Behavioural economics
A1. Explain what the ‘ultimatum game’ and the ‘trust game’ are, and what the commonly observed choices in these games imply about behaviour using the language of reciprocity.
A2. The cost of going to the gym is comprised of a monetary cost of 7 and a psychological cost, the monetary equivalent of which is 8. The benefit from going to the gym – which is enjoyed the period after going to the gym – is 20. Suppose that Sarah has preferences with and . Show that Sarah will plan to go to the gym but when the time comes won’t go. How does joining a gym with a monthly membership (so she doesn’t have to pay the monetary cost at the point of going) change the situation?
A3. In the context of a ‘p-beauty contest’, briefly describe how a level-k model of non-equilibrium strategic thinking works to explain the commonly-observed pattern of behaviour in such games.
A4. Harry is in secondary school. He typically has slightly below average academic attainment but usually works hard. His class has been separated into three groups according to ability: low; medium; and high. Harry has been allocated to the low group. His teacher has noticed that he is working less hard in class and has started to fall behind. As a response, she moves him to the middle ability group. Use the ideas of reference dependence, with reference points influenced by peer group, loss aversion and diminishing sensitivity to explain why this might be a good idea to improve Harry’s educational attainment (you may assume that educational attainment is increasing in effort).
A5. Popcorn at the cinema is available in three sizes, small, medium and large. The prices are as follows: small is £4; medium is £6.50; and large is £7. By appealing to appropriate behavioural economics concepts, explain the rationale behind this pricing strategy.
A6. In a city, 80% of taxis are black, and 20% are blue. A witness to a hit-and-run accident involving a taxi identified the taxi as blue. She correctly identifies colours 90% of the time. What is the probability that the taxi involved in the accident is blue? Carefully explain why this is not 90%.
B2. Outline the structure of the prisoners’ dilemma and discuss how this game provides us with a lens through which to understand externalities. Describe and explain how Rabin’s (1993) ‘fairness’ model of intentions-based reciprocity applies to a prisoners’ dilemma setting. If a policy maker’s objective is to achieve ‘cooperative’ outcomes, what would their approach look like if they believed in the pure self-interest hypothesis, and how would this differ if they believed people exhibited sufficiently strong reciprocity. Apply your ideas to one appropriate real-world example.
