Behavioural Economics

Question 1

(C1) Heuristics

Answer 1

Simple rules of thumb and mental shortcuts

Question 2

(C1) Biases

Answer 2

Systematic errors that are a result of the use of heuristics

Question 3

(C1) 3 Decision Making Perspectives

Answer 3

1. Normative
2. Descriptive
3. Prescriptive

Question 4

(C1) Normative

Answer 4

How should people make decisions?

Characteristics: rational; optimizing; forward-looking

Question 5

(C1) Descriptive

Answer 5

How do people make decisions?

Related concepts: boundedly rational; limited cognitive capacity; heuristics or rule-based; satisficing; myopic

Question 6

(C1) Prescriptive

Answer 6

How can we help people make better decisions?

Related concepts: debiasing; repairs; corrective measures; preventive measures

Question 7

(C1) Hindsight Bias

Answer 7

is the inclination to see events that have already occurred as being more predictable than they were before they took place.
“I knew it all along” Effect

Question 8

(C1) Perceptions/Experiences are influenced by… (2)

Answer 8

1. Cognitive Factors: prior beliefs and expectations

2. Motivational Factors: What we want to see

Question 9

(C1) Sobe (full price vs discount price) and Word puzzles test

Answer 9

People were sold either full price Sobe energy drink or discounted Sobe and then asked to perform word puzzles.
The people who paid full price solved more puzzles than the people who purchased for discount price.
Price discounts have a negative effect (it’s more a nocebo than placebo).
BUT this effect is eliminated when attention is drawn to the price-efficacy inferences (‘Given the price I was charged for Sobe, i feel that Sobe is _____ in improving concentration”)
AND if you set high expectations (“Sobe is proven to improve mental functioning”) then it will have positive effects

Question 10

(C1) Hostile Media Effect

Answer 10

the finding that people with strong biases toward an issue (partisans) perceive media coverage as biased against their opinions, regardless of the reality.
Pro-Palestinian students and pro-Israeli students at Stanford University were shown the same news filmstrips pertaining to the1982 Sabra and Shatila massacre. Both sides found that these identical news clips were slanted in favor of the other side. Pro-Israeli students reported seeing more anti-Israel references and pro-Palestinian students reported seeing more anti-Palestinian references.

Question 11

(C2) If asked to write down 3 reasons to buy a BMW, vs write down 10 reasons. Results?

Answer 11

If you write down 3 reasons you are more likely to want to buy a BMW in the next 5 years than if you write down 10.
Because coming up with 10 reasons is much harder, and it makes you think that maybe you don’t actually like BMWs because if you did then it would be easier to come up with the reasons.

Question 12

(C2) Asymmetric Dominance

Answer 12

If you have two products, product A and product B. The introduction of a third product, B, that is asymmetrically dominated in all (or almost all) ways by one of the other options, will shift consumer behavior in what they purchase.

Question 13

(C2) Compromise Effect

Answer 13

a consumer is more likely to choose the middle option of a selection set rather than the extreme options.

Question 14

(C2) Decision Frame

Answer 14

The decision maker’s conception of the Acts, Outcomes and contingencies associated with a particular choice.
Decision frames are partly controlled by the norms, habits and characteristics of the decision maker

Question 15

(C2) Too many options (choices)… (4)

Answer 15

1. Increases confusion/uncertainty
2. Decreases confidence
3. Results in a greater tendency to “stick with the status quo”
4. Can lead to people feeling regret (with non-alignable choices)

Question 16

(C2) Consequences of choice complexity (4)

Answer 16

1. deferral and non-participation
2. A complex choice set may result in a smaller number of conservative choices with a view to minimize regret. A smaller choice set encourages varied and maybe aggressive/risky choices
3. Relying on status quo or default option
4. People use other people’s choices as a heuristic to what they should choose

Question 17

(C2) Alignable vs non-alignable assortments

Answer 17

Alignable: a set of brands variants that differ along a single dimension (ex several bottles of ibuprofen that vary in tablet count). These require tradeoffs of a single attribute vs. price.
Non-Alignable: the brand variants vary along multiple, non-compensatory dimensions, such that while one alternave possesses one desirable feature, a 2nd alternative possesses another desirable feature (features are all or nothing). (ex. on a menu salmon vs steak). Can lead to people feeling regret.
Increasing choice sets can benefit consumers in an alignable assortment condition, but can be harmful if not aligned.

Question 18

(C2) Inaction Inertia

Answer 18

Inaction inertia is the phenomenon that one is not likely to act on an attractive opportunity after having bypassed an even more attractive opportunity.
When an attractive opportunity is foregone, individuals tend to decline a substantially less attractive current opportunity in the same action domain, even though in absolute sense it still has positive value.
For example once a special offer is discontinued or expired, people will be less likely to complete a task associated with the foregone discount.

Question 19

(C2) People are susceptible to influences from… (3)

Answer 19

1. Questions
2. Frames
3. Context and peers

Question 20

(C3) Expected Utility

Answer 20

A rational agent is indifferent to the reference point.
The individual only cares about absolute wealth, not relative wealth in any given situation. This is not what happens in reality - in reality there is prospective utility

Question 21

(C3) Value Function

Answer 21

S-shaped and asymmetrical.

Losses hurt more than gains feel good (loss aversion)

Question 22

(C3) Prospect Theory

Answer 22

people make decisions based on the potential value of losses and gains rather than the final outcome.
2 parts to prospect theory: Value Function and Probability Weighting Function

Question 23

(C3) Prospect Utility

Answer 23

There are diminishing returns.
There is diminishing sensitivity.
It uses a reference point.
Losses are steeper than gains.

Question 24

(C3) Samuelson paradox

Answer 24

as the expected value goes up the attraction of the game goes down (“50% to get $100; 50% to lose $50 vs. 50% to get $10,000; 50% to lose $5,000)

Question 25

(C3) Endowment effect

Answer 25

you value things that you possess more than other things. Once you own something you don’t want to part with it

Question 26

(C3) Loss Aversion

Answer 26

• Losses hurt more than gains
• Ratio of gains to losses is 2:1
• Loss aversion is often the cause for “timid decisions”

Question 27

(C3) Disposition effect

Answer 27

The tendency of investors to sell shares whose price has increased, while keeping assets that have dropped in value.
Related to loss aversion

Question 28

(C3) Probability weighting function

Answer 28

People tend to over-value small probabilities (many people play the lottery, a 1% chance of winning), but under-value large probabilities.

• Risk aversion is shown in the probability weighting function.
• Probability counts mostly at the two extremes
• Certainty is overvalued
• Risk seeking with losses and risk aversion for gains

Question 29

(C3) Mental Accounting

Answer 29

Consumers allocate money (which is fungible) to mental accounts (and therefore make it non-fungible).
consumers behave differently with respect to money that is allocated to accounts vs money not allocated.
ex. You bought theatre ticket ($100) and lost it. Do you buy a new ticket? Probably not. But if you did not have a ticket and you lost $100 on the way to the theatre to buy a ticket, would you buy a ticket? Probably yes. Because the lost $100 was not allocated

Question 30

(C3) Earmarking

Answer 30

To reserve or set aside for a particular purpose.

Money earmarked for a particular purpose is more likely to be spent on that purpose.

Question 31

(C3) Refreshing Savings

Answer 31

If people have a savings goal of $1,000,000 and their current savings is $500,000 then they feel overwhelmed and may start spending an extra $5 here and there.
Theory suggests resetting bank statements to 0 at the end of every year, so the likeliness of saving is higher. When it’s too hard to attain then it’s demotivating

Question 32

(C3) Self Herding

Answer 32

sometimes you use your past behaviour as evidence to how much you might like something. If you have gone in the past to starbucks and you have paid $5 then if you’ve done this in the past then it may be worth it to me.

Question 33

(C3) Coherent arbitrariness

Answer 33

You can convince one person to accept that listening to a loud noise is worth, say, a dime, and persuade another person to take a dollar for the same unpleasant experience. Afterward, both cling to their starting values as a reference point. To listen three times as long, one listener will demand 30 cents while the other asks for $3.

Question 34

(C3) Pain of paying

Answer 34

psychological aversion to parting with the payment, above and beyond the economic disutility and the hassle

Question 35

(C3) Aversion to making payment has 3 components…

Answer 35

1. Pain of Paying
2. Hassle, effort or annoyance of executing the payment
3. Disutility of money spent

Question 36

(C4) Altruism

Answer 36

the principle or practice of concern for the welfare of others. Altruism is the opposite of selfishness.

Question 37

(C4) Money Market vs Social Market

Answer 37

Money Market: effort will be exerted according to the reciprocity theory.
Social Market: effort will be shaped by the altruism theory and will not be sensitive to the level of payment.
Introducing monetary payments into a social exchange will cause individuals to shift from perceiving the exchange as a social market to a money market

Question 38

(C4) Shadow Value of Price

Answer 38

A proxy value of a good, often defined by what an individual must give up to gain an extra unit of the good. The Opportunity Cost of buying something.
If you’re selling a cheaper product you should point out what else people could do with the money they are saving.

Question 39

(C4) Ways to enhance opportunity cost salience (3)

Answer 39

1. simple reminders that the money used for a focal product could be used for other purchases (‘leaving you $14.99 to use for other purchases”)
2. bundling the lower priced good with a specific other product that could be purchased for the price difference (“using the $300 for CDs”)
3. specifying price difference of focal comparison as a residual cash amount (“leaving you $300 in cash”)

Question 40

(C4) Money & Help

If you are given lots of money vs little money vs no money (control)

Answer 40

Group that was given lots of money and asked to write about life with abundant finances helped the least.
Group given little money and asked to write about life with financial restrictions helped more.
Control group given no money and asked to write about their day helped the most.

Question 41

(C4) People primed with money and asking for help

Answer 41

Participants who are primed with money take longer to ask for help when they encounter a confusing and unsolvable task

Question 42

(C4) Primed with money vs not primed with money and working together

Answer 42

Participants who were primed with money will put more distance between them and someone they have a conversation with.
participants who are primed with money would rather work alone than work together

Question 43

(C4) Thinking of money…

Answer 43

1. Reduces helpfulness towards peers and experimenter
2. Reduces amount of money donated
3. Reduces asking for help
4. Makes people want to be alone (play alone, work alone, sit farther away)