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UNIVERSITY OF WARWICK

May Examinations 2019/20

Behavioural Economics


Time Allowed: 2 Hours

Answer TWO of the FIVE questions (50 marks each). All questions have parts and the
maximum marks for each part are indicated in bold in brackets at the end of the part. You
may NOT answer parts from more than two questions.

Approved pocket calculators are allowed.

Read carefully the instructions on the answer book provided and make sure that the
particulars required are entered on each answer book. If you answer more questions than
are required and do not indicate which answers should be ignored, we will mark the
requisite number of answers in the order in which they appear in the answer book(s):
answers beyond that number will not be considered.


1. In reference to the topic Non-Standard Beliefs:

(a) Explain how both the gamblers’ fallacy and overinference might result from a
belief in a law of small numbers. What does Rabin (2002) mean by fictitious
variation? (20 marks)

(b) What is projection bias? Discuss with reference to the main results of
Conlin et al (2007). (15 marks)

(c) How do Camerer and Lovallo (1999) interpret their finding that there is more
entry (and less profit) in experiments where payoffs depend not only on the
number of entrants but also on skill (in contrast to a random device)? Why
might this difference be even greater with self-selected subjects? (15 marks)


2. In reference to the topic Prospect Theory and Reference Dependent Preferences:

(a) Briefly illustrate the main characteristics of the utility function usually assumed
in Prospect Theory and explain the reasons for its shape. (15 marks)

(b) Consider the paper “Labor supply of New York city cabdrivers: one day
at a time” (Camerer et al, 1997). Discuss the main results of the paper in light
of Prospect Theory. (15 marks)

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(c) Explain how the principle of diminishing sensitivity can explain both the shapes
of the utility function and of the probability weighting function usually assumed
in the Prospect Theory. (20 marks)


3. In reference to the topic Social Preferences:

(a) Briefly describe the ultimatum and dictator games and discuss whether the
experimental evidence regarding these games is inconsistent with game
theory. Why does the dictator game provide useful information regarding the
proposer’s motivation that is ambiguous in the ultimatum game? (20 marks)

(b) Which experimental results from the ultimatum game suggest that social
preferences are not just concerned with outcomes? (10 marks)

(c) What are the main findings of Charness and Rabin (2002) regarding social
preferences across a variety of experimental games? Include a contrast
between explanations provided by difference-aversion models and models of
social-welfare preferences. (20 marks)


4. In reference to the topic Status and Social Comparison:

(a) What is the Relative Income effect, and how does the empirical literature
measure reference income? With reference to the results of Luttmer (2005),
discuss possible mechanisms. (20 marks)

(b) In the simple additive comparisons model in Clark and Oswald (1998), in what
way does the optimal reaction to a change in the comparison reference depend
on the curvature of utility? Illustrate for the case of an increase in the
comparison reference. (15 marks)

(c) Discuss Bowles and Park’s (2005) explanation for the relationship between
income inequality and work hours that they find. (15 marks)


5. In reference to the topic Behavioural Public Policy:

(a) ‘Individual failure calls for a more paternalistic role of Government in a way
that it will make choosers better off, as judged by themselves.’ Comment on
this statement. (20 marks)

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(b) What mistakes do Thaler and Sunstein (2003, 2008) claim anti-paternalistic
stances are generally based on? (15 marks)

(c) With reference to the paper of Chetty et al. (2014) discuss how a ‘nudge’ may
help increasing retirement savings. State at least three reasons why price
subsidies are considered to be less effective than automatic contributions in
increasing savings rates. (15 marks)