This short post-AS exam course studies behavioural economics - a field that specialises in studying how
our emotions and biases effect our day to day decisions. The main aim of the course is to introduce you to
aspects of behavioural economics and to consider the limitations of orthodox economic assumptions.
“Behavioural economics is a fascinating field. It suggests that people, contrary to the basic assumptions of the
standard approach, do not always behave rationally. They may avoid slight risks, and yet take wild gambles. They
may fail to save for the future, although they have the means to do so and a good prospect of a long life. They may
not be able to choose how to spend their money in a way that maximises their “utility”, economists' jargon for
happiness. They may have no idea how to attain happiness. More than this, people are not entirely selfish. Parents
seem to give up a lot for their children. People give money to charities, churches and buskers with no apparent gain
to themselves.”
Source: the Economist, 8th May 2003
“Economic Man makes logical, rational, self-interested decisions that weigh costs against benefits and maximize
value and profit to him. Economic Man is an intelligent, analytic, selfish creature who has perfect self-regulation in
pursuit of his future goals and is unswayed by bodily states and feelings. And Economic Man is a marvellously
convenient pawn for building academic theories. But Economic Man has one fatal flaw: he does not exist.”
Source: http://harvardmagazine.com/2006/03/the-marketplace-of-perce.html
“The first company to manufacture a bread-making machine offered one model, priced at $275. Virtually no one
bought it. The company then added another, larger model, priced at $400. Overnight, the sales of the $275 model
took off. Another example: A restaurant offered a fine wine at $50 a bottle. Hardly anyone ordered it. The
restaurant then added a mediocre wine for $70. Immediately, diners began ordering the $50 wine.”
Source: Predictably Irrational, Dan Ariely
Princeton psychologist Daniel Kahneman won a Nobel Prize for
integrating his field of study into economics
For some of my blog entries on aspects of behavioural economics go to
http://www.tutor2u.net/blog/index.php/economics/C11/
A Selection of Brief Thought Experiments
If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets?
Answer: ___ mins
A test for a particular genetic condition present in a tenth of a percent of the population gives the correct diagnosis
for a given subject 95 percent of the time. You take the test along with 999 other people and it diagnoses that you
have the condition. What is the probability that you actually have the condition?
a) Less than 5 percent
b) Between 5 percent and 25 per cent
c) Between 25 and 50 percent
d) Between 50 and 99 percent
e) 95 percent
When flipping a coin which of the following sequences is most likely?
HTHTHTHTHT
or
HHHHHTTTTT
A town is served by two hospitals. In the larger hospital, about 45 babies are born each day, and 15 in the
smaller hospital. You know that roughly 50% of babies born are boys, though may be higher or lower on a
particular day. Over 1 year each hospital recorded the days on which more than 60% of babies born were boys.
Which hospital recorded more such days?
LARGE / SMALLER
What is your estimated probability that, sometime in the next twenty years, there will be a
flood somewhere in the United States in which more than 1,000 people will drown?
%
What is your estimated probability that, sometime in the next twenty years, there will be an
earthquake in California causing a flood in which more than 1,000 people will drown?
%
Linda is 31 years old, single, outspoken and very bright. She majored in politics and philosophy. She is deeply
concerned with issues of gender discrimination and social justice, and also participated in anti-nuclear
demonstration
Which of these statements in your opinion is most likely (tick your preferred answer)
Linda is a bank worker
Linda is active in the feminist movement
Linda is a psychiatric social worker
Linda is a bank worker and active in the feminist movement
A cricket bat and a ball cost £1.10 in total. The cricket bat costs £1 more than the ball.
How much does the ball cost?
Imagine that you are on a beach on a sweltering day and that a friend of yours offers to go back to your hotel to buy
a bottle of your favourite beer. How much would you be willing to pay?
Your answer is ___________
Imagine that you are on a beach on a sweltering day and that a friend of yours offers to go to the nearest
supermarket to buy a bottle of your favourite beer. How much would you be willing to pay?
Your answer is ___________
Would you accept this gamble?
Yes or No?
A 50% chance to lose $100
A 50% chance to win $150
Imagine that the UK government is preparing for the outbreak of an unusual disease which is expected to kill
6000 people. Two alternative programs to combat the disease have been proposed.
Program A - 2000 people will be saved.
Program B - There is a one-third probability that 6000 people will be saved, and a two-thirds probability that no
one will be saved.
Which program would you choose A or B? _________
Imagine that the UK government is preparing for the outbreak of an unusual disease which is expected to kill
6000 people. Two alternative programs to combat the disease have been proposed.
Now consider these two alternatives
Program C - 4000 people will die
Program D - There is a one-third probability that no one will die, and a two-thirds probability that 6000 people
will die
Which program would you choose C or D? _________
Geoff is shy and withdrawn, invariably helpful, but with little interest in people. He is meek and tidy, and has a
need for order and structure, and a passion for detail.
Rank the following in order of most likely to least likely
1.
2.
3.
4.
5.
A Farmer
A Salesman
An Airline pilot
A Librarian
A Surgeon
Dates
Think of the last 3 digits of your mobile phone number.
Add 400 to it.
Now think of this 3 digit number as a date in years.
Housing
Suppose Adam, Ben, and Carl each bought their house for $200,000. They each sold it one year afterwards:
When Adam sold it, there was 25% deflation. He sold it for $154,000 (23% less than he paid)
When Ben sold it, there was no inflation or deflation. He sold it for $198,000 (1% less than he paid)
When Carl sold it, there was 25% inflation. He sold it for $246,000 (23% more than he paid)
Who was most successful in terms of their housing transaction? _____________________
Happiness
Which would you prefer?
A: You make $100,000; all of your co-workers make $150,000 or
B: You make $80,000; all of your co-workers make $60,000
What would you expect as financial compensation for lending £200 for periods of
(i) one month
(ii) one year
£
£
A: Choose between the following
£100 today or £110 tomorrow
Your choices
B: Choose between the following
£100 in 300 days time or £110 in 301 days
You head out for a night at a comedy club. On arrival you are annoyed to discover that, after a thorough search in
every pocket, you have definitely lost your ticket, which cost £20. The box office still has tickets. Do you buy
another one?
Yes
or
No
You are planning to buy a ticket for the comedy club when you get to the theatre, but when you turn up there you
discover that you have lost the £20 note you had carried with you to pay for the ticket. The box office still has
tickets. Do you find a cash point machine and buy another ticket?
Yes
or
No
You are the coach of a basketball team and your team is trailing by 2 points, with time left for just one shot. What
shot should you tell the team to go for, 2 points or 3?
A 2-point shot succeeds about half the time
A 3-pointer about 33 percent of the time
Make your choice _________ point shot
A cab was involved in a hit and run accident at night. Two cab companies, Blue and Green, operate in the city.
- 85% of the cabs in the city are Green and 15% are Blue
- A witness identified the cab as Blue
The conditions are replicated and finds that, given the circumstances, it is possible to correctly identify each of the
two colours correctly 80% of the time and incorrectly 20%
Given the eyewitness testimony, what is the probability that the cab was Blue?
Suggestions for background reading
Play the Monty Hall problem
http://www.nytimes.com/2008/04/08/science/08monty.html#
The Science of Irrationality: Why We Humans Behave So Strangely (interview with Dan Ariely)
http://www.sciam.com/article.cfm?id=the-science-of-irrational
Why we buy what we buy
http://www.guardian.co.uk/money/2008/may/20/consumeraffairs.economics
Economics, which way for Obama?
http://www.nybooks.com/articles/21491
Scientific America – the economist has no clothes
http://www.sciam.com/article.cfm?id=the-economist-has-no-clothes
What makes people give?
http://www.nytimes.com/2008/03/09/magazine/09Psychology-t.html?_r=1&oref=slogin
Higher price makes cheap wine taste better
http://www.mindhacks.com/blog/2008/01/higher_price_makes_c.html
Exuberance is rational
http://www.nytimes.com/library/magazine/home/20010211mag-econ.html
And Behind Door No. 1, a Fatal Flaw
www.nytimes.com/2008/04/08/science/08tier.html?_r=1&scp=2&sq=chen&st=nyt&oref=slogin
Homo economicus Evolves
http://www.sciencemag.org/cgi/content/full/319/5865/909
Tim Harford versus Dan Ariely
http://www.omnivoracious.com/2008/04/predictable-irr.html
Why I always buy the same sandwich
http://stubbornmule.wordpress.com/2008/05/21/self-herding/
Loss aversion and experiences of inflation
http://www.tutor2u.net/blog/index.php/economics/loss-aversion-and-experiences-of-inflation/
Who should pay the bill for a meal?
http://www.predictablyirrational.com/?p=243
How one smoker quit
http://freakonomics.blogs.nytimes.com/2008/05/30/how-one-smoker-quit/
Richard Thaler talks to Google
http://www.youtube.com/watch?v=Dz9K25ECIpU
Dan Ariely on You Tube
http://www.youtube.com/user/danariely See also www.independent.co.uk/news/science/how-predictably-irrationalare-you-835052.html and www.independent.co.uk/news/science/how-predictably-irrational-are-you-the-test835519.html