1. Default options have proved to be effective in guiding
public behavior, possibly by helping to shape individual
preferences where none existed. Suppose, in an
attempt to increase calcium intake by children, a school
decided to include a small carton of plain skim milk
with each school lunch purchased. The children are
very familiar with milk and have well-formed preferences.
Alternatively, children could request milk
with higher fat content, chocolate milk, or no milk, if
they desired, at no extra cost. How might this default
function differently from the default examples given in
2. It is generally found that those who are willing to
change jobs earn greater amounts of money. Essentially,
these people apply for alternative jobs on a
regular basis and change jobs when they receive better
offers than their current employment. However, a relatively
small percentage of employed workers ever
seek other jobs unless they are informed they might
lose their job. Using the terminology and models of
behavioral economics, explain why such a small percentage
of employees would actively look for alternative
jobs when they are secure in their employment.
Additionally, consider employees who are informed
the potential job loss is not based on performance but is
based rather on the structural conditions of the firm,
they might expect to earn more upon finding a new job.
What does the endowment effect have to say regarding
how the employee values the outcome of the job hunt
before and after finding their new job?
3. A novelty store is worried that customers may be
unfamiliar with the items they sell and thus reluctant to
purchase. The owner is considering either using instore
demonstrations of the objects they are selling or
providing some sort of money-back guarantee. Use
diagrams representing the value function of the consumer
to describe the tradeoffs in profit for each
option. What impact should each policy have on the
pricing of the items in the store?
4. Consider again the problem of determining the maximum
amount one is willing to pay to obtain a good
versus the amount willing to accept to part with a good.
Consider Terry, who behaves according to the model
presented in equations 4.4 and 4.7. Let the utility
function be given by u x1, x2 = x.5
2 , wealth is
given by w= 100, and p2 = 1, so that x*2 =100. Derive
the maximum willingness to pay and the minimum
willingness to accept for 100 units of good 1. Which
measure of value is larger? How do you answers
change if instead we considered only 1 unit of good 1?
Under which scenario are the measures of value more
nearly the same? Why? How do these answers change
if u x1, x2 =x.5
5. Now suppose Terry displays constant additive loss
aversion, with vr x1, x2 =R x1 +R x2 , with
R xi =
xi −ri if xi ≥ ri
2 xi −ri if xi < ri.
Complete the same exercise as in question 4. How do
these answers differ from those in question 4? Why?