Chapter 19 - Behavioral economcs

Question 1

What is the chapter about?

Answer 1

We have previously assumed rationality and that people follow the same paths regarding choices etc.

Now, we consider what happens if people dont follow these rational models.

Question 2

Elaborate on reference points

Answer 2

Reference point in this context refer to the setting in which some decision is made. apparently, the decision setting of when consumer decide to buy something matters a lot in regards to perceived value.

For instance, if we are really hungry, we might value some quick food more than a rational model would predict.

Another example is price of “the same house” at different geographical areas.

Reference point: The point from which an individual makes a consumption decision

Question 3

Define endowment effect

Answer 3

Endowment effect is the tendency for consumer to value an item more if they own than when they do not.

the endowment effect is an example of a reference point.

Question 4

Example of reference point?

Answer 4

The endowment effect

Question 5

Elaborate on loss aversion

Answer 5

Loss aversion is the tendency for individuals to avoid losses over acquiring gains. It hurts more to loose 1000 than to win 1000.

Question 6

elaborate on framing?

Answer 6

Framing is the tendency to rely on the context in which a choice is described when making a decision.

So, obviously, this means that the way the “deal” is presented is of great importance. We might get scammed because of a great commercial etc .

Question 7

Elaborate on Salience

Answer 7

Salience refers to situations where the decision making process is influeced by the perceived value of a good or some features of the good. Brand name is typically an example of salience, since many consuemrs consider brand name as an important feature.

Salience can be positive. A firm selling cars can emit certain strong signals that consumer will consider as important. For instance, a really long warranty signals trust in the product, which is a feature that many car buyers are looking for.

Question 8

Elaborate on fairness

Answer 8

People often act in a certain way because they believe it is the right thing to do. It is the “fair” thing to do. Charity, for instance.

Question 9

elaborate on rule of thumb

Answer 9

Rule of thimb are mental short cuts that help us make decisions. For instance, one might consider a 15% tip a “rule of thimb”. This does not mean it is rational. however, it is something we do because it is sort of a norm and a rule of how to behave.

Question 10

elaborate on anchoring

Answer 10

Anchoring refers to the tendency of relying heavily on some prior suggested piece of information when making a decision. For instance, consider some donation scheme that pops up and asks us to donate. Instead of just giving the entire option to us, they might give some “presets” of options already. These fucntion as anchors for us, since we often use one of these when making the decission.

Question 11

Elaborate on the law of small numbers

Answer 11

The law of small numbers say that people tend to overstate the probability that certain events will occur when faced with relatively little information from recent memory. for instance, a roulette player might think that the probabiltiy of black after 3 reds in a row is larger than it actually is.

So, the law of small numbers is essentially how little information leads to too large possibilities of situaitons to occur.

Question 12

Elaborate on overconfidance

Answer 12

Overestimating their abilitiy to do something. It can take the form of over-optimism.

Can also lead to over-precision: Unrealistic belief that one can accurately predict outcomes.

Question 13

Elaborate on bubbles

Answer 13

Bubbles are increase in price of a good based NOT on the fundamentals of demand or value, but instead of a belief that the price will keep going up.

Question 14

Elaborate on informational cascade

Answer 14

an assessment, typically investment, based in part on the actions of others, which in turn were based on the actions of others.

Question 15

Elaborate on nudges

Answer 15

Nudges is perhaps best understood without the economic context. Nudges are defined as ways to influence decision making. By placing a fly at the urinal, it has a proven effect of less misses.
Another example is IKEA’s arrows, indicating where to go. These arrows take consumers through the entire shite, even though there are multiple shortcuts to different departments.

Small changes in decision making contexts providing positive reinforcement.

This is basically measures used to influence decision making of consumers. For instance, place candy at the end of the store, where consumers spend much time anyways.

there are commonalities between framing and nudges. Framing relies on the specific context and presentation of a good. Thus, some types of framing could be described as nudges.

Question 16

elaborate on bounded rationality

Answer 16

Bounded rationality refers to cases where rationality is limited when consumers make deicisions, and when this is the case, consumers tend to make decisions that are satisfactory rather than rational.

Factors that affect rationality and can lead to bounded rationality:
- Time
- Complexity of problem
- Cognitive abilities
- Knowledge/information
- Values and culture?