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

this chapter?

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

1 +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

1 x.5

2 ?

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?

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