Deck 2: Transaction Utility and Consumer Pricing

Question 1

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

A) Reference dependent preferences.
B) The sunk cost fallacy.
C) The flat-rate bias.
D) Risk aversion.

Answer 1

Risk aversion.

Question 2

Transaction Utility is a concept used to describe observed behavior.

Answer 2

True

Question 3

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

A) The idea that individuals respond to the pricing of goods in non-standard ways.
B) The idea that individuals make mistakes when deciding the quantity of goods to consume.
C) The idea that prices are relative.
D) The idea that individuals just want to get a good deal.

Answer 3

The idea that individuals respond to the pricing of goods in non-standard ways.

Question 4

Transaction Utility describes the scenario in which a consumer spends too much on a good.

Question 5

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

Question 6

Firm $\mathrm{A}$ and Firm B produce a good called $\mathrm{x}$ and both firms have a production function given by $(x)=\sqrt{x}$ . It costs each firm $\$ 0.25$ to produce each unit of $\mathrm{x}$ and both firms sell a unit of $\mathrm{x}$ for $\$ 2$ . However, to purchase the equipment needed to produce $x$ , Firm A spent $\$ 2500$ and Firm B spent $\$ 1500$ . The equipment each firm purchased is identical. How many units of $x$ should each firm produce?

Question 7

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 $x_{1}$ .

Question 8

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?

Question 9

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?

Question 10

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

Question 11

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) Changes the relative price of the two goods: changes the slope of the budget line.
B) Has a negative income effect: shifts the budget line towards the origin.
C) Has a positive income effect: shifts the budget line away from the origin.
D) No effect.

Question 12

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.

Question 13

The sunk cost fallacy occurs when:

A) Losses hurt more than gains.
B) Gains or losses are compared to some reference point.
C) My utility function contains a bliss point.
D) I attempt to recover past costs by continuing an activity when there is a negative return.

Question 14

Acquisition utility refers to the utility I receive from consuming a good and transaction utility is the utility I derive from feeling like I got a good deal.

Question 15

Which of the following utility functions represents prospect theory?

A) $u_{g}(x)+u_{l}(c)=x^{.5}+\ln (c)$
B) $u_{g}(x)+u_{l}(c)=x^{.5}+\frac{1}{c}$
C) $u_{g}(x)+u_{l}(c)=x+2 c$
D) $u_{g}(x)+u_{l}(c)=x^{2}+c^{2}$

Question 16

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).

Question 17

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.

Question 18

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.

Question 19

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?

Question 20

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 .

Question 21

Which of the following is not a procedural explanation for the flat rate bias?

A) Loss aversion.
B) Payment Decoupling.
C) Self-Control.
D) Cognitive Costs.

Question 22

Payment decoupling is best described as:

A) The idea that losses hurt more than gains.
B) The idea that people suffer from the cognitive costs of choosing which bundle to purchase.
C) The idea that I take sunk costs into account when making consumption decisions.
D) The idea that the payment and consumption are separated by time and do not seem as closely linked.

Question 23

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

A) A preference for convenience.
B) A preference for self-control.
C) A preference for getting a good deal.
D) A preference for unlimited consumption.

Question 24

An individual who is risk-neutral is willing to pay a flat-rate to avoid the uncertainty of a linear-pricing plan.

Question 25

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.

Question 26

"When an individual uses a comparison to aid in making a decision, we often call this a:

A) Sunk cost.
B) Fixed cost.
C) Reference point.
D) Decoupling.

Question 27

Consider the following utility function, where $\mathrm{x}$ is the consumer good and $\mathrm{p}$ is the price of $\mathrm{x}$ . $U(x, p)=\sqrt{x}+(p-10)$ is an example of utility function for an individual who exhibits which type of transaction utility?

A) Sunk cost fallacy.
B) Flat-rate bias.
C) Reference-Dependent Preferences.

Question 28

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.

Question 29

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) $z(p, \varepsilon)=(35-p)$ .
B) $z(p, \varepsilon)=|p-35|$ .
C) $z(p, e)=|x-p|$ .
D) $z(p, e)=(x-p)^{2}$ .

Question 30

I have been saving my money to buy a new car. I know that I want to buy a Prius and that it will cost about $\$ 22,000$ . My refrigerator has been malfunctioning too, so any left over money will go towards repairs. My utility function can be written as $U(x, p, \varepsilon)=x+z(p, \varepsilon)$ , where $\mathrm{x}=1$ if $\mathrm{I}$ buy the Prius and 0 otherwise, $\mathrm{p}$ is the price of the Prius and $\varepsilon$ is my reference point. Which of the following functions for $z(p, \varepsilon)$ best describes the scenario above?

A) $z(p, \varepsilon)=(22,000-p)$ .
B) $z(p, \varepsilon)=|p-22,000|$ .
C) $z(p, e)=|x-p|$ .
D) $z(p, e)=(x-p)^{2}$ .

Question 31

There are two local bars and I always buy the same beer at both bars. At the first bar, the music is bad and the bartender is rude. At the second bar, the music is wonderful, there are lots of friendly people, and I always enjoy myself more than when I go to the first bar. An example of context adding value to a good is:

A) I pay a dollar more for the beer at the second bar than I pay at the first bar.
B) I pay $\$ 10$ for a beer at the second bar.
C) I never go to the first bar.
D) I stop talking to the bartender at the first bar.