Question

In each scenario below, please label which mistake they made in regard to economic decision making. Alexander is heavily invested in the stock of Nortel, a telecommunications giant. However, Nortel has been in steady decline and despite the fact all signs point to the fact Nortel will likely go bankrupt, Alexander holds onto his stocks, unwilling to sell unless he makes back at least the money he invested into it. Jim is washing his laundry and as he checks his jean pockets, he finds an unexpected windfall of $50. Elated because it was $50 more than he had before, he decide splurge on a lobster and filet mignon dinner. Geneva is a researcher at Genentech, a biotech firm and faces decision paralysis every time a big question is posed to her. When her boss asks her what project she wants to work on, she says she is indifferent every time, so her boss just assigns her to a project. Tiffany lives in Alameda, CA. She recently got two job offers, one in Oakland and one in San Francisco. The San Francisco job pays $1000 more per year, so Tiffany accepts the job. However, she quickly realizes the travel time, which is an hour more each way. quickly becomes a burden. Steve is trying to diet. Each day he says the diet will begin today, but each time he eats a potato chip, he indulges in it. The next day, he promises his diet will really start, but the vicious cycle continues

Answer 1

Answer:

a) Loss Aversion

b) Mental Accounting

c) Status Quo Bias

d) Misperceiving opportunity cost

e) Overconfidence

Explanation:

a) In Alexander's case, he is suffering from the Loss Aversion theory that is very prevalent in Economics where some people prefer not losing money as opposed to actually gaining money. Alexander does not want to lose the money he invested and so is holding on hoping to get back his money so he doesn't lose anything.

b) In Jim's case, he practices mental accounting. This is a situation where people group their various money related transactions in different groups in their mind and ascribe them different values. Jim did not attach enough value to the money he found though and so just decided to spend it.

c) Geneva faces Status quo bias which is a situation where one prefers things the way they are. She freezes every time big question is asked of her and just let's things continue the way they are every time. She faces the Status Quo Bias.

d) Tiffany misperceived her Opportunity Cost when she failed to calculate the transport cost associated with the job she took. Had she not done so, she would have factored in the correct Opportunity Cost and seen that it might be better to take the job closer to her.

e) Steve is overconfident in his ability to start a diet. He has been failing at doing so and yet believes he can do so. It is important therefore that he finds something else to spur him ti start the diet because his confidence in doing it himself is clearly a farce and does not match what he actually can do.