Exam 2: Transaction Utility and Consumer Pricing

Example 1: Theater Tickets and Pricing Programs described an experiment to test for the sunk cost fallacy. If the following experiment would have been run, the results would be comparable to those described in the example. Two economists team up with the local baseball team to manipulate the pricing of season tickets. The first 100 fans that signed up for season tickets paid full price, the next 100 fans got a $10 \%$ discount and the next 100 fans received a $20 \%$ discount. They then compared the attendance across the different categories of discounts to see whether those who paid full price were more likely to attend the games.

The local phone company offers the following plan: $\$ 3$ for the first call of the day plus $\$ 0.02$ for each minute OR \$21 per week for unlimited calls. I only make phone calls on Sunday, Thursday and Friday and talk for the same number of minutes on each day. My only concern is saving money. How many minutes must I spend on the phone each week in order for the flat rate to be the optimal choice?

A consumer has a budget constraint given by $p_{0} \widehat{x_{1}}+p_{1} x_{1}+p_{2} x_{2} \leq y$ where $p_{0}>0$ and $\widehat{x_{1}}=1$ if positive amounts of $x_{1}$ are purchased and 0 otherwise. If the consumer has a utility function given by $U\left(x_{1}, x_{2}\right)=x_{1}+x_{2}$ and $p_{1}=p_{2}$ then he will not purchase $x_{1}$ .

Transaction Utility is a concept used to describe observed behavior.

The transaction cost explanation and prospect theory are two ways to describe the behavior of a consumer who considers a sunk cost when making consumption decisions.

Which of the following is not one of the anomalies that fall under the concept of transaction utility discussed in Chapter 2?

Which of the following utility functions represents prospect theory?

A consumer knows with certainty that he will go to the gym 10 times every month for 12 months. He is offered two types of memberships. The first membership is a flat monthly rate of $\$ 55$ for unlimited use and the second membership plan is a $\$ 10$ one-time fee and $\$ 5$ per visit. The consumer should buy the first membership plan .

A consumer has a budget constraint given by $p_{0} \widehat{x_{1}}+p_{1} x_{1}+p_{2} x_{2} \leq y$ where $p_{0}=5, p_{1}=0$ , $y=20, p_{2}=1 . \widehat{x_{1}}=1$ if positive amounts of $x_{1}$ are purchased and 0 otherwise. If the consumer has a utility function given by $U\left(x_{1}, x_{2}\right)=x_{1}+x_{2}$ , then how much of $x_{1}$ does the consumer want to purchase?

What is one possible way a non-economist would describe preferences that display distaste for linear pricing?

Which of the following best describes the concept of Transaction Utility?

One explanation for a flat-rate bias is that it is just transitory. It takes consumers time to learn how much of a good they want to consume. Over time, they adjust their behavior and the flat-rate bias disappears.

Suppose a family is considering going to a hockey game, but the roads are covered in ice. The tickets were a gift and the family gets a value of $x$ from attending the game together, but incurs a cost of $\mathrm{c}$ for driving on the hazardous roads. The family's utility function is given by $u_{g}(x)+u_{l}(c)=\ln (x-3)-\ln (2-c)$ . The family determines that the cost of driving on the icy roads is 1 unit ( $\mathrm{c}=1$ ). What is the minimum value they must obtain from the attending the game in order for them to decide to go (what must be the value of $x$ )? (Hint: if they do not go to the game, they receive 0 and pay no costs).

Two-Part Tariffs affect the consumer's utility function.

A consumer has preferences over two goods, $U\left(x_{1}, x_{2}\right)$ , where $p_{0} \widehat{x_{1}}+p_{1} x_{1}+p_{2} x_{2} \leq y$ where $p_{0}>0$ and $\widehat{x_{1}}=1$ if positive amounts of $x_{1}$ are purchased and 0 otherwise. If both $x_{1}$ And $x_{2}$ are normal goods and $x_{1}>0$ and $x_{2}>0$ , then a decrease in $p_{0}$ has the following effect.

A consumer has a budget constraint given by $p_{0} \widehat{x_{1}}+p_{1} x_{1}+p_{2} x_{2} \leq y$ where $p_{0}=5, p_{1}=0$ , $y=20, p_{2}=1$ . $\widehat{x_{1}}=1$ if positive amounts of $x_{1}$ are purchased and 0 otherwise. If the consumer has a utility function given by $U\left(x_{1}, x_{2}\right)=\left(x_{1}-13\right)^{2}+x_{2}$ , then how much of $x_{1}$ does the consumer purchase?

A man's car breaks down and he must walk 10 miles to the nearest service station. It's a hot day and he is incredibly thirsty. When he arrives at the service station he pays $\$ 4$ for a bottle of water. A few days later, his car is fixed and he stops at the store to pick up some groceries before heading home. He noticed that a bottle of water cost $\$ 3.50$ and decided not to buy it because it was too expensive. The only explanation for this man's behavior is that he has reference-dependent preferences.

A firm must consider its fixed cost and its marginal cost when deciding how much to produce.

My daughter has saved her money all year to buy new rollerblades. The best way to describe her preferences are reference dependent - she will be sad if the price is more than $\$ 35$ because she will not be able to afford them, but she will also be sad if the price is less than $\$ 35$ because she missed out on buying them last month and cannot use the money for anything else. Her utility function can be written as $U(x, p, \varepsilon)=x+z(p, \varepsilon)$ , where $\mathrm{x}=1$ if she buys the rollerblades and 0 otherwise, $\mathrm{p}$ is the price of the rollerblades and $\varepsilon$ is her reference point. Which of the following functions for $z(p, \varepsilon)$ best describes the scenario above?

A software firm has invested $\$ 2$ million into the development of a new computer program. The firm is well aware that their ability to attract future investors heavily depends on the completion of this project. The firm has calculated that completing the project will result in a loss of $\$ 1$ million, but continue anyways. The only explanation for the firm's behavior is the sunk cost fallacy.