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Unformatted text preview: Psychology and Economics Problem Set 1 Professor Botond K˝oszegi Due February 8, 2007 1. This question asks you to think about an experiment related to the endowmenteffect experiments discussed in class. Knetsch (1989) ran an experiment in which he gave a randomly selected half of his subjects mugs, and the other half of his subjects pens. After subjects looked at both items, he offered to exchange each mug for a pen plus 5 cents, and each pen for a mug plus 5 cents. Only 12% of those who originally received a mug, and 10% of those who originally received a pen, chose to exchange it for the other item plus 5 cents. (a) What would the neoclassical economic model predict should be the outcome of this experiment? Explain in words. (b) Explain the experimental results in terms of referencedependent preferences. The rest of this question asks you to think about Knetsch’s exper iment in terms of actual utility functions. Let three dimensions of choice be mugs, pens, and money, with mugs being dimension 1, pens being dimension 2, and money being dimension 3. Denote outcomes in mugs, pens, and money by c 1 , c 2 , and c 3 , respec tively, and reference points in the three dimensions by...
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 Spring '08
 K
 Economics, Game Theory, Utility, reference point

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