1- Choice under uncertainty

Question 1

What does weak preference (≽) mean?

Answer 1

At least as good as

Question 2

What are axioms?

Answer 2

Self-evident statements which cannot be proven

Question 3

What is the axiom of transitivity?

Answer 3

If x≽y and y≽z then x≽z

Question 4

What is the axiom of completeness?

Answer 4

Either x≽y or y≽x or both

Question 5

When are weak preference relations defined as rational?

Answer 5

The weak preference relation is rational if it satisfies the Axioms of Transitivity and Completeness

Question 6

What is the indifference preference relation?

Answer 6

x~y if and only if x≽y and y≽x

Question 7

What are the 3 properties of the indifference preference relation?

Answer 7

1. Reflexivity: x~x
2. Symmetry: if x~y then y~x
3. Transitivity: if x~y and y~z then x~z

Question 8

What is the strict preference relation definition?

Answer 8

x≻y if and only if x≽y and not y≽x

Question 9

What are the 3 properties of the strict preference relation?

Answer 9

1. Irreflexivity: Not x≻x
2. Anti-symmetry: if x≻y then not y≻x
3. Transitivity: if x≻y and y≻z then x≻z

Question 10

What are the 2 requirements of a rational choice?

Answer 10

1. rational preference ordering
2. choose the most preferred option under the set of alternatives

Question 11

What is the representation theorem?

Answer 11

For finite domains, there exists a utility function u(·) that represents the weak preference relation ≽ if and only if ≽ is rational

Question 12

What are explicit costs?

Answer 12

What you have to pay in dollars to get something

Question 13

What are opportunity (implicit) costs?

Answer 13

The value of the next best option foregone

Question 14

What is net (utility) surplus?

Answer 14

Utility of your choice minus opportunity cost

Question 15

What is the opportunity cost proposition?

Answer 15

An alternative is a rational choice if and only if its utility is greater than its opportunity cost

Question 16

What are sunk costs?

Answer 16

Costs that cannot be recovered once the decision is made

Question 17

What is the sunk cost fallacy?

Answer 17

Failure to ignore sunk costs

Question 18

What is the Independence of Irrelevant alternatives?

Answer 18

If x is chosen from menu {x,y} then y cannot be chosen from menu {x,y,z}

Question 19

What is the decoy effect and how does it change preferences?

Answer 19

If you introduce a similar good which is absolutely dominated by your own good then you can shift the indifference curve slope in favour of your good

Question 20

What is the compromise effect?

Answer 20

Consumers often prefer the middle option due to extremeness aversion so firms may offer extremely expensive or cheap products to manipulate clients

Question 21

How are menu dependencies explained?

Answer 21

If you make a decision you have to justify your purchase so although you may be spending a lot, the belief it is a bargain justifies it

Question 22

What is the willingness to accept (WTA)?

Answer 22

The minimum price to give up an object if in possession

Question 23

What is the willingness to pay (WTP)?

Answer 23

The maximum price in order to obtain the object

Question 24

What should the relationship between WTA & WTP be under rational preferences?

Answer 24

WTA=WTP i.e. endowment should not affect choice

Question 25

What is the endowment effect?

Answer 25

Subjects often require more to give up an object than they would be willing to pay to get one: WTA > WTP

Question 26

What is loss aversion?

Answer 26

The phenomenon that people dislike losses more than gains

Question 27

What is the Anchor and adjustment heuristic?

Answer 27

Adjustments are frequently insufficient such that final judgements reflect the (possibly) arbitrary anchor

Question 28

How do you construct a budget line? i.e. what is its equation

Answer 28

p1q1 + p2q2 = w

Question 29

How do you find the Marginal rate of substitution?

Answer 29

Differentiate the budget line for it’s gradient

Question 30

How do you calculate the value of gains and losses with a reference point value function?

Answer 30

Insert reference point and amount in gain scenario, and subtract for ELSE scenario, vice versa for loss