ECON 344 Midterm #1

Casual Statements

causes, affects, leads, increases

Correlations

predicts, associated with, relates, linked to

Y

Outcome or dependent variable

X

independent variable

Lab experiments

Invite subjects in a computer lab, randomize treatment, and collect

data

Field experiments

Find subjects in the “real world”, randomize treatment, and collect

data

3 conditions for experiments

Treatment and control group must be the same in absence

of the treatment, on average.

Treatment and control group should react to the treatment in

the same way.

Treatment and control group cannot be exposed in isolation

to a third factor

Selection bias

a systematic error that occurs when the data or participants chosen for a study do not properly represent the target population

Cofounding variables

underlying characteristics

Between-Subject design

A subject participates only once in each treatment

Within-Subject design

a subject participates in multiple treatments

One-shot

experiment consists of a single period

Repeated

experiment consists of multiple periods

Partner design

groups stay together for several periods

Stranger design

groups are recomposed randomly between periods

Single blind

Subjects are anonymous towards other subjects

Subjects are not anonymous towards experimenter

Double blind

Subjects are anonymous towards other subjects

Subjects are anonymous towards experimenter

Flat-rate show-up fee

Give incentives to participate

Task-related payments

Give incentives while participating

IKEA effect

a cognitive bias where people place a disproportionately high value on self-created or self-assembled products due to the labor they invested

Preference based approach

decision maker’s tastes summarized in her preference relation as the primitive

characteristic of the individual

First impose rationality axioms (or assumptions) on the decision maker’s preferences

Then, analyze the consequences of these preferences for her choice behavior

transitive & complete

all rational preferences must be . . .

Continuity

no jumps, simial preferences for similar bundles

Monotonicity

the more the better; guarantees optimal solution on the budget line

Convexity

preferences of averages to extremes; guarantees solution is unique

Continuous utility function formula

Completeness + transitivity + continuity

Choice rule approach

The individual’s choice behavior is the primitive feature.

Assumptions are made directly concerning the choice behavior.

It also makes assumptions about objects/alternatives that are immediately observable

rather than things that are not (preferences).

We impose some “reasonable” assumption about the DM’s choice behavior.

▪ Weak Axiom of Revealed Preferences (WARP).

▪ Also called independence of irrelevant alternatives (IIA). (for the purposes of

this class).

• If the alternative chosen from a choice set is still available in a subset of

the choice set, then it should also be chosen from that subset.

• Preference between options should not depend on the presence or

absence of other options

Decoy effect

Adding an irrelevant alternative that is strictly dominated by one option but

asymmetrically dominates another, makes the asymmetrically dominated one less

desirable

How Decoy violates WARP/IIA

different choice in a subsample/Menu dependent choices

Decoy

worse than the target in both dimensions but better than the

competitor in one dimension that target is better than competitor

Compromise effect

When presented with choices, we tend to prefer options that are perceived as a middle

ground or compromise between extremes

Extremeness aversion

Leads us to select a middle option even when it may not align

with our true preferences

How does the compromise effect violate WARP/IIA

subverts the traditional rational choice theory, proving

that consumers' choice is not fixed, and adding a new extreme term will

increase consumers' preference for the compromise option.

o Example: high-end brands introducing a super-expensive item making the expensive one

more desirable

Default

A pre-selected option that takes effect if a decision-maker doesn't specify

anything

Status quo bias

the human preference for the current state, which results in inertia and resistance to change

Cognitive resonance

a mental state where a person's beliefs and attitudes align with their actions and experiences

Cognitive dissonance

the psychological conflict when a person holds conflicting attitudes, beliefs, or behaviors

Paradox of Choice

having an abundance of options requires more effort to decide and can leave us feeling unsatisfied with our choice

endowment effect

people assess various options depending on their endowment; byproduct of loss aversion

endowment

reference point

Anchoring

A cognitive bias that describes the tendency to rely too heavily on the first piece of information offered when making decisions.

• That first piece acts like and anchor

Loss Aversion

The cognitive bias that explains the apparent fact that people dislike losses more than they like

commensurate gains; ICs that have points and cross

Sunk cost fallacy

describes our tendency to follow through on an endeavor if we have already invested time, effort, or money into it, whether or not the current costs outweigh the benefits

Gambler’s fallacy

thinking that a departure from the average behavior of some system will

be corrected in the short term

Representativeness heuristic

Estimating the probability that some outcome was the result of a given process by

reference to the degree to which the outcome is representative of that process

Causes the gambler’s fallacy

Conjunction Fallacy

Overestimating the probability of a conjunction (A AND B).

Planning Fallacy

cognitive bias that describes when people underestimate the time,

costs, and risks of future actions—even if it contradicts our experiences.

Base rate neglect

When provided with both individuating information, which is specific to a certain

person or event, and base rate information, which is objective, statistical information,

we tend to assign greater value to the specific information and often ignore the base

rate information altogether.

Confirmation Bias

Our underlying tendency to notice, focus on, and give greater credence to evidence that

fits with our existing beliefs (more than warranted)

enforcers:

Failure to notice evidence that goes against one’s beliefs, but quickly picking up

on evidence that supports them.

▪ Vague or ambiguous evidence.

▪ Higher standards of proof for evidence contradicting one’s beliefs than to

evidence supporting them.

Availability bias

Our tendency to use information that comes to mind quickly and easily when making

decisions about the future

Overconfidence

The certainty that people (including experts) express in their judgments tends to exceed

the frequency with which those judgments are correct

Affect Heuristic

Assigning probabilities to consequences based on how one feels about the thing they

would be consequences of.

The better you feel about it, the higher the probability assigned to good consequences.

EV Violations

St. Petersburg Paradox: a game with an infinite expected monetary value commands only a very small price from real human players (dimnishing marginal utility)

EU Violations

Allais Paradoxes: common consequence effect and common ratio effects.

▪ Violate independence.

▪ From EU theory the sure-thing principle follows: your decisions should not be

influenced by sure things.

▪ Certainty effect: people overweigh outcomes that are certain.

o Procedure invariance: P-bet and $bet elicitation method leads to different answers.

o Description invariance: the pandemic problem

EU Assumptions

completeness, transitivity, continuity, independence

SEV Violation

monotonicity