Includes graphs, formulas, sample/reference questions and clear, elaborate explanations of concepts covered in the behavioural economics course taught at Erasmus University College.
- Opportunity cost (implicit cost): Value of the next best alterna ve that is foregone
- If there are more than two op ons, the opportunity cost is the value of the most valuable
alterna ve op on
- c(ai ) = m a x[u(a1), u(a 2 ), . . . . ]
- Pr oposit ion : ai i s a r a t ion a l ch oice i f u(ai ) ≥ c(ai )
- Must never choose an alterna ve whose opportunity cost is higher than its u lity
- Sunk costs: Costs beyond recovery at the me when the decision was made
- Sunk cost fallacy: One can be said to honouring sunk costs or commi ng the sunk cost fallacy when
he/she makes an irra onal decision based on previously made decisions that yielded no or less than
expected u lity
- In one scenario, your corpora on has already invested $9M in the project, and you have to decide
whether to invest the addi onal $1M required to complete it. In another scenario, you have not yet
invested anything in the project, and you have to decide whether to invest the $1M required to
complete it
- If you choose to invest an addi onal 1M solely based on the previously invested 9M, then you are
honouring sunk costs
- Outlet malls are located so far away from where people live because execu ves want shoppers to think
of the sunk cost of a long drive to the mall as an investment that will be lost if they do not shop enough
- Also called the Concorde fallacy:
- The French and Bri sh governments con nued to fund the supersonic passenger jet long a er it
became clear that it would not be commercially viable, supposedly because they had already invested
so much money and pres ge in the project
- Ra onal choices must be purely forward looking (what happens at other nodes in the decision tree is
irrelevant)
- Escala on situa on: The situa on that arises when honouring sunk costs gives rise to a vicious circle
(making repeated investments on a failed project only because so much had been invested already)
- Expansion condi on (proposi on): If x is chosen from the menu {x, y}, assuming that you are not
indi erent between x and y, you must not choose y from the menu {x, y, z}
- In simple words, introduc on of an inferior product should not change your choice
Decoy e ect: When introduc on of an inferior op on, z, changes the preference of an agent from x over y
to y over x in the menu {x, y, z}
Menu Dependence: The tendency of people’s preference to change when the menu expands
tiff titiff ti ti titi ti ti titi ti tititi ti titi ti ti tti ti ti ft
, Siddhant Soni ECB208 20/21
Explana on of the decoy e ect:
- Target and compe tor; consumer prefers the compe tor
- The consumer’s choice can be manipulated by introducing a product that is inferior to the target in every
respect
- Domina on: “Product X dominates product Y if X is be er than Y in every possible respect”
- Target dominates every product in areas B and C
- Asymmetrical domina on: “Product Y is asymmetrically dominated by X if Y is dominated only by X
and not any other member from the menu”
- Thus, decoy must be superior to the compe tor in at least one respect but inferior to the target in
all respects
- Decoy: The op on that is asymmetrically dominated by the target (must be located in C)
- A rac on e ect: Occurs when the presence of the dominated op on appears to increase the
a rac veness to the consumer of the domina ng alterna ve
- The introduc on of a decoy gives the consumer a reason to reject the compe tor and to choose the
target, in that the target no longer scores lowest along either one of the two dimensions
- The introduc on of an extreme op on gives people a reason to choose the op on in the middle
- Compromise e ect: People’s tendency to choose an alterna ve that represents a compromise or
middle op on in the menu
- Extremeness aversion: People’s tendency to avoid op ons at the extremes of the relevant dimension
- Context e ects: When people’s decisions appear to be responsive to the context in which the decisions
are made
- Forms of menu dependence are described as context e ects
Endowment e ect: The tendency of people’s preferences to appear to depend on their endowment (what
they already possess)
- Also called reference point phenomena
Framing e ects: When people’s preferences depend on how the op ons are framed
- Endowment e ect and reference point phenomena are instances of framing e ects
Money illusion: “Even if you know that one Bri sh pound equals about one and a half US dollars, paying
two pounds for a drink might strike you as be er than paying three dollars”
Loss aversion: People dislike losses more than they like commensurate gains
- Endowment e ect and other reference point phenomena are explained as a result of loss aversion
- Willingness to accept (WTA): “What amount of money will you be willing to accept to give up the
good”
- WTA is evaluated in the loss frame
- Willingness to pay (WTP): “What amount of money will you be willing to pay to acquire the good,
assuming you don’t that good”
- WTP is evaluated in the gain frame
tt ti ti ffffti tifftifffftiff ti tiff ff ti ti ttti ti ti tifftt ti ti ti ti ti ti ff
, Siddhant Soni ECB208 20/21
- Standard economic theory says WTA=WTP
- Given loss aversion, WTA will always be greater than WTP
- People value something that they have more than something that they do not have
Value func on: Represents how an agent evaluates change (change = gain or loss in endowment)
- It is kinked at the origin (usually the reference point); steeper towards the le
- |v(-1)| > |v(+1)|
- If you gain something and then lose it, you may feel worse o even though you nd yourself where you
started
De ning a value func on:
{
v(x) = x /2 f or gain s (x ≥ 0)
{
= 2x f or losses (x < 0)
Important:
- To compute the change in value, you want to
compute the value of your endowment a er the
change and subtract the value of your
endowment before the change
- To compute the value of an endowment, you
must rst express the endowment as a devia on
from your reference point and not in terms of
absolute wealth or anything of the sort.
Aspira onal treadmill: The process where increasing endowments lead to irising aspira ons
- Can be use to explain why the marginal happiness of money is hardly diminishing
Indi erence curves in loss version
- Indi erence curves in standard economic theory are reversible, i.e. they re independent of endowment
- There are two indi erence curves in loss averse situa ons that re ect ini al endowment at points x and y
fiff fiti
ti ff ti ft ti ti ff fl ti ft fi ti
Voordelen van het kopen van samenvattingen bij Stuvia op een rij:
Verzekerd van kwaliteit door reviews
Stuvia-klanten hebben meer dan 700.000 samenvattingen beoordeeld. Zo weet je zeker dat je de beste documenten koopt!
Snel en makkelijk kopen
Je betaalt supersnel en eenmalig met iDeal, creditcard of Stuvia-tegoed voor de samenvatting. Zonder lidmaatschap.
Focus op de essentie
Samenvattingen worden geschreven voor en door anderen. Daarom zijn de samenvattingen altijd betrouwbaar en actueel. Zo kom je snel tot de kern!
Veelgestelde vragen
Wat krijg ik als ik dit document koop?
Je krijgt een PDF, die direct beschikbaar is na je aankoop. Het gekochte document is altijd, overal en oneindig toegankelijk via je profiel.
Tevredenheidsgarantie: hoe werkt dat?
Onze tevredenheidsgarantie zorgt ervoor dat je altijd een studiedocument vindt dat goed bij je past. Je vult een formulier in en onze klantenservice regelt de rest.
Van wie koop ik deze samenvatting?
Stuvia is een marktplaats, je koop dit document dus niet van ons, maar van verkoper Siddhantsoni. Stuvia faciliteert de betaling aan de verkoper.
Zit ik meteen vast aan een abonnement?
Nee, je koopt alleen deze samenvatting voor €13,49. Je zit daarna nergens aan vast.
