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Chapter 7

DEPARTURES FROM STANDARD RA-TIONAL CHOICE MODELS (WITH AND WITHOUT REGRETBoiling Down Chapter 7

Rational choice theory is frequently thought to focus exclusively on egoistic behavior or "narrow self-interest" as your text calls it. This assumption of narrow self-interest makes it difficult to explain altruistic behavior. We are left with two choices. Either rede-fine tastes to include self-sacrificing behavior as something that is desired for its own sake, or show how what appears to be self-sacrificing behavior really benefits the con-sumer in ways that are rational rather than masochistic.

The text takes the latter approach, beginning with the realization that people who are perceived to be highly egoistic do not fare well in many circumstances. Furthermore, to be perceived as being an altruistic person, one must actually be one because true altruism is hard to fake. Therefore, to be truly altruistic, people must practice it until it becomes part of them. Thus tipping waitresses you will never see again or engaging in voluntary service of all kinds are all rational parts of becoming the kind of person who can reap the benefits reserved for those who are truly altruistic. Religious people might say that the temporal and eternal blessings of being a servant of others far outweigh the costs of reli-gious practice. Your text suggests that for many, the temporal benefits themselves may be sufficient to create true altruistic behavior in people.

The story of Franny's preferences shows that she genuinely cares about Zooey and can benefit by sharing with her if Zooey is poor. This example illustrates that rational choice theory can be richer if it is recognized that people are social beings with high lev-els of interdependency. How you act depends upon how others react to your behavior. In a way, this chapter has parallels with Adam Smith's concept of moral sympathy, which makes social approval something that nature predisposes us to desire.

Biologists have contributed to the discussion by showing that, over time, aggressive competition leads to lower payouts than cooperative behavior. Thus by natural selection it may become prudent to alter narrow egoism. But how does one convince others that they are not short run egoists? Building trust is a complex process so part of this chapter

deals with how trust and cooperative behavior can be recognized. Psychologists have found that simple body expressions tell a lot about one’s underlying motivational states. One way to build trust is to develop a reputation by acting consistently in a manner that is counter to rational choice predictions. If the behavior has been observed as a pattern, oth-ers will come to believe that this behavior can be expected and they will act accordingly. A second way to build trust is to make it known that certain values guide one's life and will be pursued irrespective of normal self-interest motives. The notion of fairness and virtue will become part of who a trustworthy person is. Such a person will sacrifice per-sonal gain for justice and therefore will be victim to fewer one-sided offers as illustrated in the $1000 exercise in the text. Those who fake trust, but then cheat, stand to benefit in the short run until repeat transactions occur or until the word of their cheating tendencies becomes public. How trusters and cheaters interact and survive in a population is the sub-ject of considerable discussion in this chapter. If there is a cost of discerning between the two types, there will be a place in the population for both trustworthy folks and cheaters. This is true because when the trustworthy types become dominant in the population be-cause of their cooperative behavior in joint ventures, their guard against cheaters goes down and cheaters can take advantage of this reduced vigilance. When the expected value of gains from a randomly chosen partner exceeds the net return of searching for another trustworthy partner, then the cheaters will have a permanent niche in the pop-ulation..

In the final analysis, people make choices based on the complete range of emo-tions, some of which run counter to the pure self-interest model. People do respect each other's rights even when they would gain by not doing so. They vote when the cost of doing so exceeds the benefits. They give up money in order to enhance their view of fairness. In fact, conscience, envy, love, honor, guilt, loyalty, and many other emotions impact all choices to some degree, and it is wise to understand how this fact can enrich standard rational choice theory.

It is important to realize that after all the commitments are made and all the emo-tions are assessed, non egoistic behavior will only work if the altruistic behavior is heartfelt. Fake altruism can not be hidden for long. Cultivating behavior that makes altruism heartfelt is part of what it means to be moral.

In addition to emotions and values, nonegoistic behavior results from certain psychological tendencies that program behavior. Bounded rationality means that people have certain patterns of thinking that restrict careful analysis. The moviegoer counted the $10 lost ticket as part of an entertainment budget rather than as part of general funds and therefore did not use the next $10 on the most desired purchase, another movie ticket.

Asymmetric value functions mean that people suffer more from a loss than they ben-efit from a gain of equal value and that they separate events that should be taken as a package. Rational choice theory allows for no such separation. Nevertheless, people fre-quently separate joint events as the medical insurance case in the text illustrates. This asymmetric value function also helps explain cases in which people make choices under

CHAPTER 7: Departures from Standard Rational Choice Models (with and without Regret)

risk that do not fit the anticipated expected value conclusions. Marketers take advantage of this phenomenon by bundling costs in one package and separating related gains as if they were separate events.

Sunk costs are frequently considered in decisions when they are irrelevant. Out-of-pocket costs are felt more keenly than opportunity costs that do not require a dollar out-lay. Consequently, gifts, winnings, and capital gains hurt less if they are dissipated than the dissipation of the same items that were paid for with out-of-pocket costs.

Bad decisions occur when we misjudge how current decisions impact the future. It is particularly hard to judge how experiences will be valued over time. A large screen TV may be chosen over a week vacation with family or travel abroad, but good memories are frequently undervalued at the point of decision. A lifetime pattern of growing consump-tion is preferred to a constant standard of living so saving early should be preferred to higher early consumption that is steady over time. However, earlier saving is often not the pattern. It is hard to make good choices when our minds do not give us a good per -spective on how those choices will feel in the future.

Another bias that influences rational reasoning is our tendency to give more weight to recent or available information rather than to objectively consider the entire spectrum of data that is relevant.

In some cases we are influenced by our stereotypes, which can be misleading. Shy people are likely not librarians even though most librarians may be shy. Although stereo-types can lower our search costs of information, they can lead to erroneous decisions in many cases. The regression effect illustrates a similar problem. Since most performance measurements are distributed around a mean value, it is likely that an extremely good or very poor performance is an exception that will not be repeated. This is why phrases like “sophomore jinx,” “champions don't repeat,” and “wait until next year” are not utter non-sense. Nearly every peak accomplishment or disastrous act is on an extreme end of a dis -tribution, and a regression toward the center, or mean, is likely to follow.

Another bias that distorts sound rational reasoning is the tendency to rely on initial data more heavily than on all data that are available. This “anchoring and adjusting” is what is behind a phrase like “first impressions count most.” The most powerful example in your text of this effect is the manner in which random numbers influenced student esti-mates of the percentage of African countries that are United Nations members.

The psychophysics of perception causes people to consider data according to their relative size rather than their absolute size. I get more irritated at a $20 increase in the city parking sticker tax than I do when the IRS informs me that I owe $20 additional in-come tax. This is because $20 is such a small part of the total federal tax but is a doubling of the city parking tax. Yet, I know that it really does not make any difference in my fi-nancial situation.

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Given all these influences on choice plus the principles of rational decision-making, people are often in a quandary over which choice to make. Faced with an apparent toss-up, sometimes an irrelevant factor tips the scales and becomes the deciding influence as the story of the apartment decision illustrates.

Finally, rational behavior is sometimes subverted by an inability to follow one’s best intentions. Self-control is not always easy without effective commitment devices to hold one to his intentions. Weight watchers, payroll deductions to savings plans, and not buy-ing food that is unhealthy but tempting are all ways of seeking to make rational choices effective.

Chapter Outline1. Present-aim rationality is too broad and self-interest rationality cannot explain behav-

ior where habit, passion, and appetite are involved.

2. The pursuit of rational choice self-interest does not always bring the greatest rewards.

a. Where interdependence and trust are present, the rewards of altruism and co-operation may be greater than the rewards of narrow self-interested behavior.

b. Franny gains pleasure from seeing Zooey’s income increase.

3. Biologist show that survival is enhanced when cooperative behavior prevails.

4. A model of trustworthy people and opportunists illustrates the tenuous balance in so-ciety between the two groups.

a. If trusters could always find each other they would benefit by cooperating.

b. But cheaters can mimic cooperative behavior and take advantage of trusters. Because detection costs will be positive both preferences will exist despite the common rational choice notion that tastes do not differ.

5. Emotions sometimes lead us to behavior that seems irrational.

a. People sue others when the costs exceed any possible gain because of the emotion of anger or injustice.

b. Many people vote in elections when the costs exceed the benefits except for the pull of patriotism.

c. People will give up absolute income to preserve relative income standing.

6. In short, some identifiable tastes based on emotions of all kinds can lead to advan-tages that opportunists miss, but those who benefit from the exercise of altruism and emotion must inevitably hold their preferences sincerely.

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7. Bounded rationality suggests that humans muddle through decisions using partial in-formation, with limited perspective and with psychological biases that lead to satis-ficing rather than maximizing.

a. People organize spending into mental accounts rather than treat money as fungible.

b. An asymmetric value function causes gains and expected gains to be assessed as less helpful than the same loss or expected loss would be harmful.

c. Sunk costs are frequently considered when they should be ignored.

d. Cash costs are considered more significant than implicit opportunity costs even though rational choice thinking would consider them the same.

8. It is difficult for someone to forecast how a choice will impact their future.

a. The impact of goods is easier to predict than the impact of experiences.

b. Current consumption patterns often ignore the impact that a lack of savings will have on the future.

9. Choices under uncertainty frequently are influenced by how the outcomes are framed rather than by the expected value calculations.

10. Judgmental heuristics and biases condition behavior in ways that rational choice the-ory would not predict.

a. People act on things they can recall best, which means events that occur of-ten or more recently.

b. Representativeness or stereotyping leads to mistaken conclusions.

c. Regression to the mean suggests that outstanding or very poor behavior is likely to be followed by more average behavior.

d. The anchoring and adjustment perspective leads people to weight initial data more heavily than subsequent information.

11. The psychophysics of perception causes people to consider gains and loses as per-centages of the total rather than as absolute gains and loses.

12. When deciding is difficult, it is sometimes helpful to introduce an irrelevant alterna-tive to achieve a halo effect.

13. Using commitment devices to offset a lack of self-control can help to make the ratio-nal good choice succeed over the temptation to do otherwise.

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Important Termscommitment device mimicry

cheating problem altruistic preferences

deterrence problem bargaining problem

bounded rationality segregated gains

fungibility of wealth judgmental heuristics

mental accounts regression effect

asymmetric value function anchoring and adjustment

sunk costs psychophysics of perception

out-of-pocket expenses Weber-Fecher law

affective forecasting problems halo effect

self control problem

A Case to ConsiderMatt and Megan do many things that fit the rational self-interest model. They also do

some things that are not very easily explained by that model. For example, Matt gives 10% of his income to his church and he gets up early on election day even though his vote never swung an election. He is producing a PC computer that he wants to sell in large quantities. As a service to his customers he also carries the Apple computer line that is very similar in specifications to his PC. In order to influence customer thinking he stocks another PC that has nearly identical specifications to his PC but he charges sub-stantially more for it than his machine.

Megan is feeling great about her computer business. She has just completed her year-end calculations and found that last year was by far her best year ever. She has no good explanation for why this happened, but she now is planning for another year that is just as good. She thinks that her store layout is helpful to her business. Some vendors advertise big sales and then place sale items near the back of the store so customers must pass all the vendor’s products before they get the lowest priced items. Megan puts her lowest priced specials near the entrance to the store.

Matt has a rebate policy for his computers. He rarely lowers the asking price, but he will frequently offer mail in rebates for his merchandise. Some have wondered why he goes through all the rebate hassle when he could simply lower the price in the first place.

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On trips Matt pays his self-service gas bills even though he could easily drive off without being noticed. He is a frugal guy and has put low credit limits on all his credit cards despite his substantial income.

This list could go on and on because Matt and Megan seem to be far from the typical economic maximizers that the standard textbooks talk about. In the space below, try to explain their behavior. Identify the emotions, senses, or feelings that are involved in the activity listed.

1. give to his church

2. vote

3. stocks an expensive computer he doesn’t expect to sell

4. plans for a second consecutive exceptional year

5. put sale items up front

6. price high and give a rebate

7. pay for gas

8. credit card limits

Multiple-Choice Questions1. From the stories presented in this chapter we could conclude that

a. the world would be better off if it was full of altruists, and trusters rather than full of cheaters, and egotists.

b. altruism works as long as only some have those qualities.

c. altruists are basically irrational.

d. all of the above are true.

e. none of the above are true.

2. Standard rational choice theory accepts which of the following?

a. People are creatures of reason.

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b. People are inefficient processors of information.

c. People have widely different goals and preferences.

d. Economic choices frequently involve interdependencies among people.

3. In the deterrence problem in the text, in which Jones prosecutes Smith, who stole the briefcase, the fundamental factor that makes this case difficult for the pure rational theorist is

a. the problem of not knowing the present expected value of deterrence that would be gained by Jones when he prosecutes.

b. that the briefcase may have been damaged.

c. that Jones miscalculated when he prosecuted.

d. that Jones calculated correctly that prosecuting was not worth his while, yet he went ahead anyway because of his anger.

4. If Joe is not trustworthy but there are advantages in being trustworthy, then it would be in his best interest, according to rational choice theory,

a. to become genuinely trustworthy and to be perceived as such.

b. to be perceived as trustworthy without actually having these qualities.

c. to change his preference to become trustworthy whether others know or not.

d. to remain untrustworthy and be perceived as such.

5. Which of Patrick’s utility functions below indicates that Patrick is altruistic?

a. U = f(Patrick’s wealth + Joel’s wealth/2)

b. U = f(the square route of Patrick’s wealth)

c. U = f(Patrick’s wealth / Joel’s wealth)

d. none of the above correctly answer the question.

6. When there are no search costs involved in finding others like you, the proportion of trusters in the population ends up

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a. being greater than when there are positive search costs.

b. is smaller than when there are positive search costs.

c. is unchanged from when there are positive search costs.

d. is indeterminate until one knows whether the cheaters will use the free infor-mation.

7. The text tells the story of the lost ticket and the lost $10. If the money is lost on the way to buy the ticket, the buyer is inclined to buy a ticket anyway. On the other hand, if an already purchased ticket is lost, the theatergoer is inclined not to buy another ticket to replace the lost one. This is because people have

a. asymmetric value functions.

b. mental accounts for their expenditures.

c. little understanding of sunk costs.

d. anchoring biases.

8. If economists tend to be left-brained people, then

a. if you find a left-brained person and assume you have an economist, you are falling into the representative bias.

b. if you find an economist and assume you have a left-brained person, you are falling into the anchoring bias.

c. if a person is right-brained and an economist, he must have an asymmetric value function.

d. if a person is a right-brained economist, she will be more susceptible to the psychophysics of perception.

9. By adding an irrelevant option to a tough decision process, it is likely that

a. the option closest to the irrelevant option will be chosen.

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b. the option least like the irrelevant option will be chosen.

c. none of the options will be selected.

d. the irrelevant option will be chosen out of frustration.

10. If you are trying to guess the average age of a group that walks across a stage in a guessing contest and you are influenced by anchoring and adjusting, you will guess a higher age estimate if the group

a. walks across the stage in ascending order of age.

b. walks across the stage in descending order of age.

c. walks across the stage in a randomly selected fashion.

d. has bald rather than gray-haired senior citizens.

11. Which of the following is most likely to be subject to an affective forecasting error?

a. The purchase of a delicious meal

b. Getting a haircut

c. Buying a suit

d. Putting $100 of each check into a retirement account

12. A panel of present-day baseball fans was selected by a newspaper to pick an all-time baseball all-star team. They are most likely to make selections

a. from the glory days of the distant past.

b. from the stars of the present and the recent past.

c. from those with short but glamorous careers.

d. from those with high batting averages and low total bases rather than those with lower averages but many home runs.

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13. If one codes mental losses and gains and has an asymmetric value function in which losses are felt more keenly than foregone gains of equal value, then it is possible to explain why people

a. do not ignore sunk costs in some decisions.

b. fall prey to the representative bias.

c. fall prey to the anchoring bias.

d. make all the above mistakes.

14. We had two boxes of candy on the counter. Both were identical, except one was a 10-pound box and the other was only a l-pound box. Because it was Christmas, I ratio-nalized that four pieces a day would be okay, but I always felt better when I raided the large box instead of the small one. This tendency is an illustration of

a. an asymmetric value function.

b. an anchoring bias.

c. psychophysics of perception bias.

d. all the above.

e. none of the above.

15. If you were to behave according to the typical rational choice model when con-fronted with a loss of $25 on the same day in which you receive an unexpected gift of $26 you would

a. value the loss of $25 more heavily than the gain of $26.

b. See the net gain of $1 and consider yourself better off.

c. see the two events as exactly offsetting and thereby of no consequence in your overall welfare.

d. none of the above. There is not enough information to be sure how you might feel.

16. From this chapter we might conclude that

a. people tend to overcome illogical psychological propensities.

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b. people are overly optimistic.

c. the mind is basically a massive calculator of costs and benefits.

d. we are subject to forces of the mind which qualify what we consider rational.

17. I get the Wall Street Journal and the Chicago Tribune. At the end of the day I some-times look at the papers that are unread and feel as though I need to read them to jus-tify the trees that were cut down to produce them and the delivery effort that went into getting them to my office and home. At these times I am falling into the trap of

a. the psychophysics of perception.

b. erroneously considering sunk costs.

c. counting implicit costs rather than explicit ones.

d. the halo effect.

18. Carl bought a new car and paid for it with cash from his savings account where he

was earning 2%, even though the dealer had a deal where he could pay over 36

months with zero interest. What might cause Carl to make such a choice?

a. Carl was mathematically and financial ignorant.

b. Carl has an asymmetric value system.

c. Carl was subject to the halo effect.

d. Carl was subject to anchoring and adjusting.

19. Which of the following is true according to this chapter.

a. Psychological predispositions are random and therefore unpredictable.

b. Altruistic people benefit society but hurt themselves.

c. The person who can fake cooperative behavior gets the best of the egoistic and altruistic worlds.

d. If your generosity and other-centered behavior is heartfelt it can increase your personal wellbeing.

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Problems1. Build a case for both sides of the debate issue: Chapter 7 is really only present-aim

rationality in disguise because people still are doing what is good for them.

2. Adam Smith had a very broad understanding of rational behavior. In the Theory of Moral Sentiments he argues that society holds together because people have an over-arching desire to be highly regarded by others. Consequently, they find it in their best interest to do things that contribute to social solidarity and harmony. Consider the following comment from Adam Smith:

"[The man of low condition] never emerges so effectually from this obscurity, his conduct never excites so much the attention of any respectable society, as by his be-coming the member of a small religious sect. He from that moment acquires a degree of consideration which he never had before. All his brother sectaries are, for the credit of the sect, interested to observe his conduct, and if he gives occasion to any scandal, if he deviates very much from those austere morals which they almost al-ways require of one another, to punish him by what is always a very severe punish-ment, even where no civil effects attend it, expulsion or excommunication from the sect." (Quoted in "Mr. Smith and the Preachers: The Economics of Religion in the Wealth of Nations" by Gary M. Anderson, Journal of Political Economy, 96: no 5, 1071)

Rewrite this paragraph using language from this chapter.

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3. If positional income standing suddenly becomes very important to Franny (see Figure 7-1 in the text), what does that do to Franny's indifference curves?

4. Explain why voter turnout is usually higher in national elections than in local elec-tions where issues are closer to home and relevant to day-to-day life.

5. Show graphically why many people prefer to put a month's worth of expenditures on a credit card rather than pay the purchases one at a time. Assume that free credit for a month is not the reason. Explain the graph.

6. Emma, Joe's wife, insists that Joe's love of family budgeting is really an attempt to limit her spending. She insists that the process is time-consuming and cumbersome. Joe says he is not trying to limit Emma's spending, but that budgeting helps them see what they can afford. The couple does spend less when they budget. Argue Emma's case and explain why savings rise even though they may not be budgeted.

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7. Willie collects baseball cards. In a recent negotiation process at a card show, a dealer wanted $5 for Kerry Woods' rookie card. Willie offered $4 as his final offer but was turned down. As he walked away from the table, the dealer offered him $4.50 for the Woods' cards Willie already owned. Willie said he was not interested in selling. Ex-plain this sequence of events. Was Willie irrational?

8. Illinois Route 294 has a tollbooth set up every 15 to 20 miles where the motorist must throw in 75 cents. It costs me $2.25 to go 50 miles on Route 294, and $3.00 to go the same distance on the Indiana turnpike, where payment is by toll card when one exits the toll road. I get much more irritated paying the Route 294 tolls than I do the turn-pike toll, and the stopping to pay is not the reason. How can you explain my feelings?

9. Your roommate is having a dreadful time deciding between a biology and an art his-tory course. You think she would be better off if she took the biology course, but you do not want to make her choice for her. Instead, you make a suggestion that does not appear to indicate your wishes in the matter, but she immediately picks the biology course after you offered your suggestion. What might that suggestion have been?

10. Your business produces electric space heaters that are quiet, clean and safe. You are in charge of marketing these products and you are exploring how the psychology of the consumer might help you construct the ideal plan. Sketch out some features of a good plan based on the material in this chapter.

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11. Those who oppose gun control frequently build their case on the belief that if robbers know you have a gun they will be deterred from taking your property or hurting you. Is this view consistent with the deterrence problem discussed in this chapter? If so, how, and if not, what is the difference?

Answers to Question for Chapter 7

Case QuestionsA suggested list might be:

1. Compassion

2. Patriotism

3. Halo effect

4. Regression effect

5. Anchoring and adjusting

6. Asymmetric value

6. Moral teaching

7. commitment device.

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Multiple-Choice Questions1. a, Since cooperators working together are more productive and perhaps even more fulfilled

as human beings, the world would be a better place if everyone cooperated. Alas, human na-ture has not made this possible.

2. a, People are efficient, individualistic, and have similar goals, so no others are right.

3. d, The emotion of anger resulted in irrational behavior and therefore wrong rational choice predictions.

4. b, Joe, if he could be trustworthy when only when it helpfed him, would get the benefit of both the trustworthy and opportunistic worlds unless, as your text suggests, it is impossible to succeed as trustworthy unless you really are trustworthy.

5. a, As Joel’s wealth rises, Patrick’s utility rises suggesting that Patrick feels better because Joel has become better off. . In letter (b) Patrick doesn’t care about Joel and in (c) Patrick feels better when Joel has less.

6. a, Because the net payoff will always be greater with zero search costs a truster will never work with a cheater and therefore will have a higher net payoff. Cheaters get no advantage from the information because no truster, knowing cheaters for what they are, will work with them

7. b, A $10 loss from the total budget is small relative to the loss from the entertainment bud-get.

8. a, There are far more left handed non-economists than there are left handed economists.

9. a, The halo effect applies here.

10. b, You are more influenced by the first persons to go across the stage.

11. d, Goods and services are less subject to affective forecasting errors than are experiences.

12. b, Recent and more visible achievements will count for more than older mundane records.

13. a, Losses are hard to forget.

14. c, We see things in proportions more readily than in absolute values.

15. d, Until we know the degree to which loses are valued above gains of equal value this ques-tion can not be answered definitively.

16. d, All of the psychological phenomenon in this chapter show how rational choice is distorted by perceptions of the mind that are not well understood except that they clearly effect our choices.

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17. b, The trees and delivery have already occurred and are sunk costs. Whether I read the pa-pers or not should depend on whether that time would be best spent in reading. If I would rather be doing something else I should discard the papers.

18. b, One big payment seems like much less expense than monthly payments over 36 months even if the total present value of the money is more the way he paid.

19. d, If nonegoistic behavior is faked other will soon figure that out and the benefit will be lost.

Problems 1. In all the cases where non self-oriented behavior is successful it must be heartfelt rather than

faked, according to author Frank. Is this true? If so, then altruistic behavior is not rational choice disguised. If Frank is wrong, then there are successful con artists in the long run and are they happy?

2. Be creative but get to the point of interdependence and how emotions and values and com-mitments condition behavior. Joining a sect is a form of a commitment device.

3. The indifference curve becomes positively sloped because any gain for Zooey hurts Franny's relative standing.

4. There could be many explanations for this phenomenon such as a higher cost of getting in-formation on local candidates or less controversy and political partisan identity on local is-sues. However, another issue most likely is that people feel national identity and patriotism more intensely than they do local identity. They consider themselves American or Canadian etc. before they identify themselves by their home town. Patriotism and identity issues can lead to behavior that rational choice might not predict.

5. The principle of combining loses would mean that one big payment results in higher utility than many smaller payments. A graph similar to the southwest corner of Figure 8-5 in your text will illustrate that the marginal dollars paid on a large credit card payment bring far less disutility than the summed disutility of repeated smaller payments on the same utility func-tion.

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6. Mental accounts for other categories restrict expenditures in those areas, leaving more for savings.

7. Willie was willing to pay only $4 out-of-pocket costs for a Wood card, but was willing to absorb a $4.50 implicit loss. Implicit losses are valued less than explicit losses.

8. The asymmetry of losses and gains is such that three small losses seem to be greater than one big loss of equal value.

9. You suggested a physics course, which is viewed as being the most difficult of the natural science courses. The irrelevant factor syndrome is at work here.

10. First, you might work on the payments side. If you emphasize credit card payment, people will see the cost as being lumped together with all their other card purchases and it will seem less painful. (Asymmetric value function) Next you might contrast your product with dirty, time consuming inefficient fireplaces which will make your product seem more desir-able and lead people away from simply extending their central heating system which might be another alternative. (Halo effect) You might explore the Important Terms part of this guide to make additional suggestions.

11. Deterrence in this chapter has nothing to do with you deterring others. It refers only to things you do that help you follow what you want to do. Examples like leaving credit cards at home or even setting an alarm clock can be examples that make this point

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HOMEWORK ASSIGNMENT NAME:____________________________

1. Andrew’s utility function is: U = (Andrew’s wealth + 200,000 / Mark’s wealth - 100,000)

a. If Andrew is a millionaire and Mark has one-half a million in wealth, what is Andrew’s utility level?

b. Andrew has a business idea, but needs Mark’s expertise to make it fly. The profit from the idea is expected to be $200,000. Mark is a hard bargainer and Andrew does not want to end up worse off on the deal. If Mark demands $75,000, should Andrew accept the deal?

c. What is the most he should be willing to offer to Mark to join the deal?

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d. Why does this problem not fit within the usual neo-classical microeconomic analytical framework?

e. Comment on the kinds of feelings that might underlie this utility function making it more realistic?

f. If the utility function was inverted, what would Andrew do? Would such a function make sense?

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2. Reflect on some practical ways that society does or could encourage cooperative be-havior. List 2 specific possibilities.

3. Monitor your behavior for a few days and list five occasions where you seem to have violated rational choice theory. Then explain why you did what you did.

a.

b.

c.

d.

e.

4. Asymmetrical value functions have implications for people in marketing. List several specific suggestions, not mentioned in the book or in problem 6 above, for a market-ing seminar that capitalize on this psychological phenomenon.

a.

b.

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c.

5. Should economists become more integrated with the other social sciences? What would we give up if we incorporated many of these psychological insights into our models? What would we gain in the process?

6. Reflect on the following statement: “Business people will not survive if they are driven by emotion, ego, or any of the other cognitive limitations mentioned in this chapter. Competition will weed out those who are not driven by rational choice be-havior. Therefore, this chapter is relevant mainly for personal behavior, but not busi-ness activity.”

7. The following two lifetime consumption patterns are available to you beginning at age 21 and ending at age 91. What would a purely rational choice risk averse person do if given this choice? What do most people do if given this choice? Why?

a. Consumption = 30,000 + 500(Age)

b. Consumption = $58,000

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8. Bounded rationality is highlighted in the book as one area that restricts our thinking as in a consumer budget. But are we not bounded in our thinking and the options we choose by many other boundaries. Social norms, religious and moral convictions, ge-netic predispositions, habits and customs are a few possibilities. Describe three spe-cific limitations on your consumer spending that come from something other than in-come and price constraints and appear to be irrational in the economic sense.

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