Measuring Behavior and Preferences

Question 1

Treatment effects of poverty refers to the fact that:

Answer 1

Poverty itself can cause sub-optimal behaviors

Question 2

How can scarcity affect performance at cognitive tasks?

Answer 2

There is evidence that poor are more rational when it comes to financial choices and are more focused when it comes to decision making. However, scarcity affects bandwidth and cognitive capacity which deteriorates performance at cognitive task

Question 3

Inhibitory control

Answer 3

Inhibitory control refers to the ability to control one’s attention, behavior, thoughts, and emotions. It overrides internal predisposition or external lure and enables one do what is (more) appropriate or needed.

Question 4

Working memory

Answer 4

Working memory is the ability to hold information in the mind and work with it

Example: Memorizing the information on the slides and lectures and using this information to solve finger exercises

Question 5

What were the findings of the Mall study?

Answer 5

The mall study finds that the poor perform worse on cognition when presented with the hard task where the stakes are higher i.e. USD 1500 to fix the car vs. the easy task where the stakes are lower i.e. USD 150 to fix the car. These effects persist even when the cognition tasks are incentivized.

Question 6

The harvest study was designed to ask the question:

Answer 6

Does poverty lower cognitive function?

By measuring difference in cognitive function pre-harvest (when farmers are poorer) versus after-harvest (when farmers have money), the study was meant to determine whether poverty has an impact on cognitive function.

Question 7

Discount factor

Answer 7

delta; measures how utility in later periods is discounted relative to earlier periods

Discount factor is usually less than equal to one as people tend to care more about the present relative to the future.

Question 8

Discount factor equation

Answer 8

(Y/X) ^ (1/t)
Y = today
X = tomorrow
t = time

Question 9

Calculate the one-year discount factor () if individual A is indifferent between $40 today and $80 in two years

Answer 9

Y = 40
X = 80
t = 2 years 

delta = (40/80) ^ (1/2) = 0.71

Question 10

We observe that people tend to discount utility in the near future (e.g. between now and a year from now) much more than utility in the distant future (e.g. between 10 years and 11 years from now). Frank uses this evidence to make the point that:

Answer 10

The standard exponential discounting model cannot explain these facts since it uses a constant discount factor

This model cannot explain the evidence that people tend to discount near and distance future differently, so we might want to extend it, i.e. allow for the discount factors in the short and long-run to differ. This is what the beta-delta model does.

Question 11

Dynamic inconsistency

Answer 11

Our current preference is to do something in the future, but when the future comes, that future self does not want to go through with it

Question 12

quasi-hyperbolic discounting

Answer 12

The idea of quasi-hyperbolic discounting is that we discount the future relative today. But we do not discount two different points in the future relative to each other.

Question 13

In a trust game, Person A receives $100, and can give any amount to Person B. The amount Person B receives is tripled, and then Person B can choose to give any amount back to Person A.

If Person A believes that people act solely in their own self interest, what amount would person A give to person B to maximize the money he (Person A) receives?

Answer 13

If Person A assumes everyone acts in their own self interest, he would assume Person B will give nothing back, and therefore to maximize his own wealth, he would simply not give Person B any.

Question 14

Which of the following games measures whether people are willing to pay money to penalize others for being unfair?

Answer 14

Ultimatum game

The ultimatum game allows the recipient to punish the first player for an unfair allocation by deciding no one gets anything. They may pay a cost by foregoing whatever money the first player gave them.

Question 15

Trust game

Answer 15

• Similar to the Dictator Game, but with an added first step.
• One participant given endowment (e.g. $10).
• Participant decides how much to give to the second participant.
• Amount is then (typically) multiplied by researchers.
• Second participant now acts as a dictator.
• Decides how much of the increased endowment to keep and how
much to allocate to the first participant.
• Measures how much people care about each other, but also trust

Question 16

Dictator game

Answer 16

• Simplest way to study social preferences
• “Dictator” makes an allocational decision that affects herself and other subject(s), the “recipient(s)”
• Can be thought of as measuring ‘raw’ concern for others
• When you don’t know anything about the other person and she hasn’t done anything within the interaction
• Original version: giving recipient $1 costs dictator exactly $1.
• Other versions: giving recipient $1 costs dictator $x.

Question 17

Dictator game with costly exit

Answer 17

• Lazear, Malmendier, and Weber (2006) conduct an experiment to study the motives for giving.
• Two treatments
(1) Standard Dictator game experiment, where dictators split $10 between themselves and another subject.
(2) In another treatment, subjects decide whether to even participate in the dictator game.

• If a dictator chooses to participate:
• Recipient is informed of the game.
• Standard dictator game commences.
• If a potential dictator chooses not to participate:
• She receives e10 without option to distribute the money.
• The potential recipient is not told about the Dictator Game.

Question 18

Ultimatum game

Answer 18

• Simple bargaining game extensively studied by experimental
economists.
• Two players, who typically remain anonymous
(1) The “proposer”
• Provisionally allotted divisible pie (usually money)
• Offers a portion x of the pie to the “responder”
(2) The “responder”
• Knows both the offer and the total amount of the pie.
• Accepts or rejects the offer.
• Payoffs
• If the responder accepts, she receives the amount offered, and the
proposer receives the remainder.
• If the responder rejects, neither player receives anything.

Question 19

Dictator game with costly exit - what are the findings?

Answer 19

• Exit option lowers giving.
• In standard Dictator Game, dictators share e1.87 on average.
• When dictators can exit, they share only e0.58 on average.
• Subjects even willing to pay to avoid dictator-game situation:
• Many subjects take e9 rather than split e10 in Dictator Game.
• On average, subjects are willing to take 82.4% of the pie rather than split the full pie in the dictator game.
• Why do subjects want to exit?
• They want to take the money for themselves.
• But they don’t want to indicate to the potential recipient that she’s been treated unfairly.
• Exiting allows them to both satisfy their greed and not worry about the recipient’s reaction

Question 20

Ultimatum game - what are the results?

Answer 20

(1) Most offers are between 40% and 50% of the pie.
(2) Such offers are mostly accepted.
(3) The acceptance rate is increasing in the offer.
(4) Offers below 20% are mostly rejected.

Game theory predicts..
• Clear prediction as to what happens in the game if people do not care about others
• Responder cares only about money, so will accept any x > 0.
• Proposer cares only about money, so offers as little as possible.
• Equilibrium offer: zero or smallest possible positive amount

Question 21

What is the yearly discount factor for Thomas if he is indifferent between $27 today and $43 in three years from now?

Answer 21

delta = (24/43)^(1/3) = 0.856

Question 22

Carl has a yearly discount factor of 0.89. For what value of X is she indifferent between $12 today and $X in two years from now?

Answer 22

Y = (delta) ^ t * X
12 = (0.89) ^ 2 * X
X = 15.15

Question 23

Decision Option A (Today) Option B (In 3 months)
Decision 1

Option A (Today):$39 guaranteed today	
Option B (In 3 months): $40 guaranteed in 3 months

Calculate the one-year discount factor that allows you (the decision maker) to be indifferent between the two options - for decision 1

Answer 23

t = (3/12)

delta = (39/40) ^ 1/(3/12) = 0.90

Question 24

Decision Option A (Today) Option B (In 3 months)
Decision 1 $39 guaranteed today $40 guaranteed in 3 months
Decision 2 $37 guaranteed today $40 guaranteed in 3 months
Decision 3 $34 guaranteed today $40 guaranteed in 3 months
Decision 4 $30 guaranteed today $40 guaranteed in 3 months
Decision 5 $25 guaranteed today $40 guaranteed in 3 months
Decision 6 $19 guaranteed today $40 guaranteed in 3 months
Decision 7 $12 guaranteed today $40 guaranteed in 3 months

When presented with the above price list, Amy chooses Option A until Decision 3 but switches to Option B from Decision 4. What is her approximate discount factor (δ)?

Answer 24

We know that Amy shifts between Decision 3 and Decision 4, so discounting factor lies between 0.32 and 0.52

Decision 3 = (34/40)^(1/(3/12)) = 0.52

Decision 4 = (30/40)^(1/(3/12)) = 0.32

Question 25

Jessica has a wealth of USD 50000. She is offered a gamble where she could gain USD 5000 with 60% chance but lose USD 8000 with 40% chance. Assuming she is risk averse, would she accept the gamble?

Answer 25

In this case, EMV (Accept gamble) = (55000.6) + (42000.4) = 49800

EMV (Reject gamble) = 50000

Risk averse person would not accept the gamble .

Question 26

Consider a lottery with three possible payouts: $100 with a chance of 25%, $75 with a chance of 40% and $ 50 with a chance of 35%.

What is the expected monetary value (EMV) of this lottery?

Answer 26

EMV = (100.25) + (75.40) + (50*.35) = USD 72.50

Question 27

Consider a lottery with three possible payouts: $100 with a chance of 25%, $75 with a chance of 40% and $ 50 with a chance of 35%.

What is the maximum amount that a risk-neutral person would pay to play this lottery?

Answer 27

A decision-maker is risk-neutral if, for any lottery G she is indifferent between G and getting the EMV(G ) for sure. In this case, the EMV of the lottery is USD 72.50.

Question 28

Decision 1
Option A: $500 for sure
Option B: 1/6 chance of $700 and 5/6 chance of $300

Calculate the Expected Monetary Value of Option B for Decision 1

Answer 28

For each lottery, EMV(X,Y) = PxX + PyY

EMV, Decision 1 = (1/6)700 + (5/6)300 = 366.67