## Questions

1. Consider a high school student who is given $3 every

school day by her parents as “lunch money.” The

student works a part time job after school, earning a

small amount of “spending cash.” In addition to her

lunch money, the student spends $5 from her own

earnings each week on lunch. Suppose her parents

reduced her lunch money by $2 per day but that she

simultaneously receives a $10-per-week raise at her

job, requiring no extra effort on her part. What would

the rational choice model suggest should happen to her

spending on lunch? Alternatively, what does the

mental accounting framework predict?

2. Suppose you manage a team of employees who manufacture

widgets. You know that profits depend

heavily on the number of widgets produced and on the

quality of those widgets. You decide to induce better

performance in your team members by providing a

system of pay bonuses for good behavior and pay

penalties for bad behavior. How might hedonic framing

be used to make the system of rewards and penalties

more effective? How does this framing differ

from the type of segregation and integration suggested

by hedonic editing?

3. Suppose you are a government regulator who is concerned

with the disposition effect and its potential

impact on wealth creation. What types of policies could

be implemented to reduce the sale of winning stocks

and increase the sale of losing stocks? The government

currently provides a tax break for the sale of stocks at a

loss. This tax break tends to encourage the sale of losing

stocks only in December. What sorts of policies could

encourage more regular sales of losing stocks?

4. You are considering buying gifts for a pair of friends.

Both truly enjoy video gaming. However, both have

reduced their budget on these items because of the

temptation that they can cause. Dana is tempted to buy

expensive games when they are first on the market

rather than waiting to purchase the games once prices

are lower. Thus, Dana has limited himself only to

purchase games that cost less than $35. Alternatively,

Avery is tempted to play video games for long periods

of time, neglecting other important responsibilities.

Thus, Avery has limited herself to playing video games

only when at other people’s homes. Would Dana be

better off receiving a new game that costs $70 or a gift

of $70 cash? Would Avery be better off receiving a

video game or an equivalent amount of cash? Why

might these answers differ?

5. Suppose Akira has two sources of income. Anticipated

income, y1 is spent on healthy food, represented by x1,

and clothing, x2. Unanticipated income, y2 is spent on

dessert items, x3. Suppose the value function is given

by v x1, x2, x3 = x1x2x3

13

, so that marginal utility of

good 1 is given by v x1, x2, x3

x1

= 13

x −23

1 x2x3

13

, marginal

utility for good 2 is v x1, x2, x3

x2

= 13

x −23

2 x1x3

13

, and

marginal utility of good 3 is given by v x1, x2, x3

x3

=

13

x −23

3 x1x2

13

. Suppose y1 =8 and y2 =2, and that the

price of the goods is given by p1 = 1, p2 =1, p3 = 2.

What is the consumption level observed given the

budgets? To find this, set the marginal utility of consumption

to be equal for all goods in the same budget,

and impose that the cost of all goods in that budget be

equal to the budget constraint. Suppose Akira receives

an extra $4 in anticipated income, y1 =12 and y2 = 2;

how does consumption change? Suppose alternatively

that Akira receives the extra $4 as unanticipated

income, y1 =8 and y2 =6; how does consumption

change? What consumption bundle would maximize

utility? Which budget is set too low?

6. Consider the problem of gym attendance as presented

in this chapter, where Jamie perceives the value

of attending the gym to be va xn − pδt n +

vt − pδt +pr n , where xn is the monetary value to

Jamie of experiencing the n th single attendance event

at the gym, p is the price paid once every six months, δ

is the monthly rate of depreciation, t is the number of

months since the last payment was made, n is the

number of times Jamie has attended the gym since

paying, including the attendance event under consideration,

and pr n is the price Jamie considers fair for

attending the gym n times. Suppose that the cost of

gym membership is $25. Further, suppose Jamie considered

the value of attending the gym n times in a sixmonth

window to be va n = 5n− n2 − δt25 n. Also,

suppose that Jamie considers the fair price for a visit

to be $4, so the transaction utility is equal to

vt n = −25δt +4n. Payments depreciate at a rate of

δ= .5. Determine the number of visits necessary in

each of the six months in order to obtain a positive

account. How much time would have to pass before

only a single visit could close the account in the black?