Decision Making and Behavioral Economics

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Questions and Answers

Which program resulted in a higher preference in the first framing scenario?

Program A (correct)

Both programs equally

Program B

Neither program

In the second framing scenario, what was the probability of nobody dying under Program B?

⅓ (correct)

⅔

What percentage of individuals preferred Program D over Program C in the second framing scenario?

33%

67% (correct)

76%

50%

What was the key difference in how the two groups analyzed their investments?

Group 1 saw monthly fluctuations while Group 2 saw annual aggregates. Signup and view all the answers

According to the findings, what behavior was exhibited in framing 1 compared to framing 2?

Risk avoidance in framing 1 and risk-taking in framing 2. Signup and view all the answers

What is the most common choice pattern regarding acceptance of a second gamble?

Accept when you have won the first gamble Signup and view all the answers

According to the sure-thing principle, what dictates taking action X?

Taking the same action regardless of event A's outcome Signup and view all the answers

In the scenario of purchasing a vacation package, what was the likely choice of students who passed the exam?

54% chose to buy the package Signup and view all the answers

What is the reaction of individuals after experiencing a loss in the first gamble?

They often feel they cannot lose and take the risk Signup and view all the answers

What choice did individuals frequently make when faced with an uncertain outcome on the exam?

They were split between buying the package and waiting Signup and view all the answers

How does the complexity of an alternative action influence the attractiveness of the default option?

It increases the attractiveness as it reduces cognitive effort. Signup and view all the answers

What is a common reason why people choose the default option?

Default options are often perceived as recommendations. Signup and view all the answers

Which of the following considerations should policy-holders balance when choosing defaults?

Effects of defaults on physical, cognitive, and emotional costs. Signup and view all the answers

In the context of decision-making, how do defaults function when individuals lack a clear preference?

Defaults guide decision-makers towards a chosen option. Signup and view all the answers

What is a primary concern when defaults may lead to misclassification?

Balance between ethical implications and psychological impacts. Signup and view all the answers

What is one of the psychological implications of selecting a default option?

It may lead to overconfidence in decision-making. Signup and view all the answers

What effect does accepting a default option generally have on decision-making effort?

It significantly reduces the decision-making effort required. Signup and view all the answers

How does the concept of the default relate to the status quo?

Defaults are often a representation of the current state or status quo. Signup and view all the answers

What happens to the pot in the St-Petersburg game each time a head appears?

It is doubled. Signup and view all the answers

Why do few people are willing to pay a large amount to play the St-Petersburg game despite its infinite expected value?

Players value utilities differently than monetary outcomes. Signup and view all the answers

Which characteristic best describes risk-averse individuals?

The utility gained from extra wealth diminishes. Signup and view all the answers

In which scenario are individuals more likely to become risk seekers?

When evaluating options involving certain losses. Signup and view all the answers

What does prospect theory emphasize in decision making?

Evaluation of outcomes relative to a reference point. Signup and view all the answers

How does the concavity of a utility function relate to risk preferences?

It signifies risk aversion. Signup and view all the answers

What do losses loom larger than gains mean in the context of decision making?

The emotional response to losses is stronger than to gains. Signup and view all the answers

What does risk loving behavior imply about an individual's utility?

They experience increasing marginal utility of wealth. Signup and view all the answers

What is the primary factor that leads to different WTA and WTP values in the context of the given scenarios?

The endowment effect influencing sellers Signup and view all the answers

What does loss aversion in prospect theory indicate about our perception of ownership?

Owners fear loss more than they value gains Signup and view all the answers

Which describes the disjunction effect?

Deciding differently based on whether a related event is known or unknown Signup and view all the answers

In the classroom experiment, what behavior did choosers exhibit compared to buyers and sellers?

They behaved similarly to buyers in terms of pricing. Signup and view all the answers

Why is WTA typically higher than WTP according to the findings from the experiments?

Sellers perceive a greater loss when parting with an item. Signup and view all the answers

What is the significance of reference dependence in economic decisions?

It establishes ownership as a reference point for valuing items. Signup and view all the answers

What was the observed behavior when a gamble with a potential outcome was presented?

Participants avoided the gamble due to uncertainty in outcome. Signup and view all the answers

What was the general conclusion drawn from the behavior of the groups in the classroom experiment regarding ownership?

Owners are influenced by emotional biases in valuation. Signup and view all the answers

What decision did the majority of physicians make regarding the patient's medications before hip replacement surgery?

Let the patient have the surgery first. Signup and view all the answers

In the organ donation experiment, which default option yielded the highest consent rates?

Opt-out Signup and view all the answers

What is the decoy effect in decision-making?

Adding an irrelevant third option that influences choices. Signup and view all the answers

In the economist experiment comparing 2 versus 3 subscription options, what happened with the internet-only subscription when a third option was added?

It decreased in popularity. Signup and view all the answers

What was the outcome when both trips to Rome and Paris were presented with and without an added breakfast option?

The addition of breakfast made Rome more popular. Signup and view all the answers

What does expected value calculation assume about decision-making?

People always choose the option with the highest expected value. Signup and view all the answers

What is a key difference between expected value and expected utility?

Expected utility incorporates risk preferences, expected value does not. Signup and view all the answers

What is the outcome when tossing a fair coin repeatedly until tails appears in the St-Petersburg experiment?

The game continues until it reaches a monetary value. Signup and view all the answers

Why did majority of physicians decide to pull the patient back and try medications in the first scenario?

Due to uncertainties about medications' effectiveness. Signup and view all the answers

What was found regarding the 'default' options in the organ donation study?

Defaults drastically influence people's decision-making processes. Signup and view all the answers

Study Notes

The Default Effect

The default (status quo) option influences complex decisions
Complexity of the alternative makes the default more attractive
People choose the default when unsure
Defaults are considered suggestions from policy-makers
Defaults represent the existing state
Changing defaults often involves a trade-off
Defaults need to balance between ethical and psychological factors

Organ Donor Experiment

Physicians were asked about medication and surgery decisions for patients
Majority of physicians in the first scenario chose to treat the patient with the medication
Second scenario, majority of physicians opted for the surgical procedure

Decoy Effect

Decoy Effect: options will influence decision-making, especially when an inferior option changes choices between two similar options.
Presenting options in pairs vs triplets causes significant choice change
Trip to Rome vs Paris expenses paid: one option with a slightly better deal becomes more popular

Expected Value and Utility

Expected value = outcome multiplied by probability
Calculated without sentimental attachment
Assumes equally valued gains & losses
Assumes people pick option with highest expected value
Expected Utility: subjective value related to outcome

St-Petersburg Paradox

Expected value of a coin toss game is infinite.
Few people would pay more than a small amount to play.
People prefer certainty over a gamble in terms of utility.

Prospect Theory

Prospect theory amends Expected Utility Theory
Decisions are based on gains and losses relative to a reference point
Value function is steeper for losses than gains
Diminishing marginal sensitivity to gains and losses
Losses weigh more heavily than gains
Risk averse for gains
Risk seeking for losses

Disjunction Effect

Disjunction effect occurs when someone agrees to do X if A occurs, if A doesn't occur, but isn't willing to carry out X when the outcome of A is unknown.
People can't make a rational decision when options aren't clear.

Neurofinance

Interdisciplinary field that explores how the brain influences financial decisions
Prefrontal and parietal cortex are involved (rational decision-making part of the brain )
Somatic markers: anticipatory emotions that help assess risk and reward

Unfair offers in ultimatum games activate emotional responses in the brain
Ethical implications influence decisions about fairness and altruism

Moral Reasoning

Moral dilemmas often trigger strong emotional responses, overriding purely logical reasoning
Important to consider the emotional responses in ethical decision-making

Intertemporal Choice

Decisions involve trade-offs between costs and benefits at different time points.
Current reward often outweighs future gains
People discount future payoffs.
Impulsive behavior related to the reward system.

Risk Taking

Baseline dopamine and phasic dopamine response affect risk perception
Higher serotonin levels lead to lower risk tolerance.
Testosterone linked to higher risk-taking behavior.

Ambiguity Aversion

Ambiguity aversion is when people prefer known odds over unknown odds.
Ambiguity can lead people to avoid risks when knowing the probabilities and details concerning the risk.

Information Processing

Limited cognitive abilities lead individuals to rely on heuristics (mental shortcuts) for decision-making.
This affects accuracy, as people might not consider full details of factors or all variables.

Belief Perseverance

Tendency to stick to initial beliefs, even facing conflicting evidence
Confirmation bias causes people to prioritize information that supports current beliefs.

Overconfidence

Overconfidence is when people overestimate their abilities and accuracy.
Causes over-extension and poor investment decisions.

Herding Behaviour

Herding occurs when an individual makes a decision based on observing the behavior of other people. They believe the group is more informed
Overconfidence is related as investors try to estimate market confidence.

Disposition Effect

Selling winning investments too early and holding losing investments for too long.
Emotional decisions on gains vs losses.

Household Finance

Many households save inadequately for retirement due to poor financial literacy or lack of self
control.
2006 US Law to include auto-enrollment

Nudges

Subtle interventions that influence choices in ways that achieve positive outcomes.
Automatically enroll to retirement plans
Using positive reinforcement in combination with negative reinforcement
This influences positive behavior by reducing negative emotions.

Corporate Finance

Corporate malfeasance/misconduct reduces trust and leads to financial losses.
Ethical procedures in place and strong leadership are very important in reducing misconduct.

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Description

This quiz explores key concepts in behavioral economics, focusing on the default effect, organ donor decision-making, and the decoy effect. Understand how defaults influence choices and the implications of decision-making scenarios in medical contexts. Test your knowledge on these fascinating psychological phenomena.