ps1sol - Department of Economics University of California...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Department of Economics University of California Berkeley Psychology and Economics Spring 2007 Botond K˝oszegi Problem Set 1 – Solutions (please address any questions regarding the grading of this problem set and these solutions to Matt Levy) 1. (a) According to the neoclassical economic model, the percentage of people trading their mugs for a pen and those trading a pen for a mug should sum to about 100. Although we cannot observe people’s preferences, we know that some percentage of the population prefers mugs over pens – call this percentage X. Because subjects are randomly assigned, about X percent of people given a mug prefer it over a pen, and about X percent of those given pens would have preferred a mug. When we allow them to trade, about (100-X)% of the mug-owners will do so and X% of the pen-owners will as well. If we thought X were roughly 12% (so as to explain the low amount of trading among mug-owners), then the neoclassical model would predict that over 90% of pen- owners would trade – a very different result from the 10% seen in the study! (b) It is natural to posit that the reference point for subjects in this study is status quo – that mug-owners feel endowed with a mug and that pen-owners feel endowed with a pen. Because losses are felt more strongly than correspondingly sized gains, very few mug-owers would give up their mug (and therefore experience a loss) in order to get a pen and a nickel (both gains). Likewise, pen-owners would not be willing to experience a loss of their pen for a gain of a mug and a nickel. (c) This utility function captures loss aversion, but does not display diminishing sensitivity. Loss aversion is captured be the fact that the slope of v ( x ) is 1 for x 0 (gains) and 3 for x < 0 (losses). This creates a “kink” at the reference point . Because the value function v ( · ) is linear, this formulation does not display diminishing sensitivity. (d) An owner of a mug feels ”endowed” with a mug (so
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 4

ps1sol - Department of Economics University of California...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online