Lecture #5.pdf - Reference Dependent Utility Prospect Theory Loss Aversion Willa Friedman University of Houston September 3 2019 Willa Friedman(UH

# Lecture #5.pdf - Reference Dependent Utility Prospect...

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Reference Dependent Utility Prospect Theory, Loss Aversion Willa Friedman University of Houston September 3, 2019 Willa Friedman (UH) Lecture 5 - Reference Dependent Utility 3 September 3, 2019 1 / 25
Outline 1 Announcements and Review 2 More endowment effect examples 3 Prospect Theory Applications 4 Non-Linear Probability Weighting The simultaneous purchase of lotteries and insurance 5 Summary of prospect theory Willa Friedman (UH) Lecture 5 - Reference Dependent Utility 3 September 3, 2019 2 / 25
More endowment effect examples Assignment 2 due today. Assignment 3 due next Tuesday. Willa Friedman (UH) Lecture 5 - Reference Dependent Utility 3 September 3, 2019 3 / 25
More endowment effect examples If your birthday is in the first half of the year, close your eyes, until I tell you to open them. Willa Friedman (UH) Lecture 5 - Reference Dependent Utility 3 September 3, 2019 4 / 25
More endowment effect examples How much would someone need to pay you to cut off your left foot? Please close your eyes for the next slide. Willa Friedman (UH) Lecture 5 - Reference Dependent Utility 3 September 3, 2019 5 / 25
More endowment effect examples If your birthday is in the first half of the year, please open your eyes now. Imagine you had lost your left foot in an accident. How much would you need to be compensated to be “made whole” again? Think about this. Willa Friedman (UH) Lecture 5 - Reference Dependent Utility 3 September 3, 2019 6 / 25
More endowment effect examples Everybody open your eyes. First half of the year birthdays, give me some numbers. Second half of the year birthdays, give me some numbers. First half of the year, what were you asked? Second half of the year, what were you asked? Why might these be different? We’ll come back to this. Willa Friedman (UH) Lecture 5 - Reference Dependent Utility 3 September 3, 2019 7 / 25
More endowment effect examples Buying and selling prices As last time, let c 1 and c 2 be consumption in mugs and money; and r 1 and r 2 be the reference point in mugs and money. The value/utility function is v (4 c 1 - 4 r 1 ) + v ( c 2 - r 2 ) , where v satisfies v ( x ) = x for x 0 and v ( x ) = 2 x for x 0. Normalize the decisionmaker’s current wealth to zero, and suppose she starts off with zero mugs. We found the buying price was \$2 and the selling price was \$8. Now we’ll consider the buying price for the “seller” or a person with one mug. Willa Friedman (UH) Lecture 5 - Reference Dependent Utility 3 September 3, 2019 8 / 25
More endowment effect examples What is this owner’s buying price for another mug?

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