ACE 474- midterm 3 Questions And
Complete Solutions 2026/27
Conventional Utility Function - CORRECT ANSWER people care about whether events increase
or decrease their total wealth
Kahneman & Tversky Value Function - CORRECT ANSWER people care about individual gains and
losses
What are the assumptions of Kahneman & Tversky? - CORRECT ANSWER 1. Function is much
steeper in losses than in gains.
2. Losses given much heavier weight in decisions than gains
3. People evaluate events first and then add the separate values together
4. Diminishing returns in gains and losses
Hedonic framing - CORRECT ANSWER maximize psychological pleasure and minimize pain
(regret)
To make people happier about their alternatives: - CORRECT ANSWER 1. Segregate gains: getting
pleasure form each individual
2. Combine losses
3. Offset loss with larger gains
,4. Segregate small gain from large loss: make happier with little gain
Heuristics - CORRECT ANSWER people find things out for themselves by trial and error leading
to the development of rules of thumb
-lead to errors and result in cognitive bias
3 common biases that can result when people use "rule of thumb" in decision making -
CORRECT ANSWER -availability bias
-representativeness bias
anchoring and adjustment bias
Availability bias - CORRECT ANSWER people give too much weight to what is easy to retrieve
from memory
-too much weight on recent events and bizarre events
Representativeness bias - CORRECT ANSWER judgement based on stereotypes
Regression to the mean - CORRECT ANSWER after first measurement, variable will tend to be
closer to the average on second measurement
-100% on first exam, <100% on second exam
Anchoring and adjustment bias - CORRECT ANSWER people choose preliminary estimate
(anchor) and then adjust in accordance to additional information
, -given starting point and adjust with additional information
Weber-Fechner Law - CORRECT ANSWER more likely to notice a change when the change is
larger proportional to the original situation
Independence of irrelevant alternatives (IIA) - CORRECT ANSWER adding alternative C shouldn't
affect whether A is preferred to B or B preferred to A
What is the Halo Effect? - CORRECT ANSWER The Halo Effect is a cognitive bias where the
perception of one positive trait influences the perception of other traits.
What happens when an alternative C is added that is worse than A or B in the context of the
Halo Effect? - CORRECT ANSWER People tend to choose A if A is closer to C, and B if B is closer
to C.
What does the term 'halo' refer to in the context of the Halo Effect? - CORRECT ANSWER The
term 'halo' refers to the influence of the closest alternative on the perception of other options.
What are time consistent preferences? - CORRECT ANSWER Preferences that do not change
regardless of when a decision is made.
What does it mean to trade off utility at one point in time vs another? - CORRECT ANSWER It
refers to comparing the satisfaction or benefit derived from choices made at different times.
What should you do according to time consistent preferences? - CORRECT ANSWER You should
always make the same decision no matter when you are asked.
Complete Solutions 2026/27
Conventional Utility Function - CORRECT ANSWER people care about whether events increase
or decrease their total wealth
Kahneman & Tversky Value Function - CORRECT ANSWER people care about individual gains and
losses
What are the assumptions of Kahneman & Tversky? - CORRECT ANSWER 1. Function is much
steeper in losses than in gains.
2. Losses given much heavier weight in decisions than gains
3. People evaluate events first and then add the separate values together
4. Diminishing returns in gains and losses
Hedonic framing - CORRECT ANSWER maximize psychological pleasure and minimize pain
(regret)
To make people happier about their alternatives: - CORRECT ANSWER 1. Segregate gains: getting
pleasure form each individual
2. Combine losses
3. Offset loss with larger gains
,4. Segregate small gain from large loss: make happier with little gain
Heuristics - CORRECT ANSWER people find things out for themselves by trial and error leading
to the development of rules of thumb
-lead to errors and result in cognitive bias
3 common biases that can result when people use "rule of thumb" in decision making -
CORRECT ANSWER -availability bias
-representativeness bias
anchoring and adjustment bias
Availability bias - CORRECT ANSWER people give too much weight to what is easy to retrieve
from memory
-too much weight on recent events and bizarre events
Representativeness bias - CORRECT ANSWER judgement based on stereotypes
Regression to the mean - CORRECT ANSWER after first measurement, variable will tend to be
closer to the average on second measurement
-100% on first exam, <100% on second exam
Anchoring and adjustment bias - CORRECT ANSWER people choose preliminary estimate
(anchor) and then adjust in accordance to additional information
, -given starting point and adjust with additional information
Weber-Fechner Law - CORRECT ANSWER more likely to notice a change when the change is
larger proportional to the original situation
Independence of irrelevant alternatives (IIA) - CORRECT ANSWER adding alternative C shouldn't
affect whether A is preferred to B or B preferred to A
What is the Halo Effect? - CORRECT ANSWER The Halo Effect is a cognitive bias where the
perception of one positive trait influences the perception of other traits.
What happens when an alternative C is added that is worse than A or B in the context of the
Halo Effect? - CORRECT ANSWER People tend to choose A if A is closer to C, and B if B is closer
to C.
What does the term 'halo' refer to in the context of the Halo Effect? - CORRECT ANSWER The
term 'halo' refers to the influence of the closest alternative on the perception of other options.
What are time consistent preferences? - CORRECT ANSWER Preferences that do not change
regardless of when a decision is made.
What does it mean to trade off utility at one point in time vs another? - CORRECT ANSWER It
refers to comparing the satisfaction or benefit derived from choices made at different times.
What should you do according to time consistent preferences? - CORRECT ANSWER You should
always make the same decision no matter when you are asked.
