1. Mental Accounting
Corporations and governments use accounting systems not just to
keep the books but also to display what they are doing in different ways to
help them take action and make decisions. E.g. financial, managerial,
capital accounts etc.
1. How Well Hedonic Editing Work?
a. Thaler in 1985 paper suggests it works well based on questionnaires to
students with examples like the lottery/rug. p. 204 (win lottery, damage
b. But, in later work with Johnson based on asking about preferences
1. Explaining the face experiment or the ideal wingman?
a. Recall, presented with three faces
a.i. (A) classic Greek
a.ii. (B) classic Greek but weak chin
a.iii. (C) Spanish
b. People chose A
c. This would be understandable if A or B were the reference po
1. Choice (welfare economics) vs.Judgment (experienced utility)
a.i. People chose the higher paying job but believed they would be
more satisfied at the other with better relative position.
a.ii. Some say happiness is primarily based on contrast, not e
1. Asian Disease Problem
a. Imagine that the U.S is preparing for the outbreak of an unusual
Asian disease, which is expected to kill 600 people. Two alternative
programs to combat the disease have been proposed. Assume that
the exact scientific estimate
1. Expected Utility Theory (EUT)
In the EUT framework, 4 axioms must hold. Let q, r, and s, be defined as
the following lotteries: q=(x1,p1; x2,p2;xn,pn), r=(y1,q1; y2,q2;yn,qn) and
s=(z1,w1; z2,w2;zn,wn). Also, define aWb to mean that a is weakly prefer
1. Utility as Well-Being vs. Ordinal Utility
a. Originally, utilitarian's thought of utility as well-being or pleasure (cardinal).
Could compare over time for an individual or across individuals.
b. In the late 19th century, economics abandoned this notio
1. Examples from KT article
c. More Examples from KT article
Lost $140last race of the day
Long shot bet of $10 on 15:1 race
Two Frames (or reference point)
Present state, looking forward: Gain of $140 and loss of $10
Or, Prior stat
1. Thaler Examples: Loss Aversion
Positive Theory of Consumer Choice
Out of pocket cost viewed as lost but opportunity costs are viewed as
If there is loss aversion (magnitude of pain of loss exceeds joy of gain)
then out of pocket matte
1. Loss aversion among dimension
(KT, QJE 1991)
a.i. Ninety Stanford undergrads received written instructions
indicating that some participants, selected at random, would
receive a gift package.
a.ii. For half the participants (the dinner g
1. Answers to Equity Premium Puzzle
a. Maybe we just have not seen the rare, risky events yet! Can this be what
has happened in the last decade or so?
b. Mental Accounting Explanation
b.i. If you hold stocks, over shorter periods you will lose sometimes.
1. Other Transactional Issues Related to
Opening and Closing Accounts
When to close an account? Stock price falls but you hold
onto itkeep it openbut if you sell it, you close the account.
People keep losers and sell winners (bad tax
1. Sunk Costs
a. Case I: bought basketball tickets, dangerous snow storm, still go to game
b. Case II: given tickets, dangerous snow storm, just stay home
c. But rational people should weigh things on the margin.the sunk costs of
buying tickets should not
1. Biases from Heuristics:
a. Representativeness [used to see if A belongs to a class B or originates
from process B]
b. Availability [used to calculate frequencies]
c. Anchoring [used to estimate probabilities when some numbers are given