3. Prospect theory Behavioral economists use prospect theory to try to explain why people make different decisions when facing the same outcomes, based on how a choice is framed. The following scenario illustrates how framing can influence choices. Imagine you are on a game show and have won $1,000 in the first round. You now have two options: 1. Play a second round in which you will either win an additional $1,000 (for a total of $2,000 in winnings) or win nothing but keep the original $1,000 2. Quit the game and receive an additional $500 (for a total of $1,500 in winnings) Suppose your utility (U) as a function of your total wealth is given by the following graph. Before coming on the show you had $11,000. Use the black point (plus symbol) to represent your utility reference point after having won the initial $1,000. Then use the grey point (star symbol) to represent your utility if you win an additional $1,000. Finally, use the purple point (diamond symbol) to represent your utility if you quit and accept the additional $500. UTILITY 10 10000 11000 12000 13000 WEALTH (Dollars) 14000 15000 + Reference point ✶ Win $1,000 more Accept $500 ?

3. Prospect theory Behavioral economists use prospect theory to try to explain why people make different decisions when facing the same outcomes, based on how a choice is framed. The following scenario illustrates how framing can influence choices. Imagine you are on a game show and have won $1,000 in the first round. You now have two options: 1. Play a second round in which you will either win an additional $1,000 (for a total of $2,000 in winnings) or win nothing but keep the original $1,000 2. Quit the game and receive an additional $500 (for a total of $1,500 in winnings) Suppose your utility (U) as a function of your total wealth is given by the following graph. Before coming on the show you had $11,000. Use the black point (plus symbol) to represent your utility reference point after having won the initial $1,000. Then use the grey point (star symbol) to represent your utility if you win an additional $1,000. Finally, use the purple point (diamond symbol) to represent your utility if you quit and accept the additional $500. UTILITY 10 10000 11000 12000 13000 WEALTH (Dollars) 14000 15000 + Reference point ✶ Win $1,000 more Accept $500 ?

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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