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Econ 490 Class notes - Econ 490 Evaluate outcomes not on an...

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Econ 490 1/9/08 - Evaluate outcomes not on an absolute scale but relative to reference points o Hate falling short of reference point Gambling : hate to take a loss on a given day At the end of the day, a gambler far behind will place a far fetched bet with higher stakes to try and break even Loss aversion - People tend to buy 2 nd cheapest wine on wine list - Effect of phrasing o People have different attitudes between gains and losses Tend to be risk averse with gains Tend to be risk loving with losses Insurance, financial planning (losing inflation) Save 200 people vs. killing 400 people - Caring about others o Placing monetary value on equality and punishment Choosing 0,0 instead of 9,1 Depends more on your perceived intention of the other person more than the actual offer Fairness must extend utility function - false beliefs o Not properly applying bayes rule to statistics Ignore crucial piece of information – base rate of occurrence for population o Overconfident in self and overoptimistic of prospects 9/10 people believe themselves to be better than average drivers - se lf control o inner conflicts in making choices Britain – betting on your own weight loss. 82% lose bets Can be due to naivety or lack of self control (resisting immediate temptations) o Immediate gratification vs. future People overestimate their future ability to wait Sales: no interest for ____, no payments until _______ - Mistakes most prevalent when: o Decision makers are inexperienced. Often when decision can only be made a few times. Big events, such as picking a house o When transactions are one on one or there is a personal connection o When stakes are low Supermarkets and small items o When paid advisors are not aware of these mistakes or have same biases they cannot help
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o When arbitrage is impossible Inadequate retirement savings o When transacting with professional salesmen 1/14/08 - Classical choice theory – economic models created based on “reasonable” properties of choice o Axioms include monotonicity and transitivity Every bundle can be compared (preferred, not, or indifferent), no indecision Transitive o Risk-less utility is ordinal. Arbitrary number assigned for purpose of ranking, not a cardinal measure - Reference specific o Income, relative to others o Happiness, relative to past states - Endowment effect – receiving a good has a smaller valuation than losing the same item o Kahneman – mug experiment Randomly distributed mugs and asked what value buyers would pay and sellers would sell at Prices ranged from $.50 to $9.50 in $.50 increments - Status Quo Bias o Tend to stick with the option that you have U = V1(x1-r1)+v2(x2-r2) - Loss aversion graph o Diminishing sensitivity - Constant loss aversion graph o Loss aversion coefficient = 2 o F(x) = x if x > 0, -2x if x < 0 o If you lose one unit in first dimension, must gain 2 units in second dimension to remain indifferent o R = reference (how much you have) o Losing 1 mug for candy = V(0-1)+V(1) = V(-1)+V(1) = 2*-1+1=-1 o
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