CEA Behavioral Economics and Decision Theory 1 — Questions and Answers
Question 1: Which concept in behavioral economics describes the tendency for individuals to weigh losses more heavily than equivalent gains?
- Loss aversion (Correct answer)
- Confirmation bias
- Anchoring effect
- Sunk cost fallacy
Correct answer: Loss aversion
Loss aversion, a key finding by Kahneman and Tversky, shows that losses typically feel about twice as painful as equivalent gains feel pleasurable.
Question 2: The 'endowment effect' in behavioral economics refers to which phenomenon?
- People overvalue things they already own (Correct answer)
- People underestimate future costs
- People prefer immediate rewards over larger future rewards
- People anchor decisions to irrelevant numbers
Correct answer: People overvalue things they already own
The endowment effect occurs when people ascribe more value to items simply because they own them, leading to irrational pricing and trading behavior.
Question 3: What does 'hyperbolic discounting' describe in behavioral economics?
- Preference for immediate rewards that leads to time-inconsistent choices (Correct answer)
- Overweighting of low-probability events
- Tendency to follow the choices of others
- Bias toward confirming existing beliefs
Correct answer: Preference for immediate rewards that leads to time-inconsistent choices
Hyperbolic discounting describes how people disproportionately prefer immediate payoffs over future ones, causing preferences to reverse as the time horizon changes.
Question 4: In prospect theory, how are outcomes typically evaluated?
- Relative to a reference point rather than in absolute terms (Correct answer)
- Based solely on expected utility maximization
- According to revealed preference theory
- Using cardinal utility functions only
Correct answer: Relative to a reference point rather than in absolute terms
Prospect theory, developed by Kahneman and Tversky, evaluates outcomes as gains or losses relative to a reference point, not as final wealth states.
Question 5: Which term describes the behavioral economics concept where people rely too heavily on the first piece of information encountered when making decisions?
- Anchoring (Correct answer)
- Framing
- Herding
- Satisficing
Correct answer: Anchoring
Anchoring occurs when an individual relies too heavily on an initial piece of information (the anchor) when making subsequent judgments or estimates.
Question 6: What is 'nudge theory' as applied in public policy economics?
- Designing choice environments to guide people toward better decisions without restricting options (Correct answer)
- Using tax incentives to change consumer behavior directly
- Mandating certain behaviors through regulation
- Providing direct cash transfers to influence choices
Correct answer: Designing choice environments to guide people toward better decisions without restricting options
Nudge theory, popularized by Thaler and Sunstein, involves structuring choice architectures so that people are steered toward beneficial decisions while retaining freedom of choice.
CEA Behavioral Economics and Decision Theory 1
Which concept in behavioral economics describes the tendency for individuals to weigh losses more heavily than equivalent gains?