Behavioral And Experimental Economics Final Set 1

Front 1

Suppose we construct a market experiment with the following distribution of cards:

Black (buyers): 7,7,6,6,5,5,4,4.

Red (suppliers): 1,2,3,4,5,6,7,8

a. Plot the supply and demand curves for this experiment. Assume that when they are indifferent, people will trade. Indicate the equilibrium price and quantity as p* and q*. Shade and calculate the consumer surplus, producer's surplus and total social welfare at the equilibrium.

Back 1

P= 5

Q= 5

CS=6

PS= 10

SW=CS+PS= 16

Front 2

Suppose we construct a market experiment with the following distribution of cards:

Black (buyers): 7,7,6,6,5,5,4,4.

Red (suppliers): 1,2,3,4,5,6,7,8

b. Suppose now we introduce the following externality: for each trade, there will be a cost of $3 to society. On a new graph, show the appropriate curves. Indicate the equilibrium price and quantity as p* and q*. Indicate the q that maximizes SW as q**.

Back 2

P= 5

P**= 6

Q= 5

Q**=3

Externality moves supply to the left.

Front 3

Suppose we construct a market experiment with the following distribution of cards:

Black (buyers): 7,7,6,6,5,5,4,4.

Red (suppliers): 1,2,3,4,5,6,7,8

c. Explain why, in an experiment with self interested people, there will likely be q* rather than q** trades.

Back 3

The cost is not directly on either party, but society as a whole. Self-interested people will ignore this cost and focus on their individual welfare, which is maximized at q—5

Front 4

Now forget the externality. Suppose we construct a market experiment with the following distribution of cards:
Black (buyers): 7,7,6,6,5,5,4,4

Red (suppliers): 1,2,3,4,5,6,7,8

a) Suppose we introduce a $3 tax on each transaction, paid by suppliers. Draw the appropriate curves (hint: supply, demand, and supply after tax) and show the equilibrium price paid by buyers, and the equilibrium price received by sellers. (These prices should be net of the tax payment to the government.)

Back 4

q= 3

Buyer price= 6

Price seller receives = Buyer price - tax= 6-3= 3

Front 5

Now forget the externality. Suppose we construct a market experiment with the following distribution of cards:
Black (buyers): 7,7,6,6,5,5,4,4

Red (suppliers): 1,2,3,4,5,6,7,8

b) If the experimental results match your predictions from above, do they verify the prediction about the economic incidence of taxes? Explain, using the concept of elasticity.

Back 5

The more inelastic curve should bear a higher proportion of the tax. In this case the supply curve is more inelastic and suppliers pay $2 of the $3 tax. To calculate this, subtract the price suppliers receive from the pre-tax equilibrium price. Demand is relatively more elastic and bears $1 of the tax. The predictions regarding economic incidence of taxes is verified.

Front 6

Consider this endowment experiment: Give 50 people an apple, and 50 people an orange. People can trade in their fruit with the experimenter for the other kind. Suppose that, on average, x % of people prefer apples to oranges.

a. Show that regardless of what x is, 50% of people should trade.

Back 6

50 people-have an apple and 50 have an orange

50 X% will trade an orange for an apple 50 (1-x%) will trade an apple for an orange

>>> 50 * x% + 50 — 50 * X% = total trades >>> 50 total trades out of 100 people >>>>> 50% of people should trade

Front 7

Consider this endowment experiment: Give 50 people an apple, and 50 people an orange. People can trade in their fruit with the experimenter for the other kind. Suppose that, on average, x % of people prefer apples to oranges.

b. In practice, about how many people actually trade in an experiment like this? Explain, but as a skeptic, of the idea that the above experimental result actually shows that there's an endowment effect.

Back 7

A lot fewer than 50%, around 10% according to one study. This could be because of an endowment effect, which is when people do not trade their belongings even if it would. increase their welfare. People's utility from a good is partially dependent upon whether it has been endowed to them. They may value a good they have at a higher level than they would have been willing to pay for it.

Front 8

Consider this endowment experiment: Give 50 people an apple, and 50 people an orange. People can trade in their fruit with the experimenter for the other kind. Suppose that, on average, x % of people prefer apples to oranges.

c. Now suppose that we instead use the "BDM" procedure to figure out maximum willingness to pay (WTP) for a chocolate bar. We tell the subjects that they will report a number x, and that we will draw a random number r between 0 and 200. If x > r, they get the bar at price r. If x<= r, they don't have to pay but they don't get a bar. Show why the subject would not want to report an x less than their true WTP. Then explain why the subject would also not want to report an x more than their true WTP.

Back 8

If they report a low x: is possible an r is drawn such that x =< r < WTP, in which case they would not get the bar and lose out on possible utility since r < WTP
If they report a high x: is possible an r is drawn such that WTP < r < x, in which case they get the bar but have to overpay, resulting in a loss of utility

Front 9

Consider the diagram.

a. You will need to understand the "strongly monotonic" preferences from the "GARP for kids" paper to answer this. Suppose a person chooses bundle a from choice set A, and bundle b from choice set B, and they have strongly monotonic preferences. Explain why we can say they are irrational. (Hint: If they choose a they reveal they prefer ...)

Back 9

Since more is always better, d > b and c > a Choosing a leads to a >= d and d > b, using transitivity 4 a > b Choosing b leads to b >= c and c > a, using transitivity 3 b > a These preferences are contradictory, so we can conclude the person is irrational

Front 10

Consider the diagram.

b. Now suppose the person chooses bundle a from choice set A, and bundle c from choice set B, and they have strongly monotonic preferences. Explain why we cannot conclude they are irrational.

Back 10

Since more is always better, d > b and c > a Choosing a leads to a >= d and d > b, using transitivity 4 a > b Choosing c leads to c >= b and we know c > a. Using transitivity, c > a > b, which doesn't contradict choice from .other bundle. We cannot conclude irrationality...

Front 11

Why should you sell a stock (true value= $28) at $28 despite potential devidends?

Back 11

Calculate expected value of dividends.

Front 12

Explain why it may be rational for a person who understands your answer above to offer more than $28 for a share of the asset (true value= $28)

Back 12

If you are rational. but think some other people may be irrational and be willing to pay more than $28 at some point, you should buy now, and sell when you think the price has peaked.