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CHAPTER 8
Behavioral Economics
A. Short-Answer, Essays, and Problems
1. What are the basic differences between behavior economics and traditional economic theory about
2. Define behavioral economics and discuss why it was developed.
3. What are systematic errors? How does this conflict with the assumption of rational decisions?
4. What are the two reasons neoclassical economists give for making “simplifying assumptions?”
5. What are the four major complaints behavioral economists have with the neoclassical assumptions?
7. Determine whether a behavioral economist or a neoclassical economist would be more likely to agree with
the following statement:
8. Why do behavioral economists find it important to understand the mental process that determines decision
making?
9. How do neoclassical economists and behavioral economists differ on their views on how to improve human
welfare?
10. Explain how neoclassical economics and behavioral economics can describe behavior at the supermarket.
11. (Consider This) John Wannamaker, a marking genius and department store entrepreneur, stated: “Half the
money I spend on advertising is wasted—the trouble is, I don’t know which half!” Explain how businesses
12. What are heuristics? How is it related to our decision making processes?
13. What is gaze heuristic? Steering heuristic?
14. When asked what the capital of Illinois is many people respond “Chicago.” Use behavioral economics to
15. What is shadow heuristic? How does it work?
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17. Contrast the two systems of the brain. How does this relate to heuristics?
18. What are cognitive biases? Discuss the two general categories.
19. Below are five statements. Indicate which type of cognitive biases is present in each situation.
20. What three facts about people form the basis for prospect theory?
21. Discuss prospect theory. Give two examples of prospect theory.
22. (Consider This) What is the hedonic treadmill? What are the implications of this theory?
23. Use prospect theory to explain why a cereal maker faced with a cost increase would prefer to reduce the
24. How do framing effects affect perceptions of gains or losses? Give an example based on a wage increase
25. Explain the phenomenon of “anchoring” and give an example of it based on a student receiving a good
26. Provide an explanation from behavior economics for why people tend to buy overpriced warranties for
27. A college student paid $50 at the bookstore for a textbook that she uses for a semester. She could sell it
back to the bookstore for $40 but decides to keep it. Another student sees the textbook and asks if he could
28. Use status quo bias to explain why people are more likely to “Super–Size” their meal when asked than
29. What is myopia? How does it relate to behavioral and neoclassical economics?
31. (Consider This) Describe how myopia can cause consumers to ignore opportunities that may have a
32. (Consider This) Many households in sunny cities are unwilling to invest in solar panels even though the
33. Suppose your friend is debating on whether to go to a movie or study for her economics exam. She decides
to go to the movie and wake up two hours earlier to study for the exam. Using time inconsistency, explain
to your friend decision may not be best.
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35. (Consider This) Evaluate, using behavioral economics, the Stickk.com website which sets up financial
36. How would Adam Smith respond to neoclassical models that assume people are purely self-interested?
37. Explain how giving to charity discredits the neoclassical model assumption that individuals are purely self-
38. Evaluate this statement using behavioral economics and the idea of fairness: When John is driving down a
lonely stretch of highway he debates on whether or not he should throw his stinky garbage out the window.
39. The dictator game is a game in which two people interact anonymously. One of them is designated the
“dictator.” It is the dictator’s job to split a specified amount between the participants. Discuss how the
40. What is the ultimatum game? What behaviors are common among the players?
B. Answers to Short-Answer, Essays, and Problems
1. What are the basic differences between behavior economics and traditional economic theory about
consumer behavior?
2. Define behavioral economics and discuss why it was developed.
3. What are systematic errors? How does this conflict with the assumption of rational decisions?
4. What are the two reasons neoclassical economists give for making “simplifying assumptions?”
5. What are the four major complaints behavioral economists have with the neoclassical assumptions?
6. Explain how neoclassical economists and behavioral economists would react the following statement:
“People have stable preferences that are consistent no matter the situation.”
7. Determine whether a behavioral economist or a neoclassical economist would be more likely to agree with
the following statement:
8. Why do behavioral economists find it important to understand the mental process in decision making?
9. How do neoclassical economists and behavioral economists differ on their views on how to improve human
welfare?
10. Explain how neoclassical economics and behavioral economics can describe behavior at the supermarket.
Neoclassical economics can be seen at the supermarket when individuals decide to purchase fewer of an
item that has become relatively more expensive. As the price of a given item goes up the individual will
demand less of that item.
11. (Consider This) John Wannamaker, a marking genius and department store entrepreneur, stated: “Half the
money I spend on advertising is wasted—the trouble is, I don’t know which half!” Explain how businesses
12. What are heuristics? How is it related to our decision making processes?
13. What is gaze heuristic? Steering heuristic?
14. When asked what the capital of Illinois is many people respond “Chicago.” Use behavioral economics to
explain this response.
15. What is shadow heuristic? How does it work?
16. Discuss the implications hardwired heuristics has on our decision making.
17. Contrast the two systems of the brain. How does this relate to heuristics?
18. What are cognitive biases? Discuss the two general categories.
19. Below are five statements. Indicate which type of cognitive biases is present in each situation.
(a) Mark, a financial advisor, suggested many clients purchase stock in a new technology company. When
the stock price fell dramatically Mark proclaimed he saw the fall coming.
(b) Kelly begins buying lottery tickets at a local convenience store that recently sold a million dollar
ticket.
(c) Suzie failed her mathematics exam. Despite the fact that she was unprepared for the exam, she blamed
the instructor.
(d) Jim, the new CEO of Business X, has made a string of bad decisions over the past several quarters. He
continues to ignore the advice of others on the board and basis his decisions on his judgments.
(e) Nancy tells her boss that she will be finished with a work project by the end of the day. She works until
midnight to finish the project on time.
20. What three facts about people form the basis for prospect theory?
21. Discuss prospect theory. Give two examples of prospect theory.
22. (Consider This) What is the hedonic treadmill? What are the implications of this theory?
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23. Use prospect theory to explain why a cereal maker faced with a cost increase would prefer to reduce the
size of the box of cereal rather than increase its price to offset the cost increase.
24. How do framing effects affect perceptions of gains or losses? Give an example based on a wage increase
25. Explain the phenomenon of “anchoring” and give an example of it based on a student receiving a good
grade on a test and a resulting consumer purchase.
26. Provide an explanation from behavior economics for why people tend to buy overpriced warranties for
large consumer purchases such as a large-screen TVs.
27. A college student paid $50 at the bookstore for a textbook that she uses for a semester. She could sell it
back to the bookstore for $40 but decides to keep it. Another student sees the textbook and asks if he could
28. Use status quo bias to explain why people are more likely to “Super–Size” their meal when asked than
when not offered.
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29. What is myopia? How does it relate to behavioral and neoclassical economics?
31. (Consider This) Describe how myopia can cause consumers to ignore opportunities that may have a
significant upfront cost, but become profitable in the long run.
32. (Consider This) Many households in sunny cities are unwilling to invest in solar panels even though the
investment would prove to be profitable in the future. What is the term for this problem? Explain.
33. Suppose your friend is debating on whether to go to a movie or study for her economics exam. She decides
to go to the movie and wake up two hours earlier to study for the exam. Using time inconsistency, explain
to your friend decision may not be best.
34. Explain how individuals fight self-control problems and give a couple examples.
Individuals fight self-control problems with precommitments. Precommitments are ways of taking actions
ahead of time to prevent your future self from doing damage. Examples may vary, but below are a couple
from the textbook.
• Hiding the Alarm Clock. An individual may put their alarm clock on the other side of the room or
under a pile of clothing so it is more difficult to hit the snooze button in the morning.
35. (Consider This) Evaluate, using behavioral economics, the Stickk.com website which sets up financial
incentives to can help individuals reach their goals.
36. How would Adam Smith respond to neoclassical models that assume people are purely self-interested?
37. Explain how giving to charity discredits the neoclassical model assumption that individuals are purely self-
interested.
38. Evaluate this statement using behavioral economics and the idea of fairness: When John is driving down a
lonely stretch of highway he debates on whether or not he should throw his stinky garbage out the window.
39. The dictator game is a game in which two people interact anonymously. One of them is designated the
“dictator.” It is the dictator’s job to split a specified amount between the participants. Discuss how the
40. What is the ultimatum game? What behaviors are common among the players?
41. (Last Word) Describe, using behavioral economic theory, how recent legislation has increased employees’
retirement contributions.