Chapter 10 — Exercises

Section A — Loss aversion

A1. Imagine you are offered a coin flip: heads, you win $200; tails, you lose $100. Would you take the bet? Why or why not? (Assume the coin is fair and you are not in financial distress.)

A2. Now imagine you are offered a coin flip: heads, you win $100; tails, you lose $50. Would you take the bet? Compare your willingness to take this bet to A1. What does the comparison tell you about loss aversion?

A3. A friend buys a stock for $50. Six months later, it's worth $30. Standard rational choice says she should sell if the future expected return on the $30 invested elsewhere is higher than the future expected return on the same $30 in this stock. Loss aversion suggests she might not sell. Why?

A4. Apply loss aversion to the housing market. Why do home prices fall more slowly than they rise? What does this imply for housing market analysis using the simple supply-and-demand model?

A5. A worker is offered a job paying $50,000/year. Her current job pays $52,000. Would she accept the new job? Standard rational choice says: only if the new job has $2,000 worth of non-monetary benefits to compensate for the pay cut. Loss aversion says: probably not, because the $2,000 loss feels much bigger than $2,000 of benefits would feel.

Section B — Present bias

B1. Why do people consistently save less for retirement than the standard model predicts? Use the language of present bias and hyperbolic discounting.

B2. A student plans to start exercising "next week." Each week, she defers the decision. Why does this happen? What does it imply about her future preferences vs. her present preferences?

B3. A "Save More Tomorrow" plan asks you to commit now to increasing your retirement contribution rate when you get a raise in the future. Why does this work better than asking people to increase their current contribution rate? Apply hyperbolic discounting.

B4. Payday loans charge very high interest rates (often 300%+ APR). Why do people take them out? Use present bias to explain.

B5. A New Year's resolution is a classic example of time inconsistency. The present-self commits to a future change. The future-self often doesn't follow through. Have you experienced this? Explain using the framework.

Section C — Anchoring

C1. Replicate the Kahneman-Tversky African countries experiment with a friend. Have them write down a random number between 1 and 100. Then ask them what percentage of African countries are in the UN. Did the number influence their answer?

C2. A car dealer puts a sticker price of $30,000 on a used car. The actual fair market value is $25,000. The dealer "negotiates" the price down to $26,500. Why is the customer likely to feel they got a good deal, even though they overpaid by $1,500?

C3. A retailer marks up an item from $40 to $100, then offers it at "60% off" — back to $40. Are buyers fooled? Explain using anchoring.

C4. Why is the listing price of a house often the most important number in the entire housing transaction?

Section D — Status quo bias

D1. Compare two retirement plans: - Plan A: employees are automatically enrolled at a 6% contribution rate but can opt out - Plan B: employees must actively sign up to enroll at any contribution rate

Which plan do you predict would have higher participation? Why?

D2. Some countries have "presumed consent" organ donation (you are an organ donor by default unless you opt out). Others require active registration. How does the choice of default affect organ donation rates?

D3. Pick a default in your own life (a phone setting, a software preference, a subscription). How long has it been since you changed it? Are you sure the default is what you actually want?

Section E — Framing

E1. A surgeon tells a patient: "This surgery has a 90% survival rate." A different surgeon tells a different patient: "This surgery has a 10% mortality rate." The two patients are facing the same surgery. Which patient is more likely to consent? Why?

E2. A retailer offers: "Save $100 if you buy today." A different retailer offers: "Lose $100 if you don't buy today." Which is more effective marketing?

E3. A government program is described two ways: - "This program reduces unemployment by 2%." - "This program saves 1 million jobs." The two descriptions are mathematically equivalent. Which is more persuasive?

E4. Find a real example of framing in advertising. Identify what the frame is and what the alternative frame would be. Which version do you think is more truthful? Which is more effective?

Section F — Nudges and choice architecture

F1. Define a nudge in your own words. Distinguish it from a regulation and from a tax.

F2. Identify three nudges you have encountered in real life. For each, identify what the choice architecture is and what behavior it nudges toward.

F3. Suppose a school cafeteria wants students to eat more vegetables. Identify three possible nudges. Which would be most effective? Which would have the strongest ethical objections?

F4. "Auto-enrollment in retirement plans is paternalistic — it assumes that the architect knows better than the worker what the worker should do." Evaluate this objection. Where does it have force, and where does it fail?

F5. Some critics argue that nudges are manipulative because they exploit cognitive biases. Others argue that any choice architecture is unavoidable, and the question is just whether to design it thoughtfully. Which view do you find more persuasive?

Section G — Applying the behavioral lens

G1. Re-read the Millbrook housing example from Chapter 5. How does the behavioral lens (loss aversion, status quo bias) change your analysis? Are there features of the housing market that the simple model misses?

G2. Re-read the Walden County rent control case study from Chapter 7. How do behavioral effects shape voter support for the proposal? How do they shape landlord behavior?

G3. Re-read the China shock case study from Chapter 9. How does loss aversion explain why displaced workers experienced the shock so intensely?

G4. Pick any market in your own life (your gym, your phone plan, your apartment, your favorite restaurant). Apply the behavioral lens. Are buyers rational in this market? Are sellers exploiting any specific bias?

Section H — Reflection

• Which of the five behavioral findings do you find most surprising or compelling?
• Have you noticed yourself falling into any of these biases? Which ones?
• Does behavioral economics make you more skeptical of the standard supply-and-demand model, or just more careful about applying it?
• Do you think nudges are an acceptable form of policy intervention? Where do you draw the line?

Selected answers in appendices/answers-to-selected.md.