ARE 133 Behavioral Economics Practice Midterm PDF

ARE 133: Behavioral Economics Kiesel Name:___________________________ Last 4 digits of SID:_____________ Practice Midterm Instruct...

ARE 133: Behavioral Economics Kiesel Name:___________________________ Last 4 digits of SID:_____________ Practice Midterm Instructions: Instructions: Please answer questions in Part I and II using a scantron form (UCD Scantron 2000), and Part III in the space provided. Read the questions carefully and check your answers before handing in your exam. Please make sure you bubbled in your student ID and test version on your scantron. You have 80 minutes to complete the exam. Total points: 150. You studied and you can do this! What matters is your lessons learned rather than your mistakes. Part I: Multiple-Choice Questions (90 points, 3 points each) 1) Behavioral economics is the study of how _______________ human behavior impacts the allocation of scarce resources. a) Predicted. b) Observed. c) Irrational. d) Rational. 2) All of the following are motivations for employing behavioral models, except for developing ___________ theories. a) Strategic. b) Therapeutic. c) Unifying. d) Academic. 3) The concept of bounded rationality refers to: a) A utility function that cannot be fully described. b) Individuals unable to use “rule-of-thumbs” to make decisions. c) Only individuals who have been well-trained in economics can make the optimal decisions. d) Limits on cognitive abilities, access to information and limits on other necessary resources keep individuals from achieving utility maximization. 4) What types of tools do all rationally bounded individuals use to make a decision? a) Calculators. b) Advertising. c) “Rule of thumbs” or heuristics. d) Their friends. 5) The below figure shows three utility curves. Which of the following statements is not true? a) Utility increases as you move upwards along a utility curve. 2 x b) On a single utility curve, the level of utility is constant. c) Utility decreases as you move to utility curves towards the origin. x1 d) Utility is an ordinal measure. x2 * U > U ( x1*, x2 *) U = U ( x1*, x2 *) U < U ( x1*, x2 *) x= 2 ( y − p1 x1 ) p2 x1 * x1 6) If and are both normal goods and , then necessarily increases if a) increases. b) increases. c) increases, decreases. d) Both increase. 7) A consumer typically buys toothpaste A. He is watching TV one day and sees an advertisement about toothpaste B. He realized that toothpaste B has been available for purchase as long as toothpaste A, but he never knew it existed. What assumption is violated? a) Transitive preferences. b) Increasing utility for normal goods. c) Complete preferences. d) Stable Preferences. 8) A relationship between and has been estimated in an experimental setting. If this relationship can be broadly applied outside of the laboratory, then the experiment is considered: a) internally valid. b) externally valid. c) a natural experiment. d) a quantitative experiment. 9) What is the main difference between a behavioral model and a procedurally rational model? a) Behavioral models are not based on any particular assumptions, whereas procedurally rational models are. b) Procedurally rational models do not depart from the rational model, whereas behavioral models do. c) Behavioral models tell us why individuals make certain choices, whereas procedurally rational models do not. d) There are no differences. 10) The sunk cost fallacy occurs when: a) Losses hurt more than gains. b) Gains or losses are compared to some reference point. c) I attempt to recover past costs by continuing an activity when there is a negative return. d) My utility function contains a bliss point. 11) Payment decoupling is best described as: a) The idea that losses hurt more than gains. b) The idea that the payment and consumption are separated by time and do not seem as closely linked. c) The idea that people suffer from the cognitive costs of choosing which bundle to purchase. d) The idea that I take sunk costs into account when making consumption decisions. 12) A consumer has preferences over two goods, where where and if positive amounts of are purchased and 0 otherwise. If both and are normal goods and and , then a decrease in has the following effect. a) Changes the relative price of the two goods: changes the slope of the budget line. b) Has a negative income effect: shifts the budget line towards the origin. c) Has a positive income effect: shifts the budget line away from the origin. d) No effect. 13) There are two local bars and I always buy the same beer at both bars. At the first bar, the music is bad and the bartender is rude. At the second bar, the music is wonderful, there are lots of friendly people, and I always enjoy myself more than when I go to the first bar. An example of context adding value to a good is: a) I pay a dollar more for the beer at the second bar than I pay at the first bar. b) I pay $10 for a beer at the second bar. c) I never go to the first bar. d) I stop talking to the bartender at the first bar. 14) When an individual uses a comparison to aid making a decision, we often call this a: a) Sunk cost. b) Fixed cost. c) Reference point. d) Decoupling. 15) What is one possible way a non-economist would describe preferences that display distaste for linear pricing? a) A preference for convenience. b) A preference for self-control. c) A preference for getting a good deal. d) A preference for unlimited consumption. 16) Bob and Amy have the same utility functions and purchase the same two goods at the same prices. Bob works two jobs. He makes $100 a week at his first job and $500 at his second job. Amy works one job and makes $600 a week. What does the rational model predict about their optimal consumption choices? a) Amy consumes more than Bob. b) Bob consumes more than Amy. c) Bob and Amy consume the same total amount of goods, but different compositions of the two goods. d) Bob and Amy’s optimal consumption bundles are the same. 17) What is the main feature of the double-accounting system? a) The gain of some transactions is so great that the benefit is doubled. b) Each transaction is recorded either as a benefit or as a cost. c) Each transaction is recorded twice, once as a benefit and once as a cost. d) The net value of a transaction is always 0. 18) The most common heuristic in the theory of mental accounting is the segmenting of purchase. The segmenting of purchases means that a) The consumer considers all consumption plans simultaneously. b) The consumer enters each transaction into the ledger simultaneously. c) The consumer enters each transaction on a piecemeal basis and keeps separate accounts for different types of transactions. d) The consumer shares the decision-making responsibility with other consumers. 19) Suppose a consumer as a value function over gains given by. If and then which of the following is true? a) The consumer should integrate over gains. b) The consumer should segregate over gains. c) The consumer is equally well off if he/she/they segregate or integrate. d) The consumer should integrate if and are allocated to different budgets. 20) The gain from consuming a good and the loss from paying for purchasing the good is known as: a) Transaction utility. b) Loss aversion. c) Consumption utility. d) Acquisition utility. 21) Suppose a consumer buys a very expensive bottle of wine and consumes the entire bottle in one evening. However, he had to put the expense on a credit card and knows he will be paying his balance at the end of the month. Which type of behavior does this consumer necessarily exhibit? a) Loss aversion. b) Payment Decoupling. c) Reference dependence. d) Risk Aversion. e) An individual whose preferences are given by the indifference curve in the figure below has preferences that violate which of the following assumptions found in the rational model: a) Completeness only. y b) Completeness and transitivity. c) Transitivity only. d) Monotonicity. y1r v ( x, y | x1r , y1r ) = k1 y2r v ( x, y | x2r , y2r ) = k2 x1r x2r 22) An individual must choose between 4 insurance policies, where is the company’s default option. The utility the individual receives from each option is ordered the following way:. Which option does the individual choose? a) b) c) d) 23) What is the difference between the status quo bias and the default option bias? a) No difference. b) The default option bias is a preference for failing to pay back loans, whereas a status quo bias is a bias that results from a preference for the currently chosen option. c) The default option bias is a bias that occurs when there is a preference for a default option and a status quo bias is a bias that results from a preference for the currently chosen option. d) The default option bias is a bias that occurs when there is a preference for a default option and a status quo bias is a bias for what other individuals have chosen. 24) Anne and Jim participated in an experiment about the willingness to pay for a set of head phones. Jim is suggested a price of $22 and Anne is suggested a price of $13. The experimenters conclude that both Anne and Jim use the anchoring heuristic to arrive at a final willingness to pay. What are possible values of their willingness to pay: a) Anne: $15. Jim: $30. b) Anne: $30. Jim: $30. c) Anne: $13. Jim: $13. d) Anne: $25. Jim: $15. 25) Strictly decreasing marginal utility from gains implies what about the slope of the value function in the domains of gains? a) Concavity. b) Linearity. c) Convexity. d) None of the above. 26) The endowment effect is: a) The difference in willingness to pay and willingness to accept when there should not be a difference. b) Always in violation of the rational model. c) Describes the bias of individuals endowed with more money. d) An increase in utility from more income. 27) Segmentation Independence refers to which concept? a) The available choices do not change based on how they are grouped together. b) When all decision-makers make choices simultaneously they make the same choices. c) Decisions of a single individual do not change based on how they are grouped together. d) Elements of your choice set can be broken into smaller pieces. 28) The following statements about excepted utility theory are all equivalent except: a) For all gambles an individual’s certainty equivalent equals 0, b) E(u(x))=u(E(x)) c) The individual is risk averse. d) The individual is risk-neutral. 29) Narrow bracketing of investments in a portfolio of risk assets can lead to which of the following except: a) Excess exposure to risk. b) Excess diversification. c) Optimal exposure to risk. d) No risk in the portfolio. 30) A tendency to broadly bracket decisions may be evidence of a) A diversification bias. b) Melioration. c) A status quo bias. d) A default option bias. Part II: True/False Questions (40 points, 2 points each) 31) An individual’s utility function is always expressed in terms of dollars or money. 32) If preferences are complete and transitive then utility curves will never intersect. 33) Transaction Utility describes the scenario in which a consumer spends too much on a good. 34) A firm must consider its fixed cost and its marginal cost when deciding how much to produce. 35) Two-Part Tariffs affect the consumer’s utility function. 36) Acquisition utility refers to the utility I receive from consuming a good and transaction utility is the utility I derive from feeling like I got a good deal. 37) Mental accounting is a theory of how individuals group and categorize money and transactions so that they can more easily evaluate the trade-offs. 38) The idea that money in a savings account is different than money in a checking account is an example of segmenting. 39) Mental accounting is an alternative concept to transaction utility. 40) Whether a consumer is better off “integrating” or “segregating” is independent of whether he/she/they are experiencing multiple losses or multiple gains. 41) Regret and temptation are key features of the rational model. 42) There are three bundles of goods: A consumer has preferences such that If then the consumer’s preferences cannot be described as transitive. 43) Under the rational choice model, a default option should hold no special place in the mind of the individual decision maker. 44) Diminishing Sensitivity implies that when there are two goods (i & j) and when I expect less of good i, then to give up a set amount of good i, I need to be compensated with less j then when I am initially expecting more of good i. 45) Consider two bundles and and a reference point If then it must also be true that and 46) The policy implication of the default option bias is that policy-makers can set a desired choice as the default option. If the default option bias is present then this increases the likelihood that the government’s choice is implemented. 47) The status quo bias is necessarily inconsistent with the rational model. 48) Narrow bracketing can lead to addiction because I consider the benefits of my addictive behavior today separately from the costs it will impose on me tomorrow. 49) A decision-maker always arrives at different choices if he/she/they segment their decisions. 50) An individual’s certainty equivalent is the amount of money the individual must receive with certainty in order to attain the same level of utility as the expected utility of a gamble or uncertain event. Part III: Short Answer Questions (20 points, points as marked) 1) Experiments: Two economists team up with the local basketball team to manipulate the pricing of season tickets. The first 100 fans that signed up for season tickets paid full price, the next 100 fans got a 10% discount and the next 100 fans received a 20% discount. They then compared the attendance across the different categories of discounts to see whether those who paid full price were more likely to attend the games. (5 points) a) Would this experiment allow you to credibly test the sunk cost fallacy? (2 points) b) Why or why not? Briefly explain (3 points) 2) Concepts: What does loss aversion imply about an increase and decrease of about equal size from a reference point? (6 points) a) Briefly explain. (2 points) b) Show this graphically. (2 points) c) Briefly describe the relationship between the default option and the “anchoring and adjustment” mechanism by relating them both to the concept of a reference point. (2 points) 3) Application: A consumer knows that he/she/they will go to the gym 10 times or less every month for 12 months. He is offered two types of memberships. The first membership is a flat monthly rate of $55 for unlimited use. The second membership plan is a $10 one-time fee and $5 per visit. (9 points) a) The consumer decides that he/she/they should buy the first membership plan. Is that the correct choice? Briefly explain. (3 points) b) What type of bias explains this choice? (3 points) c) Assuming the consumer is affected by payment depreciation, what would you expect about gym attendance if he/she/they can pay the membership fee in full (with a slight discount resulting in $600 overall payment) at the beginning of the year? ( 3 points)