ACE 474 Midterm 2 Questions And Complete Solutions

Risk Averse - CORRECT ANSWER A person who will always refuse a fair gamble (Expected Value/Utility = 0) Risk Neutral - CORRECT ANSWER A person who is generally indifferent between accepting and refusing a fair gamble Risk Loving - CORRECT ANSWER A person who always accepts a fair gamble Certainty Equivalent - CORRECT ANSWER The amount you would have to be offered as a "sure thing" to be indifferent between the offer and the gamble Risk Pooling - CORRECT ANSWER Pooling your resources and sharing the risk. Ex. Wealthy people invest in projects to spread out their risk Adverse Selection - CORRECT ANSWER The process by which sellers has more information than the buyer regarding product quality. Ex. a person with a dangerous job is more likely to have life insurance Moral Hazard - CORRECT ANSWER Some type of insurance or incentive that will lead people to behave in a more risky manner. Statistical Discrimination - CORRECT ANSWER Conclusions are drawn based on some known characteristics. Ex. insurance premiums, credit scores, ACT/SAT scores Search Goods - CORRECT ANSWER Quality determined by inspection before purchase Experience Goods - CORRECT ANSWER Quality determined by consuming a good Credence Goods - CORRECT ANSWER Quality cannot be determined even after goods are consumed Asymmetric Information - CORRECT ANSWER One party knows more information than the other and can be used to manipulate for personal benefits Voluntary Food Labeling - CORRECT ANSWER Companies will voluntarily label if their benefits outweigh their costs. 3 big limitations -- Presents undesirable characteristics, Relative information, partial disclosure and innuendo Third Party Labeling - CORRECT ANSWER Increases reliability and credibility. Verifying producer claims, certifying products, enforcing quality claims, consistent standards Mandatory Food Labeling - CORRECT ANSWER Initially large impact on manufacturers production decisions than on consumers food choice. More successful at filling information gaps than at addressing externalities. Kahneman & Tversky's Value Function - CORRECT ANSWER People care about individual gains and losses. Steeper in losses than gains, Losses weigh more on decisions than gains, people evaluate the event and then add the separate values together, Diminishing returns in gains and losses Hedonic Framing - CORRECT ANSWER Divide money into mental accounts, attempts to maximize psychological pleasure and minimize pain Segregate Gains - CORRECT ANSWER Break up gains -- opening 3 gifts opening 1 gift with 3 items inside Combine Losses - CORRECT ANSWER Combining all the losses into one -- telling your parents all the bad news at once telling them in bursts Offset Small Loss with Large Gain - CORRECT ANSWER $50 from grandma or $250 from grandma and $200 speeding ticket Segregate small gains from large losses - CORRECT ANSWER Rebate on a car you purchased (Pay $12,000 get $1,000 back) or buying a cheaper car (Pay $11,000) Heuristics - CORRECT ANSWER The process in which people find things out on their own, usually by trial and error, leading to the development of a "rule of thumb" Availability Bias - CORRECT ANSWER People weigh on what is easy to retrieve or remember from memory. Too much weight on recent events and bizarre events. Ex. are there more suicides or murders in NYC? Suicides. Representative Bias - CORRECT ANSWER Judgements are based off of stereotypes. Anchoring & Adjustment Bias - CORRECT ANSWER People choose preliminary estimate and then adjust it in accordance with any additional info they have that seems relevant Weber Echter Law - CORRECT ANSWER Notice change when change is a larger proportional to the original situation. Ex. $5 off a $5 pizza or $5 off a $1,000 computer. Halo Effect - CORRECT ANSWER Choose between A and B -- add in C close to B and people will choose B over A. Makes the alternative look much better Time Consistent - CORRECT ANSWER Doesn't matter when you ask a person about a decision the utility will be the same at both moments B=1 Time Inconsistent - CORRECT ANSWER Person has different trade-offs between two points in time depending on when the question is asked. Naive Time Inconsistent - CORRECT ANSWER The person does not realize their preferences will change in future. They perform better when rewards are immediate because they do not realize the reward in front of them. Sophisticated Time Inconsistent - CORRECT ANSWER The person is more aware and they value the present much more highly than the future. They perform better when costs are immediate because they know they are procrastinating