CBE Behavioral Economics 3 — Questions and Answers
Question 1: A firm offers customers 'buy 10 get 1 free' rather than a 10% price discount. This tactic exploits which cognitive bias?
- Confirmation bias
- Denomination effect
- Pseudocertainty effect
- Evaluation mode and ratio bias (Correct answer)
Correct answer: Evaluation mode and ratio bias
Ratio bias leads consumers to prefer a larger numerator (1 free out of 11) over an equivalent percentage discount, making the offer feel more generous.
Question 2: In the context of intertemporal choice, hyperbolic discounting predicts that discount rates are:
- Constant across all time horizons
- Higher for shorter delays and lower for longer delays (Correct answer)
- Lower for shorter delays and higher for longer delays
- Unrelated to the length of the delay
Correct answer: Higher for shorter delays and lower for longer delays
Hyperbolic discounting assigns disproportionately high discount rates to near-term delays, creating present bias and preference reversals over time.
Question 3: Which term describes the cognitive shortcut where people judge probability by how easily an example comes to mind?
- Representativeness heuristic
- Availability heuristic (Correct answer)
- Simulation heuristic
- Recognition heuristic
Correct answer: Availability heuristic
The availability heuristic leads individuals to overestimate the likelihood of events that are easily recalled, often due to recency or vividness.
Question 4: A CEO continues funding a failing project because $50 million has already been spent on it. This illustrates:
- Confirmation bias
- Sunk cost fallacy (Correct answer)
- Optimism bias
- Framing effect
Correct answer: Sunk cost fallacy
The sunk cost fallacy is the tendency to continue investing in a project due to past unrecoverable costs rather than future expected value.
Question 5: Overconfidence bias in financial markets most directly contributes to:
- Excessive portfolio diversification among retail investors
- Lower-than-average trading volume
- Excessive trading and underestimation of investment risk (Correct answer)
- Preference for index funds over actively managed funds
Correct answer: Excessive trading and underestimation of investment risk
Overconfident investors overestimate their forecasting ability, leading to excessive trading that typically reduces net returns after transaction costs.
Question 6: The 'compromise effect' in consumer choice means buyers tend to:
- Always select the cheapest available option to minimize regret
- Choose the middle option in a product lineup rather than extremes (Correct answer)
- Prefer goods bundled with free add-ons regardless of value
- Stick with familiar brands when uncertain about quality
Correct answer: Choose the middle option in a product lineup rather than extremes
The compromise effect causes consumers to avoid extreme choices, gravitating toward the middle option when it is positioned between two more extreme alternatives.
Question 7: Which policy intervention uses 'if-then implementation intentions' to help individuals follow through on their stated plans?
- Commitment devices (Correct answer)
- Nudges via default changes
- Precommitment contracts with financial penalties
- Deliberative polling
Correct answer: Commitment devices
Commitment devices harness implementation intentions by having individuals specify in advance exactly when, where, and how they will act, reducing the gap between intention and behavior.
CBE Behavioral Economics 3
A firm offers customers 'buy 10 get 1 free' rather than a 10% price discount.
This tactic exploits which cognitive bias?