Week 2 Flashcards
(38 cards)
Why do consumers prefer consumption today rather than in the future?
Because:
* There is a chance that they will not be able to
consume in the future
* Expectation that income will be higher in the future (economy will grow)
What is the opportunity cost of spending now?
If you don’t consume today, you can put this money on the bank and earn interest.
Explain the direct connection between time preferences and interest rates.
If people are more impatient, they will save less. This makes it harder for firms and other agents to lend money. As a result, the interest rate will be higher.
Taking the opposite route: if the interest rate is higher, it becomes more worthwhile to save, and people will spend less now.
What is an extra factor you take into acount by the formula of exponential discounting?
De delta factor: For every time period squared, which is not zero. For example 0,9.
What is the formula for beta-delta discounting?
Uoverall = U0 + β [δ1U1 +δ2U2 +···]
Where:
* δ is the regular discount factor that discounts utility incrementally more in each subsequent period.
* β is the present bias parameter that discounts utility in all non-current periods.
What is an other name for beta-delta discounting?
(quasi) Hyperbolic discounting
What is characteristic for (quasi) hyperbolic discounting?
Rapid rate of decline in the short run
But, slow rate of decline in the long run
Due to that present bias addition of Beta
Why are people procrastinating to change unhealthy behavior (explained with the beta-delta model)?
Imagine it is thursday and you want to quit smoking on friday. The only difference between friday and saturday then is delta. But when it becomes friday the difference between friday and saturday is beta + delta. So then it is not optimal anymore to quit on friday. So you keep postponing the change of your bad behvior.
What is the sign effect?
Gains are discounted at a higher rate than losses
What is the magnitude effect?
Large outcomes discounted at a lower rate than small outcomes
What is the sequence effect?
We often prefer improving to declining sequences.
(in 1 year: 30,000 euros, in 2 years: 40,000 euros,
in 3 year: 50,000)
≻
(in 1 year: 50,000 euros, in 2 years: 40,000 euros,
in 3 years: 30,000)
What are habits?
Habits are learned sequences of acts that have become automatic responses to specific cues, and are functional in obtaining certain goals
or end-states.
What are 4 characteristics of habits?
1) It is easier to form a new (non-competing) habit than break an existing one
2) Simple behavioural responses are easier to become habitual
3) Habits form quickly when context-behavior links are followed by reward/success
4) Due to the automaticity of habits, breaking the habit is effortful and deliberate
Which 2 systems describes the dual-system theory?
The automatic system:
- Fast
- Unconscious
- Automatic
- Everyday decisions
- Error prone
The deliberate system:
- Slow
- Conscious
- Effortful
- Complex decisions
- Reliable
What is ego-depletion?
Ego-depletion is like a muscle. You can hold the temptation for a while, but at some moment you need to give up.
What is self-licensing?
Self licensing means that you’ve worked so hard, that you can reward yourself with for example, a cookie or a beer.
Link the following:
Ego-depletion, self-licensing
Automatic system, deliberate system
Ego-depletion: Automatic system
Self-licensing: Deliberate system
Which three kinds of risk attitudes exist?
- Risk neutrality: indifferent between a sure outcome and a lottery with the same expected value
- Risk aversion: preferring a sure outcome to a lottery with the same expected value
- Risk seeking: preferring a lottery to a sure outcome with the same expected value
What does reference-dependence mean?
Preferences are defined relative to a reference point.
What is the four-fold pattern of risk attitudes?
Results from the combination of:
* A value function concave for gains and convex for losses
* Inverse-S-shaped probability weighting functions
Which results in:
- Gains and small probability: Risk seeking
- Gains and large probability: Risk aversion
- Losses and small probability: RIsk aversion
- Losses and large probability: Risk seeking
Which issues with expected utility theory were the reason to conduct the prospect theory?
- Overvaluing certain events
- Overweighting small probabilities
- Importance of framing (reference points)
- Loss aversion
What are the three pillars of prospect theory?
- Reference-dependence (a value function instead of standard utility function)
- Probability weighting (instead of probabilities)
- Loss aversion (a pure psychological phenomenon, an extra)
What are three key differences between economic risks and health risks?
- All risks appear to be known
o In real life, often we face ‘uncertain’ conditions (no information on probabilities) - Outcomes are monetary
o Many risky ‘gambles’ involve health outcomes or both - Pay-outs are hypothetical
o Although generally we find no qualitative difference in preferences, generally more variance
What is the representativeness heuristic?
The probability that A belongs to B -> How representative is A for B?
Representativeness = similarity to ‘stereotype’
