ECON 440: Lecture 7 - More evidence on risk preferences

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Questions and Answers

What does the prospect theory value function indicate for scores above par?

It represents heightened sensitivity when scoring.

The score is multiplied by $λ$.

The score is represented as $v(∆x) = ∆x$. (correct)

The score is diminished by a constant value.

Why are putts for par generally more accurate than putts for birdie?

Golfers lose focus when aiming for lower scores.

Birdie putts are usually taken from a further distance.

Golfers are better at short putts.

Putts in the loss domain trigger less anxiety. (correct)

What is the predicted behavior of golfers attempting putts from the same distance for bogey versus birdie?

They will make more birdie attempts.

There will be no difference in accuracy.

They will be more accurate for bogey attempts. (correct)

They will focus more on par than bogey.

What influences the choice of a reference point according to the expected outcome?

It can be based on a range of potential outcomes. Signup and view all the answers

In the Abeler et al (2011) experiment, which payment scheme would likely induce higher effort among subjects?

Fixed amount payment scheme of 7 Euros. Signup and view all the answers

How is the expected value determined among various payment schemes in the effort task?

It averages the potential earnings including piece rates. Signup and view all the answers

What psychological bias is illustrated by the preference for par over eagle putts?

Loss aversion. Signup and view all the answers

In reference to effort provision, which scenario represents a potential reference point for a subject?

The average expected payment between piece rate and fixed amount. Signup and view all the answers

What is the implication of the endowment effect in the context of golf putts?

Golfers tend to overestimate the value of putts they own. Signup and view all the answers

What outcome can be predicted from the experiment manipulating expected payments for tasks?

Subjects will put in maximum effort to achieve higher earnings. Signup and view all the answers

What does the willingness to pay vs willingness to accept gap indicate about the values of buyers and sellers?

Sellers' stated price is typically higher than buyers' stated price. Signup and view all the answers

What best describes the endowment effect?

The change in perceived value of an item due to ownership. Signup and view all the answers

Which of the following best illustrates the concept of loss aversion in professional golfers?

Scoring above par is perceived as a loss compared to scoring below par. Signup and view all the answers

Why do owners experience loss aversion in the context of the endowment effect?

They feel that losing an item causes greater emotional pain than the pleasure from acquiring it. Signup and view all the answers

In the classic experiment related to the endowment effect, what was the role of the subjects who were endowed with an item?

They were randomly given items to test their willingness to sell. Signup and view all the answers

What is the primary reason sellers set higher prices according to the endowment effect?

Sellers are attached to the items they own. Signup and view all the answers

What does prospect theory primarily explain in relation to the endowment effect?

How behavior changes based on potential losses and gains. Signup and view all the answers

In the context of professional golf, what is described as a 'birdie'?

One shot below par. Signup and view all the answers

How does the concept of reference points apply to professional golfers?

It creates a benchmark, such as par, which affects their perception of gains and losses. Signup and view all the answers

What expected relationship exists between willingness to pay (WTP) and willingness to accept (WTA) for items?

WTA tends to be higher than WTP. Signup and view all the answers

What is the expected relationship between willingness to pay (WTP) and willingness to accept (WTA)?

WTA is typically higher than WTP. Signup and view all the answers

What is an implication of the endowment effect for consumers in the market?

They may overestimate the value of their possessions when selling. Signup and view all the answers

What impact does the endowment effect have on market transactions?

It leads to inflated prices set by sellers. Signup and view all the answers

Which experimental goods were used to illustrate the endowment effect in the classic experiment?

Pens and mugs. Signup and view all the answers

What motivates Professor A's behavior regarding the bottle of wine in the motivational example?

His emotional attachment to wine after purchasing it. Signup and view all the answers

Which term best describes a situation where golfers exceed par by two strokes?

Double bogey Signup and view all the answers

What aspect of prize money in golf tournaments contributes to the stakes for professionals?

Winners receive a significantly larger share than lower-ranked players. Signup and view all the answers

What is one reason consumers may struggle to sell items they own?

They perceive the loss of ownership as significantly negative. Signup and view all the answers

Study Notes

The Endowment Effect

Individuals tend to value items they own more highly than items they do not own, even if the objective value remains the same.
Motivating Example: Professor A values his wine bottle more highly after owning it, refusing to sell it for less than 100despitebeingwillingtopayonly100 despite being willing to pay only 100despitebeingwillingtopayonly35 for it.
Explanation: Prospect Theory: Owning an item creates a reference point, and losing it feels like a loss, which is more impactful than gaining an equivalent item.

Classical Experiment (Kahneman, Knetsch, and Thaler, 1991)

Undergraduate participants participated in 11 markets for goods like pens and mugs.
Half were randomly assigned ownership of the items.
WTP (willingness to pay) and WTA (willingness to accept) for each item were gathered.
The median WTA (seller's price) was 2-3 times higher than the median WTP (buyer's price).
This gap demonstrates the endowment effect, as sellers value the owned items more highly.

Loss Aversion

Loss aversion is a key principle in behavioral economics.
It explains why individuals are more sensitive to potential losses than potential gains of equal magnitude.
Example: Cab drivers work longer hours on days with lower earnings, indicating aversion to losses relative to their expected earnings.

Is Tiger Woods Loss Averse?

Why Golf? Professional golfers use par as a natural reference point for performance.
Connection to Prospect Theory: Golf scores above par are in the loss domain, while scores below par are in the gain domain.
Prediction: Due to loss aversion, putts attempted for avoiding losses (par, bogey, double-bogey) will be more accurate than putts attempted for gains (birdie, eagle).
Results: Golfers are 2-4% more likely to successfully make putts from the same distance for par compared to birdie.

Reference Points and Effort Provision

Expectations as a Reference Point: Reference points can evolve based on expectations, not just fixed values.
Lab Experiment: Subjects completed a tedious task with a variable payment scheme (piece rate or fixed amount), with uncertainty about the scheme until the end.
Expected Results: Subjects are expected to exert more effort when their expected earnings are higher, due to the reference point shifting towards the higher expectation.

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Description

Explore the intriguing concept of the endowment effect, where individuals value owned items more than their objective worth. This quiz delves into the classic experiments by Kahneman, Knetsch, and Thaler that highlighted this phenomenon and its relation to loss aversion. Test your understanding of how ownership influences valuation.