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Exam 4: Status Quo Bias and Default Options

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Standard utility maximization cannot be used to describe preference reversals.

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In the experiment discussed on page 5 of Chapter 4 , the researchers could have suggested any number to the participants. For example, the researchers could have suggested the number given by the subjects' arrival to the experiment instead of the last two digits of the social security number.

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A default option is the option that is selected when the decision-maker is indifferent between choices.

A preference for the default option is called:

The endowment effect is only an "anomaly" if utility is linear.

Constant sensitivity implies all of the follow except:

An individual must choose between 4 insurance policies, $x_{1}, x_{2}, x_{3}, x_{4}$ , where $x_{1}$ is the company's default option. The utility the individual receives from each option is ordered the following way: $u\left(x_{3}\right) >u\left(x_{1}\right) \geq u\left(x_{2}\right) >u\left(x_{4}\right)$ . Which option does the individual choose?

Diminishing Sensitivity implies that when there are two goods (i \& j) and when I expect less of good i, then to give up a set amount of good i, I need to be compensated with less j THAN when I am initially expecting more of good i.

Refer to Figure 4.3. Bundle $\mathrm{x}$ and $\mathrm{y}$ both have more of good $\mathrm{I}$ than reference points $\mathrm{r}$ and s. The curve $v_{s}$ traces out the difference curve when using reference point s. Let $\Delta_{1}$ be the amount of good $\mathrm{j}$ the individual must be given in order to be indifferent between bundle $\mathrm{y}$ and bundle $\mathrm{x}$ under reference point $\mathrm{s}$ . Let $\Delta_{2}$ be the amount of good $\mathrm{j}$ the individual must be given to give up the SAME amount of good i under reference point $r$ . Which of the following is true?

What is the difference between the status quo bias and the default option bias?

The endowment effect is:

Strictly diminishing marginal pain from losses implies what about the slope of the value function in the domains of losses?

If there is a violation of transitivity or completeness then a standard utility function cannot represent the individual's preferences.

There are three bundles of goods: $x, y, z$ . A consumer has preferences such that $x \geqslant$ $y, y \geqslant z$ . If $x \sim z$ then the consumer's preferences cannot be described as transitive.

If the amount of utility I receive from a good is the same amount of utility I would lose if the good was taken away then I'm willing to pay the same amount to acquire the good as I would be to sell the good.

The default option bias implies that the default option is specified by an outsider, whereas the status quo bias does not have this implication.

Suzie has $\$ 50$ of income and a utility function given by $u=\sqrt{x_{1}}+\sqrt{x_{2}}$ . The price of good $2, p_{2}$ , is $\$ 2$ . a. First suppose $x_{1}=0$ . How much of $x_{2}$ does Suzie have? b. How much is Suzie willing to pay to acquire one unit of $x_{1}$ ? c. Now suppose $x_{1}=1$ . How much is Suzie willing to sell her one unit of $x_{1}$ ? d. George faces the same prices and has the same income as Suzie, but his utility function is given by e. Repeat part a. f. Repeat part b. g. Repeat part c. h. What feature of the utility function results in $p^{W T P} \neq p^{W T A}$ ?

The relationship between the default option bias and a reference point is best described by which of the following:

In 3 sentences describe the relationship between the default option and the "anchoring and adjustment" mechanism.

The rational model predicts that if an individual has complete preferences over a set of goods, then the fact that one of the goods is the default option should have no impact on his choices.