An individual has preferences consistent with prospect theory. The person takes their current wealth of 10,000 (plus any certain additions) as their reference point. Gains above this reference point are worth +1 util. Losses below this reference point are worth -2 utils. The person is faced with two choice problems. The first involves a choice between (A) no gamble and (B) a gamble with an equal chance of winning 1,800 and losing 1,000 . The second choice problem, the person first has 1,000 taken away (resulting in the adjustment of the reference point). The choice is then between (C) being given back 1,000 for sure and (D) an equal chance of winning 2,800 or nothing. What choices would the person make?
a. A and C.
b. A and D.
c. B and C.
d. B and D.
Question 2
The government is considering a mandatory savings program that forces people to save 8 of their income each year for retirement. What behavioral biases might be used as a justification for such a program? (Choose all that apply.)
a. Limited cognitive ability, preventing people from being able to accurately estimate how much an investment early in one's career will grow.
b. Limited willpower, preventing people from being able to give up the pleasure of current consumption for the benefits of consumption later in retirement.
c. Limited commitment power, leading the government to use the funds for current expenditures.
d. Risk aversion, leading people to consume now rather than wait until the uncertain future.
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