Final exam econ 115 practice.pdf

# Mental accounting the reference point component the

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mental accounting : the reference-point component: the perception of outcomes in terms of gains and losses the name component: the assignment of activities to various accounts the time component: how often the accounts are balanced. Summary: the probability formulation makes people less frightened than the frequency formulation where both the number of cases and the denominator are given. Gambler’s Fallacy: the belief that, if something happens more frequently than normal during some period, it will happen less frequently in the future, or that, if something happens less frequently than normal during some period, it will happen more frequently in the future Hot Hand Fallacy : the sometimes fallacious belief a person who experiences success with a random event has a greater probability of further success in additional attempts. -Economic behaviors that can be explained by confirmation biases • naivete: persistent overestimation of self-control and underestimation of future temptations (health clubs and credit cards) overinvesting in individual stocks excess trading Conjunction fallacy refers to the tendency to overestimate the probability of independent events occurring together: Examples: GRGRRR perceived as more likely than RGRRR What is the probability that 6 million parts work in a Boeing if the probability of a single part failure is 1 in a million? P(6 million events of probability 0.999999) = (0.999999) 6000000 =0.25% Availability Effects • Vivid description of an event increases the subjective probability of this event. Examples: accidents, terrorist attacks, deceases. •Partition dependence. Explicit listing of possible events affects beliefs. Our tendency to construct and believe coherent narratives of the past makes it difficult for us to accept the limits of our forecasting ability. This tendency is known as hindsight bias . Taleb calls it narrative fallacy . Hindsight bias combines: Availability heuristics: the past is more vivid than the future The law of small numbers: small sample is enough Confirmation bias: people forget that their forecasts did not work in the past. There are several related behavioral patterns: •Framing •Reference Dependence •Anchoring •Narrative Fallacies

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They all mean that some irrelevant features (words, status quo, irrelevant numbers, fictional stories) can affect choices with material rewards. Framing is the most general term. Reference dependence is about status quo, gains and losses. Anchoring is about irrelevant numbers. Small samples makes it easier to produce extreme results (best schools are small) -A representativeness heuristic is a cognitive bias in which an individual categorizes a situation based on a pattern of previous experiences or beliefs about the scenario. It can be useful when trying to make a quick decision but it can also be limiting because it leads to close-mindedness such as in stereotypes.
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