CBE Behavioral Economics 2 — Questions and Answers
Question 1: Which concept describes the tendency for people to rely too heavily on the first piece of information encountered when making decisions?
- Framing effect
- Anchoring bias (Correct answer)
- Availability heuristic
- Status quo bias
Correct answer: Anchoring bias
Anchoring bias occurs when individuals over-weight the initial information (the anchor) when making subsequent judgments or decisions.
Question 2: A company sets its product's default option as the premium tier rather than the basic tier. This strategy primarily leverages which behavioral principle?
- Loss aversion
- Hyperbolic discounting
- Default effect (Correct answer)
- Gambler's fallacy
Correct answer: Default effect
The default effect exploits inertia—people tend to stick with pre-selected options, so setting a premium default increases uptake.
Question 3: In behavioral economics, 'mental accounting' most directly explains why consumers:
- Prefer smaller, sooner rewards over larger, later ones
- Treat money differently depending on its source or intended use (Correct answer)
- Overestimate the probability of rare events
- Prefer certainty over probabilistic outcomes of equal expected value
Correct answer: Treat money differently depending on its source or intended use
Mental accounting refers to the cognitive tendency to assign money to separate psychological 'accounts' based on origin or purpose, leading to non-fungible treatment of money.
Question 4: Which of the following best illustrates the 'endowment effect'?
- Investors holding losing stocks too long to avoid realizing losses
- A seller valuing an owned coffee mug higher than a buyer is willing to pay (Correct answer)
- Consumers preferring status quo insurance plans during open enrollment
- Employees contributing more to 401(k) when auto-enrolled
Correct answer: A seller valuing an owned coffee mug higher than a buyer is willing to pay
The endowment effect is the tendency to assign higher value to objects simply because one owns them, causing a gap between willingness to accept and willingness to pay.
Question 5: The concept of 'time inconsistency' in behavioral economics best describes:
- The tendency to prefer consistent outcomes over time
- Preferences that reverse as the time horizon for a decision changes (Correct answer)
- The inability to accurately perceive elapsed time
- Overweighting recent events in long-term forecasts
Correct answer: Preferences that reverse as the time horizon for a decision changes
Time inconsistency (or dynamic inconsistency) occurs when preferences between delayed outcomes reverse as those outcomes become more imminent, often modeled with hyperbolic discounting.
Question 6: Prospect theory, developed by Kahneman and Tversky, differs from expected utility theory primarily because it:
- Assumes risk neutrality for all decision makers
- Evaluates outcomes relative to a reference point with asymmetric value for gains and losses (Correct answer)
- Predicts that all individuals maximize long-run expected monetary value
- Ignores probability weighting in risky choices
Correct answer: Evaluates outcomes relative to a reference point with asymmetric value for gains and losses
Prospect theory uses a value function defined over gains and losses relative to a reference point, with losses weighted more heavily than equivalent gains (loss aversion).
Question 7: Which behavioral phenomenon explains why employees are more likely to enroll in a retirement savings plan when enrollment is automatic rather than voluntary?
- Overconfidence bias
- Present bias
- Default/inertia effect (Correct answer)
- Sunk cost fallacy
Correct answer: Default/inertia effect
Automatic enrollment exploits the default/inertia effect: people tend not to deviate from pre-set defaults, so auto-enrollment dramatically raises participation rates.
CBE Behavioral Economics 2
Which concept describes the tendency for people to rely too heavily on the first piece of information encountered when making decisions?