Economic

 

 

 

 

 

Part A – Essays  (about  15 words per point)

 

 

• 10 pt Discuss the relationship between tunneling/focusing and deciding/choosing

 

 

 

• 10 pt John enjoys expensive stuff. He also prefers to see himself as an ascetic (someone who lives very modestly). If his will power over his behavior was stronger than over his preferences, how would he solve this seeming contradiction? What if it was reversed?

 

 

 

• 30 pt We often hear the phrase “Time is Money.” Discuss how wage rate, wealth, time preference and time constraint impact our perception of the value of time.

 

 

 

• 20 pt Compare and contrast how financial slack and temporal slack affect decision making.

 

 

Part B- Problems

 

• 20 pt Pat realizes they need to change their life.  They are considering   either renovating their home, or transforming their sense of appreciation.   Either way will cost them C.  Their utility function is

 

• = V  ^B   ,

where V  is the value of their home, and B is sense of appreciation.

 

The value of their home starts at  V₀  = 10,  and if renovated  will be worth

• = (1+V₀ )* C ^1/2

 

Their sense of appreciation  starts at  B₀,    and  if transformed becomes   B = B₀ + .2*(1-B₀) .

 

 

1. Fill in the following table:

B0	C	V (renovated)	B (transformed)	U if renovate (no transformation)	U if transform (no renovation)
.1	1
.3	1
.5	1
.1	4
.3	4
.5	4
.1	9
.3	9
.5	9

 

Show your work, or the spreadsheet formulas.

 

1. What does imply about when Pat pays for renovation or transformation?  Hint: consider the relative utilities.

 

 

 

 

• 30 pt Assume Jane is considering self-improvement training for either emotional or rational strengthening. The training affects her will power over events in the following way:

 

Training	Will Power over the present	Will Power over the next year	Will Power over two years
Emotional	.6	.1	.05
Rational	0	.3	.6

 

 

She is faced with two possible sequences of Natural Probabilities of feeling successful. One declines over time, and the other stays constant (as shown in the table below). Let her experience of utility from the trainings be equal to the discounted value of the changes in probability (δ is the discount rate):

 

PV of training =   ∆ Prob ₀  +    ∆ Prob₁  / (1+ δ)   +   ∆ Prob₂  / (1+ δ)²

 

Where ∆ Prob  =  Nomicity after training – Natural probability

 

When she’s feeling anxious she discounts at the rate of 100% a year. When she’s calm, she discounts at the rate of 10% a year.

 

1. Fill in the following table. Describe the ways her state of mind affect her decision making. Make sure to show all your work or include your spreadsheet formulas .
2. How does this affect how to sell the different types of training?

 

Training	Natural Prob In the present	Natural Prob Over the next year	Natural Prob Over two years	∆ Prob In the present	∆ Prob Over the next year	∆ Prob Over two years	Present Value when Anxious	Present Value when Calm
Emotional	.75	.5	.25
Rational	.75	.5	.25
Emotional	.5	.5	.5
Rational	.5	.5	.5

 

 

 

• 50 pt Paul has an opportunity for a job that increases his income $20,000 a year for the rest of his career. However, the firm might be moving. The uncertainty about moving (σ_t ) increases with how far in the future it is considered, and is represented by σ_t = exp(t) . Let his ability to handle uncertainty be described by h = 100.  This means if the uncertainty at t years is less than h, he does not discount the future.  However, he can reduce the uncertainty he has to handle by discounting future years by exp(-pt), where p is the discount rate, using the formula for discounted uncertainty:

 

exp(-pt)* σ_t

 

** Hint: To find minimum discount rate, determine the smallest p necessary so that                                                                         exp(-pt)* σ_t  <=  h

 

However, that also means it changes his perception of the maximum transition cost  to take the job, C*. That perception is determined by the present value of extra income through years into the future and its associated discount rate, using the formula:

 

PV(p, T, Extra Income per Year)  =              ∑ ₌₁ ( ∗ (1 + )⁻ )

 

** Hint:  If using excel, consider its PV function

 

1. Fill in the following table (make sure to show all your work):

 

 

Year  into the future focused on	Uncertainty about Moving (σt )	Minimum Discount Rate to Handle Uncertainty (p)	Maximum Transition Cost  (C*)
1
2
3
4
5
6
7
8
9
10

 

 

1. What is the Maximum Transition Cost he would be willing to pay, and its associated discount rate and years into the future?
2. The company offers him a free stress reduction program that triples his capacity to handle uncertainty. Recalculate the answers for b).
3. Did the company make it more likely he would take the job? Explain what happened to Paul’s time horizon and discounting.

 

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