Minor - Week 2 Flashcards
Interest rate
How high the costs are of borrowing money or rewards for saving
Interest rate higher results in
Becoming more attractive to consume later on
- Most likely induce a subsitution effect
Discounted utility
-People care about consumption more now than in the future.
- Weight added to utility
VB: 50 min now or 60 min later
50 kost minder moeite
Time preference
Positive time preference (prefer consumption today rather than in the future)
Because
- Income can be higher in future
- Chance not able to consume in future
Link time preferences and interest
- Spend tomorrow, can not earn interest at the bank (opportunity cost of spending now)
- The more impatient the more they spent
- For firms harder to lend money
- Interest rate will be higher
Classic exponential - Theoretical function of discounted utility
- Formula: Ut = ut + delta^1 (ut+1) +delta^2 (ut+2) + delta ^3 (ut+3) +
Discount function does not decline more quickly in the short-run
than in the long-run. (neemt constant met bv 10 % af) itt tot hyperbolic discounting
time inconsistency
People tend to be not consistent with decisions for the future.
- Change our mind often
They change their mind due to a higher weight on utility in the present
The beta delta discounting
Uoverall = U0 +β [δ^1* U1 +δ^2 *U2 +…]
- beta= present bias parameter
β<1 (present high evaluation - Delta = regular discount factor δ ≤ 1
Delta
Discount rate utility incrementally more in each period
- Time dependent
- Discounting factor showing how impatient somebody is
δ ≤ 1
Beta why smaller than 1?
Because future is less utility, if it was 1, then rewards in the future would be the same
Beta
Present bias parameter, discounts utility in all non-current periods
- 0 < β
- Utility in the present is valued especially highly
- Utility from any future period receives an extra devaluation
- Special value of “now”
beta delta discounting model - Sort of discounting
Hyperbolic discounting
- First period high decline
- Lower decline if you go futher into the future.
When are you time inconsistent ?
- When beta is lower than 1.
Less value in future than initially thought
Hyperbolic discounting also known as
Myopic preferences
Uoverall = U Thursday + β δ UFriday + β δ^2USaturday+
Here it seems logic to quit smoking on saturday, your utility is at is lowest point
- But there will be a saturday when your utility is high
Why time inconsistent preferences are self destructive
myopic preferences lead to a cricle of postponing, because utility in the future is always lower
Implications time inconsistency
- Costs are mostly reaped in future periods (health consequences, are less negative than at the present)
- In contrast: doing exercises has costs today and benefits much late
- Laying in bed costs is present and not discounted
- benefit of going to lecture is discounted due to present bias
Cost benefit analyse is different
Overcome hyperbolic discounting?
- Commitment contract; brings costs of smoking forwards
- Money on the bank for 6 months otherwise to charity
Higher discount rates
- Relation with money stronger than health outcomes
- Hyperbolic more unhealthy behavior than constant discounting
Other effects hyperbolic discounting in constract to constant discounting
- Sign effect
- Magnitude effect
- Sequence effect
Discounting depends on consumption!
Sign effect
Losses are treated other than gains, hyperbolic (constant discounting says this shouldn’t matter)
- Losses in future are more bad than losses now (not in line with consistent theory); that says all outcomes are less worth in future!
- Gains are discounting in future, less worth
-Constant discouting says equal not the case
Magnitude effect
Large outcomes discounted at a lower rate than small outcomes
- Individuals may not want to wait too long for small amounts
- For example: prefer 1-, now to 2-, in a year but also prefer 200,000-, in 1 year to 100,000- now (not consistent, than there is no discounting)
Delayed speed-up assymetry
- Delay from some temporal reference point.
- Acceleration from some temporal reference point.
- Different discount rate
Ex; 100 euro in a week, but now month later. Discount rate is higher and otherwise
Sequence effect
We often prefer improving to declining sequences.
Explanations
Time inconsistency perspective from pyschology
- Intention behavior gap
- Habits
- Self- control
- Dual systems
- Ego depletion
- Self licensing & confabulation
Theory of planned behavior
- Attitude
- Subjective norms
- Percieved behavioral control (influences intention and behavior)
Leads to intention
Leads to behavior
Attitude
“how do I feel about exercising?- values/characteristics etc.
subjective norms
what do others do?”,- conformism/normative beliefs
Percieved behavioral controo
“to what extent do I feel like I can
influence the behavior in question, do I have the skills or resources to do it?”
- Skills and resources
Habits
=automatic behavior
Definition: learned sequences of acts that have become automatic responses to specific cues and are functional (successful) in obtaining certain goals or end-states.
- Easier to form than to break
Contextual cue
A stimulus in your surrounding that is linked to a behavioral response, with no deliberation needed
- Work –> bike
How to form habits
- a contextual cue in the same stable context
- leads to a behavioral response frequently
- it leads to a positive experience/reward
Breaking a habit
- Easier to break than to form
- Simple behavioral responses are easier to become a habit
- easy when followed by reward
- breaking habits requires deliberate action
Hot cold gap
Hot environment; high emotional and arousal (likely to act on impulses)
Cold environment; low emotional and arousal
Hot cold gap; trouble imaging what we would do in hot environments
- Need self control
Self control (hoffman, Friese en strack)
Capacity to resist impulses
- Reflective precursors
- Impulsive precursors
- Reflective precursors
Components of self-control that
we have our own control through logic.
- Restrain standards
- Deliberate eveluations
- Impulsive precursors
- Automatic affactive response
-Automatic approach-avoidance reactions
situational or dispositional boundary conditions
(kind of a slope between reflective and impulsive precursors)
so the outcome depends on the situation and position people are in, do I generally have high self-control?
Dual system theory (Kahneman)
System 1 - Automatic: Fast, automatic, acts on impulses, error prone (Homer economics)
(automatic system)
System 2 - Reflective: Slow, conscious, reliable, older, captures cold cognition (deliberate system)
Ego deplation
Self control is a limited resource, especially when:
- Suppressing emotions
- Choosing healthy in the face of temptation
- Under cognitive load
- After a boring task or challenging task
People are less motivated to control their impulses
Self-licensing & confabulation
Ego depletion and dual systems looks like automatic system always lead to bad health behavior.
- Not the case
Self licensing; Feeling like you deserve a reward after exertion, which can lead to unhealthy behaviour. Example: “I worked hard, so I deserve these biscuits.”
Risks in health economics
- Diagnostic risk (screening)
- Treatment risk
- Effectiveness medicine
- Risk of disease
- Risk of outbreaks
Calculation EU
EU= p1U1+p2U2
Expected Utility of wealth
E(U(W)) = (1-p) * U (Wh) + p * (Ws)
- Wh = wealth healthy
- Ws = Wealth sick
U(w)= Wortel (w)
Insurance utility maximizing
- Expected utility of wealth is 97,24
- Wealth sick = 2000
- Wealth healthy = 10.000
- Prob sick = 0.05
- Would you insure?
Loss of wealth (income) = 8000
- Probabilty of this loss = 0,05 * 8000 = 400
- Insurance offers premium for 9600 (10.000 - 400)
EU=U(9,600)=97.98>97.24
Would insure because higher level of certainity
Concave graph
Risk aversion
3 risk types
- Risk aversion; sure outcome above lottery with same expected value
- Risk seeking; Lottery above sure outcome with same value
- risk neutral; indifferent to lottery or sure outcome with same value
Allias paradox
People don’t follow the rules of being consistent as it is in the utility theory
- Chance to loose small –> don’t take the gamble (choose for the safest option, with less chance to win nothing)
Not consistent with
- Chance to loose are high people like to take the gamble even it is not the safest option.
(choosing not for 89% nothing but for 90% nothing)
People dont take rationality in to account but more the perception and weight of losses and wins
Allias paradox violation of
independence axiom
independence axiom
If a choice has the same outcome in both scenarios, you can ignore that part of the gamble because it doesn’t add any new information or change the odds.
- score out the same chances
Elements in prospect theory (Kahneman & Tversky)
- Reference dependance (framing)
- Loss aversion
- Overestimating small probabilities
- Overvaluing certain events
Reference dependance
Attitudes might be different in the gain and in the loss
domain
- gains strictly prefered to the reference point
- Losses strictly less prefered to the reference point
Examples of reference dependance
- Sticking to current health insurance
- Patients in very poor health may take more risk as their reference point is
death
-
Status quo bias
This knowledge can be used to construct clever default options to ‘nudge’ people
- Vaccinations the norm
- Organ donation the default
Diminishing sensitivity
the higher the number is absolute value, the less sensitive the individual is
- valid for gains and for losses
- Gains; reinforces concavity of the utility function
- losses; induces convexity of the utility function
Loss aversion
More sensative to losses than to gains
v(x) = u+(x) if x > 0
V(x) = -λ*u-(-x) if x ≤ 0
Formulas loss aversion
- x are gains and losses relative to the reference point
- Loss averion is increased by lambda
- Steeper for losses
Consequences of loss aversion
- Disparity to willingness to pay and willingness to accept; WTP is much lower than WTA en eventually to loose
- Endowment effect; more valuable when you poses certain goods, harder to loose for people.
- Incentive framed losses are more effective in prevention health
Basic elements of probability weighting:
- Reference dependance; w + (p) and w -(p) (different function for gains and losses)
- Overweihting small probabilities;
- Underweighting of large probabilities
Linked to pyshological phenomena
- optimism; underweighting; character treat
- Insensitivity (all p weighing as 0,5); cognitive bias
Underweighting
w(p) < (p)
Percieved smaller than actual
Overweighting
w(p) > (p)
Percied weight is higher than actual probability
Impossibility effect:
overweighting of rare events
Overweighting small probabilities
- w(0.01) > 0.01
- People overestimate the (low?) probability
of illness, p - This implies that they may accept an
actuarially unfair premium (r > p*q)
Experience more risk, and are willing to pay for their percieved risk
Overvaluing certainty
- 1−w(0.9999)>0.0001
- Percieve this the high chance as a small chance
- smaller than a 0.0001 chance, because of the overestimation
risk averse
= means mostly case of overweighting
Framing
People tend to be response in framing with the same outcomes and not just the end to end results in their decision
- Not accounted in expected utility function
Fourfold pattern
- Prospect theory predicts four distinct patterns of risk attitudes, eg. EU function just one
Small probability, gains; risk seeking
Small probability, losses; risk averse
Large probability, gains; risk averse
Large probability, losses; risk seeking
shape diminishing sensivity
- Concave (gains) to convex (losses)
Examples calculations - steps
- Look at percieved risks
- Look at utility alternative
- losses are negative
Three pilars prospect theory
- loss aversion (a pure psychological phenomenon, an extra)
- Reference dependence (a value function instead of standard utility function)
- Probability weighting (instead of probabilities)
They can pay a lower premium (smaller certain loss) if they choose a gamble with paying nothing (probability 1-p) or paying their higher voluntary deductible (probability p)
- Status quo bias
- overweighting of low probabilities,
- fear of regret
small risks
Risk aversion
- Weighted high
Representativeness heuristic
is a thinking shortcut where people judge if something (A) belongs to a group (B) based on how similar A is to their idea of that group, without using logic or statistics.
- overestimate probabilities when something fits a stereotype.
Problems;
- Prior probabilities
- sample size
- Randomness of outcome; something looks more random than other sequences
Regression to the mean bias
If one of the outcomes of an experiment is extreme, the next outcome will be
closer to the population mean
- Moving back towards the mean
Availability heuristic
= a mental shortcut that relies on immediate examples that come to a given person’s mind when evaluating a specific topic, concept, method, or decision.
If it comes easier to mind the probability must be higher, more common or more likely
Anchoring (and not enough adjustment) heuristic
= a cognitive bias that causes us to rely too heavily on the first piece of numerical information we are given about a topic.
Systems and biases/heuristics
- Automatic system; relies on biases and heuristics
- Deliberate system; relies on rationality
affect heuristic
The affect heuristic is a mental shortcut where people make quick decisions based on their emotions or feelings (positive or negative) about something, rather than on logical reasoning or facts.
- Experiences (past products associated with feeling)
- Evaluability; (how easy/hard is it to judge goodness/badness)
- Individual differences (like something benefits higher than the risk)
simons scissors
Human rational behavior is shaped by a scissors whose two blades are the structure of task environments and the computational capabilities of the actor
- Computational capabilities (to calculate)
- structure of the task
Ecological rationality or bounded rationality
what’s rational depends on task and environment, not on laws/axioms
- Rational decision makers use fast-and-frugal heuristics that work well
- To understand and predict choices we should go beyond ‘as-if’ models (prospect
theory) and study ‘process’ models (take the best heuristic)
satisficing
Non-compensatory decision rule
- Search for passes aspiration and that is good enough
- rather than maximizing (costs time and energy)
Take the best heuristic
considering a task or choosing proces
- Search rule; Look at cues (characteristics or information) one by one, starting with the most relevant or valid.
- Stopping rule; Stop searching as soon as you find a cue where the two options differ. This difference indicates a potential decision point.
- Decision rule; Choose the option with the better value on that cue
Experiential Sampling Paradigm
In experiential sampling, individuals explore outcomes by sampling. They receive:
Partial feedback: Only informed about the outcome of the chosen option.
Full feedback: Informed about both the chosen outcome and what would have happened with the unchosen option.
Description-Experience Gap
The tendency for people to make different decisions when risks are described vs. when they are experienced.
- Described risks: People choose riskier options with small chances for good outcomes.
-Experienced risks: People choose safer options after sampling the outcomes.
description-experience gap why?
- Incomplete sampling; People tend to sample too few times (median: 16 samples), leading to incomplete information. Rare outcomes may be overlooked, assume the same outcomes
- Recency Bias in Decision Making; rare bad outcome more risk averse
Prospect Theory: Described Alternatives
When risks are described:
- Certainty Effect: People prefer certain outcomes in gains.
- Risk-Seeking in Losses: People take risks when faced with losses, even for unlikely outcomes.
Example: People buy insurance for unlikely losses, even if the risk is very small, because described losses feel more significant.
Description vs. Experience-Based Decisions
In described decisions, people follow predictable patterns. In real-world decisions, they often make the opposite choice, relying on experience and choosing safer options.
