Choice Presentation & Time (Week 11)

Question 1

What is the Expected Utility Theory?

Answer 1

• Utility is determined by FINAL STATE OF WEALTH
• Money is EXCHANGEABLE - labels & mental accounts do not matter
• Ppl tend to maximise utility **based on the goods they consume

Question 2

What is the Behavioural Perspective?

Answer 2

• Utility is determined by **perceptions of losses & gains, based on SALIENT REFERENCE POINTS
• Labels & mental accounts INFLUENCE choice behaviour
• Ppl want to feel like they are getting a FAIR DEAL

Question 3

What is the normative perspective regarding utility?

Answer 3

Expected Utility Theory: An emphasis on actual outcomes

• The utility of consuming an item is SOLELY determined by ACQUISITION UTILITY

Question 4

What is the descriptive perspective regarding utility?

Answer 4

Prospect Theory: Framing & mental accounting

• The utility of consuming an item is determined by BOTH acquisition utility AND transaction utility

Question 5

What is acquisition utility?

Answer 5

A measure of the VALUE of the good obtained **relative to its price

AU = (Px C would place on receiving item as gift) - (Px paid for item)

Question 6

What is transaction utility?

Answer 6

A measure of the PERCEIVED VALUE of the deal

TU = (Ref px C expects to pay for item) - (Px paid for item)

Question 7

How do we conclude that people’s utility is determined by the perceived fairness of a transaction (beer on the beach)?

Answer 7

1. Ultimate consumption act is the same in both scenarios (i.e. *same acq. utility)
2. There is *no statement for the actual price paid for the bottle of beer
3. There is no “atmosphere” consumed by survey respondent

Question 8

What are the principles of hedonic framing?

Answer 8

Implications of prospect theory: Hedonic framing

1) Segregate gains
2) Integrate losses (unless very small or large)
3) Integrate small losses with larger gains
4) Segregate small gains from larger losses

Question 9

What is principle #1 of hedonic framing?

Answer 9

1) Segregate gains : v(x) + v(y) > v(x+y)

Essence of principle: Appreciate diminishing sensitivity

Question 10

What is principle #2 of hedonic framing?

Answer 10

2) Integrate losses: v(-x + -y) > v(-x) + v(-y)

Essence of principle: Appreciate diminishing sensitivity

Question 11

What is principle #3 of hedonic framing?

Answer 11

3) Integrate small losses (y) with larger gains (x)

If x > y, then v( x+ -y) > v(x) + v(-y)

Essence of principle: Try to offset loss aversion

Question 12

What is principle #4 of hedonic framing?

Answer 12

4) Segregate small gains (x) from larger losses (y)

If x &laquo_space;y, then v (x + -y) < v(x) + v(-y)

Essence of principle: Emphasise silver linings

Question 13

What are the aspects of decision matrices for choices over time?

Answer 13

• Time period (instead of attributes
• Alternatives
• Outcomes

Question 14

What is the formula for the Normative Model: Discounted Utility Theory (DU)?

Answer 14

> > > > > Uo (x,n) = δ^n Un(x) ««<

Uo (x,n): Present utility of receiving $x at time period n

δ^n: Discount coefficient raised to n power. δ = 1 / (1+r)

r: (After tax) Mkt rate of interest

Un(x): Utility in period n of receiving $x

Question 15

What are the assumptions of Discounted Utility Theory (DU)?

Answer 15

1. r > 0, +ve discount rate
2. r = a constant across different time points
3. r determines *everyone’s utility at diff. time points. Indiv. differences in intertemporal choices should be *minimal

Question 16

What is the descriptive perspective of intertemporal choice?

Answer 16

A VIOLATION of Indiv. Homogeneity Assumption (Assumption #3 of DU)

Some ppl have *extremely high discount rates (strong desire to acquire immediate gains)

Question 17

What are some ways to exert better self-control?

Answer 17

1. Pre-commit yourself
2. Remove temptations
3. Disable yourself
4. Penalties