Function But Also Transaction Utility For That Particular Deal 71F Am Summer 2021 - Profile 1 - Microsoft Edge 07575/Fullscreen/35423939 /View Investment And Closing Accounts People Would Prefer To Close An Account When They Have A Positive Or Zero Balance Example: Suppose You Bought A House. The Initial Cost Of The House Is A Natural Reference Point (Question: Are There Other Natural Reference Points?) Selling The House Will Close The Account. People Become Reluctant To Sell The House At A Loss 2011 Gage See 359 Example 2: Investment And Divestment: The Disposition Effect Definition: Winning Stock: Stock Who's Price Is Above The Purchase Price Losing Stock : Stock Who's Price Is Below The Purchase Price Mental Accounts Provide An Explanation For The Disposition Effect In The Following Way: People Sell Winning Stocks Too Fast And Hold On To Losing Stocks Too Long (Review: Why Is This Irrational?) On Example 3: Investment And Divestment: The Disposition Effect (Cont) Example 4: Investment And Divestment: The Disposition Effect (Con't)Finding (Odean) Looking At People's Actual Stock Portfolios, The Average Return Of Winningstocks That People Sold In The Year Following The Sale Was 2.4%. The Average Return Of Losing Stocks That Were Not Sold In The Following Yearwas - 1%. Investors Would Have Been Better Off Doing Nothing. An Summer 2031 - Profile 1 - Microsoft Edge 27575/Fullscreen 35423939/Iew Example 4: Gym Membership Finding (Gourville And Soman) •Membership Payments At A Gym Are Made Once Every Six Months •35% Of Members Will Show Up At The Gym The Month The Payment Is Made •Only 10% Will Show Up 4 Or 5 Months After The Payment Is Made 71"F Summer 2021 - Profile 1 - Microsoft Edge 7575/Fullscreen/35423939Niew Budgets, A Ccounts, Temptations An Dgifts • Because Budgets Are Treated As Non-Fungible, People Can Use Mental Accounts By Making Abudget To Limit Temptation • Shefrin And Thaler Propose Three Accounts:- Current Income - Current Wealth - Future Wealth O Be Fam Summer 2021 - Profile 1 - Microsoft Edge 307575/Fullscreen/35423939Niew Example 5: Windfall Gains Experiment (Arkes) •Design: 40 Students Were Recruited At A Basketball Game. Half Were Told They Were Going To Be Paid $5 At The End Of The Game. Then They Were Asked How Much They Spent On Concessions •Results: Those Who Were Going To Be Paid $5 Spent More Than The Half Who Were Not Promised A Payment Of $5, And They Spent More Than $5 On Average. For Fam Sumer 2021 - Profile 1 - Miss Eye 12307575/Fullscreen/35422939 Niew Chapter Summary • People Use Mental Accounts To Make Decisions • Mental Accounts Have Three Main Properties - People Behave If Transactions Across Accounts Are Notfungible - Gains Versus Losses Matte Rthe Pain Experienced From A Loss Is Much More Than The Happiness Received From An Equivalent Percentage In Gains - Hence People Are More Risk Averse When Their Transactionsbecome Profitable (Want To Win And Preserve Their Profits) - People Become More Risk Taking When Their Transactions Result In Loss - Transaction Utility Also Matters Secres 3021 - Microsoft Te S Fuise23919/View Thought Questions 1. Consider A High School Student Who Getslunch Money, Money From A Part Time Job, An Allowance, And A Raise. How Does Each Source Matter? Summer 2021-Probe - Microsoft Edge 575/Fullscreen 35424019/View Chapter 4: Status Quo Bias And Defaul Toptions-Choice Architecture Module 2 Continued... Am Summer 2021 - Profile 1 - Microsoft Edge 07575/Fullscreen/35424049/View Rational Consumers And Default Standard Economic Models Assume People Consider All Possible Options And Choose The Best One A Default Should Not Matter To A Rational Consumer (Question: Why Might Rational Consumers Care About Default?) For Fam Summer 2021 - Profile 1 - Microsoft Edge /2307575/Fullscreen/35424049Niew Example 1: Organ Donors Experiment (Johnson And Goldstein) •Countries Where People Have To Opt-In To Organ Donation Have Low Opt-In Rates (Always Less Than 28%, The Us Is The Highest At 28%) •Countries Where People Have To Opt-Out Of Organ Donation, Have Organ Donor Rates For The Most Part Of 98% •An Online Experiment Where People Were Hypothetically Asked If They Had To Either Opt-Out Or Opt-In Had 82% Versus 42% Donation Rates Mer 2021 - Doble 1 - Microsoft Edge Bullscreen 35-24049Niew Example 2: Journal Subscriptions Many Prominent Economists Involved In This Decision Believed That More Individuals Would Subscribe To All Three Journals If It Was Presented As The Default Option, With A Discount For Eliminating One, Rather Than A Default To Receive Two Of The Journals With An Optional Extra Fee For Receiving The Third О 05 9 Doll 71F C Immer 2021 - Profile 1 - Microsoft Edge "S/Fullscreen/35424049 Niew Preference Formation, Framing Andthe Default Option Contrary To Traditional Economics Which Assumes Preferences Are Rational, In Fact People May Make Choices That Appear Irrational Or Biased'. The Default Pption Fills The Void When A Person Is Confused About Making A Decision Experiment (Ariely, Lowenstein, Drazen) •Design: Students Were Asked To Write Down The Last Two Digits Of Their Ssn. They Were Presented With Various Items With A Retail Price Around $70 (Like A Bottle Of Wine). They Were First Asked Whether They Would Pay More Or Less Than Those Two Digits. Then They Were Asked Using A Random Device, What They Would Actually Be Willing To Pay (Wtp) O 03 9 Doll Am Summer 2021 - Profile 1 - Microsoft Edge 17575/Fullscreen/35424049Niew Preference Formation, Framing Andthe Default Option (Con't) •Finding: Students Wtp Were Higher For Students With Higher Ssn •Since Ssn Are Likely To Be Random, Students Were Likely Anchoring And Adjusting Ori 07 W] 2001P1 - Massot Edge Screen 3500029 Nie Anchoring And Adjustment People Anchor On Conveniently Available Numbers When Forming New Beliefs. They Thenadjust That Number Up Or Down Accordingly • The Default Number May Be A Particularlysalient Number, And Therefore Affects Preferences О 1 Doll Fam Summer 2021 - Profile 1 - Microsoft Edge 2307575/Fullscreen/35424049Niew Ar Bitrary Coherence (Or Coheren Tarbitrariness) In The Ariely, Lowenstein Prelec Experiment: Once Someone Has Been Anchored On A Price, They Make Consistent Decisions Based On This 'Anchored Reference Point There After. O Ba 07 W 9 Dil Fam Summer 2021 - Profile 1 - Microsoft Edge 307575/Fullscreen/35424049/View E Xample 3: Retirement Savings An Ddefault Natural Experiment (Madrian And Shea) •Design: Looked At A Firm That Changed Their Retirement Savings Program From Opt-In To Optout •Result: Changing The Default Increased Participation By 50% 1 Plan For Fam Summer 2021 - Profile 1 - Microsoft Edge Ntent/2307575/Fullscreen/35424049Niew Th Exa Mple 4: Status Quo Bias And Healt Hinsurance Findings (Samuelson And Zeckhauser) •When New Insurance Plans Were Introduced At Harvard, Only 3% Of Employee Would Switch Each Year, But New Employees Were Very Likely Ato Adopt The New Plans Plan For Fam Summer 2021 - Profile 1 - Microsoft Edge Ntent/2307575/Fullscreen/35424049Niew Rational Explanation S Of Status Qu Obias • Switching Co Stsexploration Costs Aversion Of The Unknown . . 1Ig The Theory Of Preferences Definitions: •We Can Represent Preferences Using The Relation >, Where X > Y Means X Is Preferred To Y •Similarly 2 Means Preferred Or Indifferent. While Means Indifferent Rationality Presumes Preferences Are Complete And Transitive Complete Means For Any X And Y, X> Y Is Either True Or False. Transitive Means If X > Y, And Y> Z Then X> Z Finan Plan For Fam Summer 2021 - Profile - Microsoft Edge E/Content/2307575/Fullscreen/35424049/Iew Preference Reversals • Violations Of These Axioms Of Preferences Areoften Called Preference Reversals The Simplest Is To Find A Case Where Sometimes Xxy But Other Times Y>X An Plan For Fam Summer 2021 - Profile 1 - Microsoft Edge Content/2307575/Fullscreen/3542404 9Niew Preference Reversals And Referenc Estructure Tversky And Kanheman Propose That Preferences Depend On The Reference State R, So That We Can Write >, Such That X >R1 Y But Y >R2 X Rational Utility Is A Special Case Of The Reference Dependent Model Where >R1=>R2 For All Reference Frames. For Fam Summer 2021 - Profile 1 - Microsoft Edge 74/2307575/Fullscreen/35424049Niew Ch Choice Architecture: Applying Diminishing Sensitivity: Bait And Switc . A Similar (Better Quality But More Expensive) Product Is Also Offered As A Choice A Similar Product That Is Visibly Of A Much Inferior Quality Is Advertised At A Relativelylower Price • The Baited Product Sets The Reference Pointand Makes The Consumer Less Sensitive To Price Differences For The Higher Priced Good O Be O W Dal Pam Sommer 2021 Beteiset 307575/Bullscreen Example: The Endowment Effect Suppose You Buy A Car. A Few Days After Picking U The Car, The Dealer Realized He Sent You The Wrong Car, The One You Received Has A Slightly Inferior Sound System. The Dealer Offers To Let You Come Back To Exchange The Car, But You Decline •Question:- How Might The Status Quo Bias Explain This? - How Does Endowment Effect Explain This? - What Rational Reasons Might Explain This? O # Fam Summer 2021 - Profile 1 - Microsoft Edge 307575/Fullscreen/35 424049Niew Loss Aversion And The Endowmen Teffect Owning A Good Makes It Part Of Your Referencepoint. Losing It Would Be Felt As A Loss • Buying A Good You Don't Own Is Evaluated As Again • Loss Aversion Predicts That People's Willingnessto Pay For A Good Is Less Than Their Willingness To Accept To Part With It This Is Called The Endowment Effect . Bi For Fam Summer 2021 - Profile 1 - Microsoft Edge 1/2307575/Fullscreen/35424049Niew Example: The Endowment Effect Experiment (Kahneman, Knetsch, Thaler) •Design: Half The Participants Were Given A U Penn Mug. The Other Half Of Participants Were Not Given Any Mug. They Were Then Given The Chance To Either Buy Or Sell Mugs To Each Other •Results: The Median Price Charged By The Mug Holders Was $5.25. The Median Price That The Buyers Were Willing To Pay Was $2.25 For For Summer 2021 - Profile 1 - Microsoh Eoge 12307575/Fullscreen 35424049 Niew . Example 5: Money Back Guaranteesand Free Trials • How Does The Endowment Effect Explainmoney Back Guarantees And Free Trials? How Else Might Firms Take Advantage Of The Endowment Effect? O An For Fam Summer 2021 - Profile 1 - Microsoft Edge Ent/2307575/Fullscreen /35424049Niew . Rational Explanations Of Th Eendowment Effect Maybe People Are Uncertain About The Value Maybe It Goes Away As People Gain Skill Or Fam Summer 2021 - Profile 1 - Microsoft Edge 2307575/Fullscreen/35424049/View Thought Questions 1. Why Is It That People Don't Change Jobs Verymuch Even Though They Could Make Moremoney? 2. Should A Store Offer In-Store Demonstrationsor Offer Money Back Guarantees? Mer 2021 - Profile 1 - Microsoft Edge /Fullscre En/35443786/View Chapter 5: Winner's Curse An Dauction Behavior Ammer 2021 - Profile 1 - Microsoft Edge Ts/Fullscreen/35443786/View Example: Auctions Experiment (Kagel Harstad And Levin) Design: Participants Played An Auction Where They Were Randomly Assigned A Private Reference Jaluation For Winning -Results: Bids Were On Average 12 To 20% Higher Than The Private Value Since All Participants Wanted To Win. • As A Result The Highest Bid Was Well Over The Private'Reference' Valuation For Winning That Was Distributed To The Participants Mmer 2021 - Profile 1 - Microsoft Edge /Full Screen/35443786/View Procedural Explanations Fo Roverbidding It Is Difficult To Learn From Experience In This Game Because You Never Have To Pay The Price You Bid Related To Anchoring And Adjustment, Where People Do Not Come Up With An Optimal Strategy, But Anchor On Some Number (Their Estimated Valuation) And Adjust Based On Experience 021 - Profile - Microsoft Edge Creen 35443786/View Levels Of Rationality Andard Game Theory And 'Nash Equilibrium' Resumes Everyone Is Perfectly Rational And Erfectly Anticipates Everybody Else's Actions Ut What If There Were Some People Out There Mat Just Enjoyed Bidding Wars And Would Start Ff Low? Or What If People Increased Their Attachment O The Good Or Service Over Time (I. E. The Endowment Effect Grows)? 2001-Bolestie Bidding Heuristics And Transparency Experiment (Bajari And Hortacsu) Find That A Lower Minimum Bid In An Auction 'Anchors' People Lower, And Therefore Lowers The Final Outcome There Is Also Evidence That Very Experienced Bidders Learn To Play The Rational Strategy 71 C Summer 2011 - Microsoft Edge $75/Fullscreen 35443786 New Basic Probability Theory. The Probability Is How Often An Outcome Occurs The Expectation Is The Weighted Sum Of All Possible Outcomes: Typically Economists Assume That When Facing Uncertainty, People Try To Maximize The Expectations Of Their Payout - The Expectation Is Formed Based On What The Personthinks Others Will Do Example: Dutch Auction The Dutch Auction Is One Where You Start With A Very High Price And The Auctioneer Lowers The Price Ittle By Little Until Someone Bids. In Effect, This Is The Same As The First Price Sealed Bid Auction Experiment (Cox, Roberson, Smith) Design: Conducted Dutch And First Priced Auctions In The Lab. Results: The Highest Valuation Person Won 80% Of The Time In The Dutch Auction.-Researchers Find Higher Bids In The Dutch Auction Than In The Other Types Of Auctions. Fam Summer 2021 - Profile 1 - Microsoft Edge 2307575/Fullscreen/35443786/View Example 6: Free Agents In Sports Free Agents Often Lead To Bidding Wars Finding (Cassing And Douglass) •Argue That Free Agents In Baseball Are Overpaid. They Estimate The Marginal Revenue Due To Various Statistics Like Slugging Average. They Then Compare The Pay To Their Statistics. Question: Why Might This Still Be Rational Behavior? Er 2021 - Profile 1 - Microsoft Edge Ullscreen/35443786/View The Winner's Curse The Winner's Curse Refers To The Fact That The Winner Of An Auction Frequently Overpays Because They Do Not Account For The Uncertainty Of The Information Or The Number Of Bidders. Auctions Are More Volatile Than Markets Because - The Price Is Set By The Choices Of Just A Couple Ofpeople Rather Than The Multitude In A Market - The Nash Equilibrium Of An Auction Is Highly Complex Mmer 2021 - Profile 1 - Microsoft Edge S/Fullscreen/ 35443786/View Rational Explanation Of The Winner' Scurse What If The Assumptions Are Not Correct? What If We Are Not Properly Measuring Returns In The Field Data? What About Risk Aversion? 2021 - Profile 1 - Microsoft Edge Sc Reen/35443787 Niew Chapter 7: Representativeness An Davailability Summer 2021 Mer 2021 - Profile 1 - Microsoft Edge Fullscreen/35443787 Niew Chapter Overview: Epresentativeness And Availability View Content In Ne Ople Use Information From Past Experience To Make Better Decisions. The Way They Use This Information Is Subject To Representativeness And Availability. This Chapter: We Consider Rational Models Of How Information Should Be Used To Make Decisions Psychological Evidence For How We Actually Use Information 0987 Screen 500S New Basic Statistics - The Mean We Represent By U - The Variance We Represent By O2 - The Central Limit Theorem Tells Us That Theaverage Of N Draws From A Sequence Will Be Normally Distributed With Mean U And Variance O2/N View Conte N For Fam Summer 2021 - Profile 1 - Microsoft Edge Nt/2307575/Fullscreen/35443787 Niew The Weak Law Of Large Numbers View Co •As The Number Of Observations Goes To Infinity, The Average Of The Sample Converges To The True Probability. •For Example, If We Toss A Fair Coin A Large Number Of Times, The Ratio Of Heads Approach Es 0.50 O Bi 09 W] - 2021 - Profile 1 - Microsoft Edg Etriting Calibration Exercises The Precision Of An Estimate Is How Close Our Estimate It To The Actual Number Or Event The Calibration Of An Estimate Is How Close To The True Frequency Our Estimate Is 立 07 9 Doll View Content In Ne Summer 2021 - Profile 1 - Microsoft Edge 575/Fullscreen/35443787/View Representativeness W M Individuals Who Display The Representativeness Heuristic Determine The Probability Of An Event By The Degree To Which The Event (I) Is Similar In Essential Characteristics To Its Parent Population; And (Ii) Reflects The Salient Features Of The Process By Which It Is Generated Often They Tend To Overestimate Or Underestimate This Probability As A Result Be Use Its Based On Their Perception And Can Often Be Incorrect О Ri 09 W] Dol View Content In Summer 2021 - Profile 1 - Microsoft Edge 575/Fullscreen/35443787 Niew View Content Implications Of Making Decisionsbased On Representativeness Bias · Might Lead To Poor Investment Decisions • In General Individuals Inflate The Probability Ofevents That They Are Familiar With - For Example, If The Person Has Recentlyexperienced A Big Loss From Her Investments, She Will Be More Risk Averse About Investing In The Near Future Even Though The Performance Of A Stock Or An Investment In The Past Is Not A Predictor Of Its Performance In The Future. Doll Summer 20011Nicast Edge 575 Screen 35337St Example 3: Rachel ♡ Experiment (Tversky And Kahneman) Design: Rachel Is 31 Years Old, Single, Outspoken, And Very Bright. She Majored In Philosophy. As A Student She Was Deeply Concerned With Issues Of Discrimination And Social Justice. •Please Rank The Following Statements By Their Probability, Using 1 For The Most Probable And 8 For The Least Probable. Linda Is A Teacher In Elementary School. Linda Works In A Bookstore And Takes Yoga Classes. Linda Is Active In The Feminist Movement. Linda Is A Psychiatric Social Worker. Linda Is A Member Of The League Of Women Voters. Linda Is A Bank Teller. Linda Is An Insurance Salesperson. Linda Is A Bank Teller And Is Active In The Feminist Movement. Result: Most People Ranked C. O M Summer 2021 - Profile 1 - Microsoft Edge 7575/Fullscreen/35443787 Niew Conjunction Bias View Content In - The Intersection Of Two Events Somehow Feelsmore Probable If It Feels More Representative • Related To Stereotyping O Ri 09 W Summer 2021 - Poble 1 - Microsoft Edge 575/1 Screen 35443787Niew Law Ot Small Numpers The Law Of Small Numbers (Tversky And Kahneman) Is The Mistaken Belief That A Small Sample Should Look Like The Entire Population View Content In New For Example, Flipping A Coin 4 Times, It Is More Likely To Get A Not 2 Heads, Than Getting Exactly 2 Heads. But People Overestimate The Probability It Is Exactly 2 Summer 2021 - Profile 1 - Microsoft Edge 575/Fullscreen/35443787/View View Content In Ne Rabin's Mental Model Of Smallnumbers While Flipping A Coin, We Have A Mental Representation In Our Head, Of Possible Outcomes For The Coin Perhaps Our Mental Representation Has 6 Balls, 3 For Heads, 3 For Tails Every Time We Flip A Coin And See Heads, We Take Out The Ball For Heads, Making Us Think Tails Ismore Likely Next Time • The More Balls In Our Mental Representation, Themore Accurate Our Predictions O Ri Summer 2021 - Profile 1 - Microsoft Edge 7575/Fullscreen/35443787 Niew Summary: Law Of Small Numbers People Jump To Conclusions On Too Little Information Depends On How Big Our Mental Urns Are And On How Often It Refreshes 左 02 View Content In Ne Example: The Hot Hand Theory: Reversion To The Mean Finding (Gilovich, Vallone, Tversky) -Design: Is The Probability Of Making A Basket Higher After Having Just Made A Basket? Result: No. Streaks Are An Illusion-When Basketball Players Have A Great Year And Deliver Statistics That Are Higher Than Their Overall Average, They Tend To Score A Better Financial Deal With Their Basketball Teams In The Nba -But Chances Are That More Seasons A Player Has More Likely They Are To Regress Back To Their Mean -Similarly If A Player Has A Pretty Good Average And Has One Bad Year, Chances Are That If Given A Few More Opportunities The Player Will Improve Her Or His Score Back To Her/His Overall Average Mer 2021 -Proel Nicosche Edge 5 Screen 35213787 Nies Example 8: The Gambler's Fallacy Vew Content Inne Finding (Croson And Sundali) After 4 Or More Red (Black) Spins On A Roulette Wheel, People Tart Betting Against The Streak.- People Bet 50% Red/Black With Streaks Up To 3. - 58% Bet Red After A Streak Of 4 Black - 65% Bet Red After A Streak Of 5 Black · 85% Bet Red After A Streak Of 6 Black Called Gambler's Fallacy *Note That Every Spin Is Unrelated To The Previous Spins, So What Happened In The Previous Draws/Spins Should Not Matter Rationally Or Bias The Gamblers' Expectation, But It Does! This Is Known As The Gambler's Fallacy O Ri Oa Fam Summer 2021 - Profile 1 - Microsoft Edge 307575/Fullscreen/35443787 Niew Illusion Of Control And Lottery Tickets View Conten Experiment (Langer) •Design: Sold Lottery Tickets. Half Were Assigned Numbers, Half Were Allowed To Pick •Result: Those Who Picked Numbers Valued The Ticket At $8.67, Those Who Were Assigned Numbers Valued The Ticket At $1.96 •People Tend To Value Things More When They Can Control Some Of The Decisions And Vice-Versa Mer 2021 - Poble 1 - Microsoft Edgescreen 3543787 New Example: Diseases And Accidenta Ldeath Inding: Most (80%) People Believe That Accidents Are More Dangerous Than Stroke, Vhen In Fact, You Are Twice As Likely To Die By Troke. You Are 15 Times More Likely To Die From A Disease Than An Accident. Finding (Lichtenstein) Argues News And Representativeness Is To Blame View Content In New 71" Summer 2021 - Profile 1 - Microsoft Edge "575/Fullscreen/35443787/View Availability Heuristic The Availability Heuristic Says That We Associate The Frequency Of Something Based On How Easy They Are To Recall. Similar To Salience Related Is The False Consensus Effect. People Assume Others Hold The Same Opinions As Themselves O Bi E 03 W] View Content In M Summer 2021 - Profile 1 - Microsoft Edge 07575/Fullscreen/35443787 Niew Example: Earthquake Insurance Finding (Shelor, Anderson, Cross) •Demand For Earthquate Insurance Went Up After The California Earthquake In 1989 O Ri E 07 W] View Content In 5. 33 Nic Extreme Behavior And Availability Finding Design: Participants Were Told The Height Of 50 Men And Asked To Guess How Many Were Over 6 Feet Tall. In Both Cases, The Correct Answer Is 10. In The Extreme Condition, Some Men Were Very Tall (6'11") Compared To The Control Where The Tallest Man Was 6'4" •Results: In The Control, People Guessed 10, In The Extreme Condition, They Guessed 15 O Chapter Summary: Representativeness And Availability Vie - This Chapter Presents Statistical Methods Forassessing The Likelihood Of Something Givenobserved Past Events • Instead People Use Heuristics Likerepresentativeness And Availability To Interpret Past Information 08 Dell Thought Questions How Might False Consensus Affect An Investor's Beliefs About His Invention . How To Think About Win Streaks In Basebal Lhow To Interpret Trends In Stock Prices 1. Since Lottery Winnings Are Divided Amongstall Winners, How To Use Gambler's Fallacy To Increase Your Chances Playing The Lottery Ri Doll View

Disposition Effect

People sell winning stocks too fast and hold on to losing stocks too long(Review: Why is this irrational?)

Endowment Effect

Suppose you buy a car. A few days after picking up the car, the dealer realized he sent you the wrong car, the one you received has a slightly inferior sound system. The dealer offers to let you come back to exchange the car, but you decline Experiment (Kahneman, Knetsch, Thaler) •Owning a good makes it part of your reference point. Losing it would be felt as a loss •Buying a good you don't own is evaluated as a gain •Loss aversion predicts that people's willingness to pay for a good is less than their willingness to accept to part with it •This is called the endowment effect • •Design: Half the participants were given a U Penn mug. The other half of participants were not given any mug. They were then given the chance to either buy or sell mugs to each other •Results: The median price charged by the mug holders was $5.25. The median price that the buyers were willing to pay was $2.25 • •Question: -How might the status quo bias explain this? -How does endowment effect explain this? What rational reasons might explain this Rational Explanations of the Endowment Effect •Maybe people are uncertain about the value • Maybe it goes away as people gain skill

Flat Rate Bias

consumers often favor flat rate tariffs, although a pay-per-use tariff would be cheaper with regard to their actual usage volume. Research Finding (Kridel, Lehman, Weisman) •Only 24% of customers who switched to the unlimited calling plan of SouthWestern Bell in Dallas Texas during the early 2000's saved money. The rest would have done better on the old rate -Flat rate bias: Individuals prefer to pay a flat rate or a fixed rate over a variable rate. Possible to find Rational Explanations •Individuals may not know expected usage •Individuals may prefer the flat rate in case of high use "emergencies" and therefore choose a flat-rate plan for its option value

Positional Externality

•A positional externality is an other-regarding preference where my utility depends on my position relative to others in terms of consumption •Many 'altruistic' parents derive greater happiness by choosing scenario 'B'.

Uses of Behavioral Economics

•Behavioral economics focuses on -Systematic deviations from the best possible decision -How observed behavior impacts financial decision making -The psychology behind the mistakes we make when the outcome is not known immediately.1.Behavioral economics may be used therapeutically to help people make better decisions. a)Example 1: Financial planners and financial counselors can use tools and techniques learned from behavioral economics in helping clients make better financial decisions. b)Example 2: Financial Therapists can help clients, experiencing stress and anxiety from their financial situations, improve their overall subjective well-being. 2.Behavioral economics provides students and scholars with a better understanding of how our society functions. 3.Alternatively, corporations and marketers in the business of selling goods and services to consumers, can use concepts from behavioral economics strategically to exploit consumer biases and increase profits and sales.

Review the Different Biases

•Confirmation bias-People look for examples and anecdotes that confirm their prior beliefs. •After people buy a new car they eagerly read the advertisements for that car - the ads, of course, confirm that their purchase was a good one Recency Bias:•Pay more attention to Newsworthy events •People often rate the chance of death by plane crash higher after plane crashes, and death by natural disaster as too likely only because these events are reported more often than common causes of death. •People tend to believe that stocks of corporations that they are familiar with are better •When an event is easier to recall, more importance is assigned to it •People remember painful experiences more •Investors' perceptions are biased by personal experiences that likely represent only a fraction of the complete economic picture •Example: -A person whose home has lost 20% of its market value and whose spouse endured a long period of unemployment is less likely to see or feel an economic recovery even while housing markets show signs of recovery and unemployment falls. -Someone who just landed a great job would be inclined to see that as proof the economy is recovering -Those who grew up in the 1930s and 40s are more frugal but very risk averse in their investment decisions -Many individuals continue to stay away from the stock markets after losing money in 2008.

Prospect Theory

•Expected utility theory suggests that individuals can determine expected values of risky prospects and make choices consistent with utility maximization. •Prospect theory-people are not good intuitive statisticians -Furthermore, people often behave as if extremely unlikely, but still possible, outcomes have no chance whatsoever of occurring.

Anchoring and Adjustment

•Finding: Students WTP were higher for students with higher SSN •Since SSN are likely to be random, students were likely anchoring and adjusting

Framing and Salience

•Framing Effects -Framing is the combination of beliefs, values, attitudes, mental models, and so on which we use to perceive a situation. •Kahneman and Tversky defined a decision frame as 'the decision-maker's conception of the act, outcomes and contingencies associated with a particular choice.' •When would a person trust her or his money with this financial planner? -The financial planner tells them "90% of his clients have increased or retained their wealth after 5 years and met their financial goals." -"10% of patients lost a huge chunk of their fortune in 5 years." •The salience or saliency of an object or event refers to its prominence in our perceptions relative to other objects or events. •Salience is a cognitive consequence of framing events relative to each other. •Behavioral economists such as George Akerlof [Nobel Prize 2002] identify salience or non-salience as reasons for decisions to be less than perfectly rational. •Decision makers tend to overemphasize recent events that have occurred with greater than normal frequency or amplitude, and consequently overweigh the probability that such events will recur, while placing inadequate weight on the likelihood of events that have recently occurred less frequently or less intensely than usual. •Imagine a disease is expected to kill 600 people -Under program A, 200 people will be saved -Under program B, there is a 1/3 probability that 600 people will be saved and a 2/3 probability that no people will be saved -Under program C, 400 people will die -Under program D, there is a 1/3 probability that no one will die and a 2/3 probability that 600 people will die •72% prefer A to B and 78% prefer D to C

Procrastination

•If our discount factor declines with time, then we will procrastinate. •Models of procrastination can be combined with prospect theory to account for differences in discounting gains versus losses. Experiment (USDA) •Design: Randomly assign some people to food stamps some people to cash •Result: People on food stamps ate 100 to 200 more calories. Contradicting the fact that people on food stamps still supplement with cash. Finding (Parke and Ranney) •Design: Studies patterns of eating over a month •Result: People spent $5 per day in the first two days, in contrast with $2 for the rest of the month. Calories drop by 10% in the last week.

Context Dependent Preference

•Individuals use a reference point when making decisions •For example, a hamburger that normally costs $5 at a restaurant, feels like a good deal if you were offered the same hamburger for $3.But would feel like a rip off if it normally costs $2. -The reference point is an example of the context of a choice problem -Choices that depend on the context of the problem, are context dependent

Types of Economic Models

•Rational choice model and utility theory are traditional microeconomic theories, which posit how people should behave. Behavioral economics identifies the systematic deviations from the rational choice model, when individuals make decisions. •We typically assume that people are well informed, and have stable preferences •But then what is the role of advertising? -People try to make the best possible choice within the constraints of their human capital and mental capacity at that point in time (rational thinking) •The rational choice model has normative benefits and offers a coherent structure for economic science -But we all have made choices we regret (like studying for a test or eating an unhealthy dessert) [Deviation from rational thinking] 1.Rational 2.Behavioral 3.Procedurally Rational

Rate of Time Preference

•Thought to reflect a bias toward immediate gratification, know as present bias -A person with present bias often suffers from lapses of self-control •Laboratory experiments have documented the existence of present bias •Precommitment is useful in situations in which people don't trust themselves to follow through on their intentions •Precommitment is a choice that removes future options -Example: A student who wants to avoid driving while intoxicated hands his car keys to a friend before joining a party Discounting & The Rate of Time Preference: •Being happy in the present (today, this week, this year) is typically more desirable than the prospect of being happy in the future (tomorrow, next week, next year) •The discount rate is the additional future happiness that can compensate for the loss of one unit of happiness in the present Assuming happiness is measurable

Trust

•Trust surveys asked people "Generally speaking, would you say that most people can be trusted or that you can't be too careful in dealing with people?" •Possessing social capital seemed to increase trust and perhaps trustworthiness •Trust is tied up with Risk. Those who are more risk tolerant also would be happy to trust more •However, trust is tied up in a complex social relationship and thus no model of trust has become standard •In a survey of 21 countries, measures of trust and social capital are associated with faster GDP growth. • •Relationships are essential to the economy. •Relationships are governed by trust. Trust and reciprocity are related to risk and fairness, but depend far more on the social context

Intertemporal Decision Making

•When making financial decisions involving different points in time, individuals demonstrate several patterns of behavior in their financial decision making -Preferences over a set of alternatives available at a future date are dynamically inconsistent if the preferences change as the date approaches -The sunk cost fallacy is the belief that, if you paid more for something, it must be more valuable to you -Projection bias is the tendency to evaluate future consequences based on current tastes and needs

Mental Accounting Applications

•Winning stock : stock who's price is above the purchase price •Losing stock : stock who's price is below the purchase price Mental accounts provide an explanation for the disposition effect in the following way: - People sell winning stocks too fast and hold on to losing stocks too long(Review: Why is this irrational?)

Definition of Behavioral Economics

•behavioral economics is the focus of how decision making resources are allocated •