Exam 4: Status Quo Bias and Default Options

The status quo bias is necessarily inconsistent with the rational model.

The policy implication of the default option bias is that policy-makers can set a desired choice as the default option. If the default option bias is present then this increases the likelihood that the government's choice is implemented.

Consider two goods: $\mathrm{a}$ and $\mathrm{b}$ . Each consumption bundle contains some $a \geq 0$ and some $b \geq 0$ . Suppose there are two reference points: $r_{1}$ and $r_{2}$ , which contain $(3,5)$ and $(5,5)$ of $(a, b)$ , respectively. Consider two consumption bundles $x_{1}$ and $x_{2}$ which contain $(6,2)$ and $(3,8)$ , respectively. Further, suppose $x_{1} \sim_{r_{1}} x_{2}$ and the reference structure displays loss aversion, what MUST be true?

An individual whose preferences are given by the indifference curve in Figure 4.1 has preferences that violate which of the following assumptions found in the rational model:

A difference in willingness to pay and willingness to accept mean there is an endowment effect.

Consider the constant loss aversion utility function in 4.1. This function creates a kink in the value function whenever $\lambda_{i}>0$ .

A preference reversal is a violation of transitivity.

A consumer faces three bundles of goods: $x, y, z$ . He has complete preferences. Using the preference relation notation " $>$ " describe his preferences. (Hint: There are several correct answers.)

Anne and Jim participated in an experiment about the willingness to pay for a set of head phones. Jim is suggested a price of $\$ 13$ and Anne is suggested a price of $\$ 22$ . The experimenters conclude that both Anne and Jim use the anchoring and adjustment heuristic to arrive at a final willingness to pay. What are possible values of their willingness to pay:

Consider two bundles $x$ and $y$ and a reference point $r$ . If $x \sim_{r} y$ then it must also be true that $x \sim r$ and $r \sim y$ .

The endowment effect can be explained by loss aversion.