Winter 2008 - Newhouse's Class - Problem Set 4

# Winter 2008 - Newhouse's Class - Problem Set 4 - Econ 171...

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Econ 171 Winter 2008 Problem Set 4 – Solutions 1. Round Table pizza deliveries take a random number of minutes. The minutes that occur with positive probability are {15, 20, 25, 30, 35, 40}. Customers prefer that their pizzas are delivered sooner rather than later. Round Table can move probability mass from the higher times to the lower times by adding staff. They want to determine their customers’ preferences to determine the optimal hours of staff time to use. Assume the customers are vNM utility maximizers. a. Suppose Round Table uses a purely hypothetical survey. i. Explain how they should construct such a survey. First they should make assumptions about the best and worst outcomes. Our standard set-up is to set u (15) = 1 and u (40) = 0. Then they should figure out each person’s utility for the remaining times. For instance they could ask for the value of p that would make a person indifferent between receiving a pizza in 20 minutes with certainty or receive it according to (15 min, p ; 40 min, 1 – p ). They should repeat this procedure until they have utility values for all of the relevant times. It would also be a good idea to check for consistency through some additional questions. ii. What are the benefits and drawbacks of conducting such a survey? Three main benefits to this type of survey are as follow: Cheap. Easy to administer. Wealth effects won’t be a problem. The main drawback is that people don’t have much incentive to tell the truth. They may not put much thought into their responses. iii. Do their customers have an incentive to lie about their preferences? It’s hard to say if they have an incentive to lie about their preferences. Under our standard set-up they would not have an incentive to lie. However if they are Round Table customers they may lie to try to influence the delivery times and cost. b. Suppose Round Table uses a survey with real consequences. For instance, if someone chooses a lottery of (15 minutes, 0.5; 25 minutes, 0.5) he would receive a slice of pizza after waiting either 15 or 25 minutes, depending on the outcome of the lottery.

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i. Is this method likely to have the equivalent of wealth effects?
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Winter 2008 - Newhouse's Class - Problem Set 4 - Econ 171...

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