Topic 1 - Part 1: Rational Choice

Question 1

What type of relations are these examples:
Betsy is younger than Alfred
Germany is bigger than Norway

Answer 1

These example express a relation between two entities - they are binary relations

Question 2

Example:
Betsy is younger than Alfred: bRa
Germany is *bigger than** Norway: gRn

What do the small and large letter denote?

Answer 2

Small letters denote entities
Capital letters denote relations

Question 3

What does the term universe specify

Answer 3

The term universe specifies what sort of entities may be related to one another

Question 4

When we talk about a preference relation, what term do we use to describe it?

Answer 4

‘Is at least as good as’

Question 5

If x is at least as good as y, and y is at least as good as x, what type of relations is observed.

Answer 5

The indifference relation

Question 6

A rational preference relation is a preference relation that
is

Answer 6

transitive and complete

Question 7

If a person prefers (A) over (B) and (B) over (C), then they must also prefer (A) over (C).
This is an example of what?

Answer 7

Transitivity: This ensures consistency in preferences.

Question 8

For any two options, say (A) and (B), a person can always say which one they prefer or if they are indifferent between them. In other words, given any two choices (A) and (B), either:
(A) is preferred to (B)
(B) is preferred to (A), or
The person is indifferent between (A) and (B)

This is known as….

Answer 8

Completeness

Question 9

Since we assume preferences are rational (transitive and
complete), a preference ordering can be constructed. What roles do completeness and transitivity play in this preference ordering?

Answer 9

Completeness guarantees that there will be only one
ordering; transitivity guarantees that there will be no cycles
in strict preference.

Question 10

Economists like to use numbers to represent strength of
preference. This is done through what?

Answer 10

Utility Functions

Question 11

A utility function associates a number with each member of
the universe (assuming ………)

Answer 11

Completeness

Question 12

What is a Consumption set (or, menu)

Answer 12

The space of all possible
bundles of goods and services.

Question 13

To make rational choices, means: (2 things)

Answer 13

(1) that you have a rational preference ordering, and
(2) that whenever you are faced with a menu (consumption
set), you choose the most preferred item, or (in the case of
ties) one of the most preferred items.

Question 14

Why do economists insist on
rational choice?

Answer 14

Samuelson (1938) identifies choice as a more fundamental
notion than preference mostly because the latter is not
observable while the former is.

Question 15

Suppose we observe the consumption choices that a
consumer makes for different budgets. We can use this
information to do two things

Answer 15

(1) Test rational choice; hence, the behavioural hypothesis
that a consumer chooses the most preferred bundle from
those available;
(2) Discover the consumer’s preference relation.

Question 16

What does A ⊂ X mean?

Answer 16

( A ) is a proper subset of ( X ). In other words, ( A ) contains some, but not necessarily all, elements of ( X ), and ( X ) has additional elements that are not in ( A ).

Question 17

What is the ultimate goal of Behavourial Economics?

Answer 17

The ultimate goal of Behavioural Economics is to construct theories of behaviour. Behavioural Economics is not experimental economics.

Question 18

3 Examples of Methods used to identify anomalies

Answer 18

1. Laboratory experiments involve real people, choices, and incentives, though in a laboratory setting.
2. Field experiments randomly assign participants to test and control groups and track how their behaviour differs in “the real world”
3. Process measures combine these results with brain scans and other data to provide a model of the decision-making process.

Question 19

Which word can be used interchangeably with decision

Answer 19

Choice

Question 20

Which theory of decision describes how people in fact make decisions

Answer 20

A descriptive theory

Question 21

Which theory of decision captures how people should make decisions

Answer 21

A normative theory

Question 22

What does WARP stand for? What is it?

Answer 22

The Weak axiom of revealed preference
If A, B feasible and A chosen, then at any prices and income where A, B are feasible, the consumer will choose A over B. This axiom says two things:
1. People choose what they prefer
2. Preferences are consistent

Question 23

Suppose x is revealed as directly preferred to y, and y is revealed to be directly preferred to z. Then, by transitivity, x is revealed as …….

Answer 23

indirectly preferred to z

Question 24

X being chosen when y is available and y being chosen when x is available, is an example of what?

Answer 24

A violation of the Weak Axiom of Revealed Preference (WARP)

Question 25

Some implications of assumptions of the standard theories

Answer 25

Only incremental costs and benefits at the time of decision-making should matter: choices are made to equate marginal costs with marginal benefits.

Question 26

Assumptions employed about preferences:

Answer 26

Preferences:
1. Are reference independent (e.g., are not affected by the individuals transient asset position)
2. Are invariant with respect to superficial variations in the way that options are described
3. Do not depend on the precise way that preferences are elicited
4. Invariant with respect to irrelevant alternatives

Question 27

Preference reversal

Answer 27

A phenomenon observed in decision-making, where an individual’s preferences change when the context or the way options are presented is altered.

Example:
If bet A offers a high probability of a small payoff and bet B offers a small probability of a high payoff
- People choose the more conservatives A bet over bet B when asked to choose, but:
- People are willing to pay more for the riskier bet B when asked to price them separately

This is an example of preference reversal

Question 28

Choice under certainty

Answer 28

The phrase “under certainty” simply means that there is no doubt as to which outcome will result from a given act.

Question 29

The theory of rational choice under certainty is an …….. theory

Answer 29

Axiomatic theory. This means that the theory consists of a set of axioms: basic propositions that cannot be proven using the resources offered by the theory, and which will simply have to be taken for granted.

Question 30

The theory of rational choice under certainty is an …….. theory

Answer 30

Axiomatic theory. This means that the theory consists of a set of axioms: basic propositions that cannot be proven using the resources offered by the theory, and which will simply have to be taken for granted.

Question 31

A preference is a …….

Answer 31

Relation

Question 32

A relationship that involves three different entities is …….

Answer 32

Ternary, because it involves three different entities. For example “Mum stands between Bill and Bob”.

Question 33

How do we list entities within a universe?

Answer 33

All members of a universe U should he separated by commas and enclosed in curly brackets, like so {Huey, Dewey, Louie}.