Behavioral Decision Making and Employee Stimulation Questions

Description

You should complete the long question according to the lecture notes( including 11 attachments).

Long question 1 (10 points)

To test whether a proposed incentive program would increase productivity, a manager applied the program to a group of workers who had the lowest productivity. A month later, their productivity indeed increased. Give five viable explanations to the increase in productivity. (2 points for each reasonable explanation spotted)

Long question 2 (10 points)

Airlines often charge higher airfares during busy seasons (e.g., in the summer) than during slow seasons. Most consumers consider this practice fair and do not complain. Now, suppose that you are the owner of a small store, and you are the only store in the region that carries face mask.

Because of the recent COVID pandemic there is a great increase in demand for face mask, and you doubled the price of the mask. Having no other choices, many residents still bought masks from you. However, they were angry and considered you unfair. Your store’s reputation is badly damaged. Please list the key differences between what you did and what the airlines do which you think make consumers react so differently in the two cases.

Long question 3 (10 points)

You are the owner of a computer software company. Instead of buying, many people illegally copy your software from their friends and relatives. Propose two designs or strategies that would make consumers feel guiltier if they copy your software. The strategies should be based on psychological principles. For example, to reduce the price of your software is not an acceptable strategy for this question.

Long question 4 (10 points)

TORO COMPANY

Toro had begun in 1914 by making tractor engines and later branched out into lawn mowers. In the early 1960’s they added snow throwers. By 1984 they offered a full range of products for “outdoor care” to both institutional and residential customers. Residential lawn care products constituted about 40-50% of sales, with snow throwers accounting for a further 10-15%.

Snow thrower sales were channeled through twenty-six regional distributors who supplied snow throwers to independent retailers, such as hardware stores and lawn and garden centers, across

the snow belt (a number of regions near the Great Lakes in North America where heavy snowfall in the form of lake-effect snow is particularly common). Toro also sold directly to mass merchandisers, like Marshall Field, whose private labels made up about 30-35% of Toro snow thrower sales. Although snow throwers were sold throughout the year, 60-70% of sales occurred during November, December, and January, dropping off during the ensuing months and becoming minimal during the summer. Sales were especially strong in a year following a severe winter, presumably because people resolved not to be “caught again.”

The Toro product line included the newly-introduced lightweight power shovel, as well as the more traditional single-stage and two-stage models. The (smaller) single-stage machines, with suggested retail prices between $270 and $440, had been selling in excess of 100,000 units per year. The self-propelled two-stage machines, ranging in price from $640 to $1500, had been selling at somewhat less than 20,000 units per year.

These figures were a far cry from the heady days of the late 1970’s when several years of strong growth had culminated in two year, 1978-1979 and 1979-80, of exceptionally high sales. During that time Toro sold approximately 800,000 single-stage and 125,000 two-stage machines. The severity of the three winters beginning in 1977/1978 created a demand that rewarded dealers for their aggressive inventories.

The following year, 1980/1981 sales plummeted. Dealers and distributors were left with unsold inventories that in some cases lasted them three years. Toro not only had to forego the lost income as orders fell to a trickle but they also offered to pay some of the huge holding costs faced by their dealers. There next two winters were equally mild, causing a sharp downturn in Toro’s fortunes. Dealers had become disenchanted with the snow removal equipment. The outlook was bleak.

Questions

1) In general, why were consumers reluctant to purchase snow throwers? (5 points)

2) Describe some marketing/promotional strategies Toro could use to improve sales. (5 points)

Long question 5 (10 points)

You are debating whether or not to invest $180K in a R&D project aimed at developing a new product. There is a 50% chance that the project will be successful. If the project is successful, the company can choose between building a large plant which costs $400K or a small plant which costs $200K. The market size for the product may be large (50% probability), medium (30%

probability), or small (20% probability). The present value of the net cash flows corresponding to sales in a large, medium, and small market over the life of the plant are $1000K, $500K, and

$250K, respectively. However, a small plant can only cope with a small or medium market size, but not with a large market size; in other words, for a small plant, the net cash flow in a large market is the same as that for a medium market.

1) Draw a Decision Tree showing these choices. (6 points)

2) Based on the Decision Tree analysis, decide 1) whether to invest in large or small plant (2 points), 2) whether to invest in this project at all (2 points).

Long question 6 (20 points)

Mike is a fisherman living on a rural island. He is deciding to take one of the three potential jobs for today: A) working for the local store, with a fixed salary of HK$400 for sure, or B) fishing in the small river near his home, in which he could make either 0 (and no loss) or HK$1000, with equal probabilities; or C) fishing in the sea, in which he could lose HK$200 (e.g., the cost of the boat) or make HK$1500, with equal probabilities.

Assume that Mike’s expected utility (EU) function is x0.5, where x>=0, that his prospect theory (PT) value function is x0.5, where x>0, and that she is twice as sensitive to a loss than to a gain of the same size. Mike’s PT weighting function is the same as the probability of events.

6.1. If Mike is an expected value maximizer, which option will he choose? Back up your conclusion with calculations (3 points).

6.2 What are EU(A), EU(B), and EU(C) if Mike’s current wealth is worth HK$100? Based on the calculation, which option will he choose if Mike is an expected utility maximizer? (3 points)

6.3 What are EU(A), EU(B), and EU(C) if Mike’s current wealth is worth HK$300? Based on the calculation, which option will he choose if Mike is an expected utility maximizer? (2 points)

6.4 What are EU(A), EU(B), and EU(C) if Mike’s current wealth is worth HK$2000? Based on the calculation, which option will he choose if Mike is an expected utility maximizer? (2 points)

6.5 Suppose Mike has just moved to the island with HK$100 wealth, and local living cost is about HK$320 per day. Based on your analyses of results from 6.2, 6.3 and 6.4 (assuming Mike an expected utility maximizer), what kind of career path would you recommend Mike to take? (4 points)

6.6 What are Prospect Theory V(A), V(B), and V(C) if Mike’s current wealth is worth HK$100? Based on the calculation, which option will he choose if Mike is a PT utility maximizer? (3

points)

6.7 What are Prospect Theory V(A), V(B), and V(C) if Mike’s current wealth is worth HK$2000? Based on the calculation, which option will he choose if Mike is a PT utility maximizer? (3 points)

Explanation & Answer length: 6 Questions.

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Session 1 Course Introduction Research Area • Behavioral Decision Making • Behavioral Economics • Behavioral Insights in Big Data Research • Consumer Behavior Scholars (main contributors of this course) • Daniel Kahneman • Nobel Laureate in Economics, 2002, Princeton; • Richard Thaler • Nobel Laureate in Economics, 2017 , Center for Decision Research, University of Chicago; • George Loewenstein • Carnegie Mellon • Christopher Hsee • Center for Decision Research, University of Chicago • Dan Ariely • Duke University; This Session Basic concepts – Rational vs. normal decision maker – Optimizer vs. satisficer – Normative vs. descriptive theories – Three basic characteristics of rational decision makers – Examples of violations – How to improve Basic concept – The rational decision maker – The normal decision maker Basic concepts – Optimizer/maximizer – Satisficer Basic concept

– Normative theories – Descriptive theories Rational decision maker Three basic characteristics of rational decision maker – Being consistent – Treating money as fungible – Making unbiased judgements Examples of violations – Gain-loss asymmetry – Mental accounting – Wishful-thinking – Overconfidence How to improve – Knowledge – Trading places – Reverse correction Session 4 Heuristics & Biases III This Session Some important biases – Hindsight bias – False consensus – Mental accounting – Proportion bias – Reliance on irrelevant reference price Two sets of data Mturk: Data from the Amazon Mturk (104 Participants) Class: • Data from the previous class (140) • Data from this class (64); in total (204) Hindsight bias The tendency of people to overestimate their ability to have predicted an outcome that could not possibly have been predicted. “knew-it-all-along effect” or “creeping determinism” “I knew it!”

Question 1 For some years after the arrival of Hastings as governor-general of India, the consolidation of British power involved serious war. The first of these wars took place on the northern frontier of Bengal where the British was faced by the plundering raids of the Gurkas of Nepal. The British attempted to stop the raids by an exchange of lands, but the Gurkas would not give up their claims to country under British control, and Hastings decided to deal with them once and for all. The campaign began in November, 1914. The Gurkas were only some 12,000 strong; but they were used to fighting in territory well-suited to their raiding tactics. The older British commanders were used to war in the plains where the enemy ran away from a resolute attack. In the mountains of Nepal it was not easy even to find the enemy.

The troops and transport animals suffered from the extremes of heat and cold. However, the British/Gurka won eventually. Now, suppose that you did not know the actual outcome (i.e., British victory), report your subjective assessment of the probability of the following two outcomes based on the background information provided above. British victory: _____% Gurka victory: _____% Total: 100 % Mturk 60% 58% 52% 48% 50% 42% Given British win Given Gurka win 40% 30% Predict British win Predict Gurka win Class 80% 60% 59% 57% 43% 40% 41% Given British win Given Gurka win 20% 0% Predict British win Predict Gurka win Hindsight bias • People overestimate their own prediction ability. Hindsight bias • Example • In a study, researchers found that among those who failed in their entrepreneurial attempts, 77.3% believed before their failure that they would succeed; however, after the failure, only 48% thought they believed they would succeed before the attempt.

Hindsight bias: discussion • Attack of Pearl Harbor • Fear of uncertainty • Revise evidences in memory • Admiration for correct (but random) prediction. False consensus People tends to overestimate the extent to which their beliefs, opinions, preferences, values and habits are typical of those of others. People think others also think the same way that they do. The effect is stronger in instances where we are very sure that our beliefs, opinions or ideas are the correct ones

Question 2 (1) If you have the following two options, which would you choose? A. Receive 1000HKD for sure B. Flip a coin; receive 3000HKD if heads, or receive nothing if tails  To A  To B (2) Which option do you think most of your classmates would choose? A B Those who chose A (or B) are more likely to predict others to choose same option A (or B) 80% 73% 70% 55% 60% 45% 50% 40% Predict same with self 34% Predict different from self 30% 20% 10% 0% Class Mturk Question 2 Pred. others’ Own choice A B A 113(82.5%) 24(17.5%) B 31 (46.3%) 36 (53.7%)

Question 3 You arrive for the first day of class in a course. The professor says that the grade in your course will depend on a paper due the final day of the course. He gives the class the option of two alternatives upon which they must vote. They can either do papers individually in the normal way, or they can work in teams of three persons who will submit a single paper between them. You are informed that he will still give out the same number of A’s, B’s, and C’s, etc., but that in the first case every student will be graded individually while the second case all three students who work together get the same grade. (1) Which option would you choose?  Do the paper individually  Do the paper in a group. (1) Which option do you think most of your classmates would choose?  Do the paper individually  Do the paper in a group. People are more likely to predict others to choose same option 80.0% 71.1% 70.0% 60.0% 50.5% 49.5% 50.0% Predict same with self 40.0% 30.0% 28.9% Predict different from self 20.0% 10.0% 0.0% Class Mturk

Question 3 Pred. others’ Own choice A B A 60 (60%) 40 (40%) B 19 (18.3%) 85 (81.7%) Expansion • From false consensus to projection • Projection bias: making sense of the world (other people; average people) by projecting from one’s own characteristics • Implication for market research, and interpersonal understanding in general Mental accounting Individuals divide their current and future assets into separate, non-transferable portions. Money is fungible, but people put it in separate “mental accounts” Mental Accounting budgeting Allocate a certain amount for a particular activity (e.g., movie). If we have spent it, we do not allocate additional resources for this category

Question 4 Imagine that you have decided to see a play and paid the admission price of 500HKD per ticket. As you enter the theater, you discover that you have lost the ticket. The seat was not marked, and the ticket cannot be recovered. Would you pay 500HKD for another ticket? Imagine that you have decided to see a play where admission is 500HKD per ticket. As you enter the theater, you discover that you have lost a 500HKD bill. Would you still pay 500HKD for a ticket for the play?  Yes  No More people choose to pay for the ticket when lost bill comparing to lost the ticket The proportion of people chose to pay 56% 60% 50% 40% 37% 36% 30% Lost ticket Lost bill 17% 20% 10% 0% Class Mturk Mental Accounting Monitor and open/close a mental account Question 5 Suppose you bought a case of a good 1982 Bordeaux in the futures market for 150HKD a bottle. The wine now sells at auction for about 600HKD a bottle. You have decided to drink a bottle. Which of the following best captures your feeling of the cost to you of drinking this bottle?

A. 0HKD B. 150HKD C. 150HKD plus interest D. 600 HKD E. -450HKD (I drink a 600HKD bottle for which I paid only 150HKD) Suppose you bought a case of a good 1982 Bordeaux in the futures market for 150HKD a bottle. The wine now sells at auction for about 600HKD a bottle. You have decided to drink a bottle. Which of the following best captures your feeling of the cost to you of drinking this bottle? Mturk Class A. 0HKD 10% 7% B. 150HKD 23% 10% 7% 20% 42% 32% C. 150HKD plus interest D. 600 HKD E. -450HKD 18% 31% (I drink a 600HKD bottle for which I paid only 150HKD) Question 6 An avid sports fan plans to travel 2 hours to see a basketball game. He paid 200USD for his ticket/He got a ticket worth 200USD from a friend for free. The observatory forecasts a severe storm for the night of the game.

Do you think this person should brave the storm to see the game?  Yes  No More people choose to brave the storm to see the game when the ticket was paid by self Proportion of people chose to see the game 100% 92% 90% 80% 75% 73% 70% Free 61% 60% 50% 40% Class Paid Mturk Question 7 You need money to cover the costs of your daughter’s wedding and will have to sell some stock. You remember the price at which you bought each stock. One stock you are holding is Blueberry Tiles, which you bought with 15000USD/25000USD. Now it’s worth 20000USD. In other words, if you sell it today you will have achieved a gain of 5000USD/ 5000USD less than you paid for it. The value of this stock has been stable in recent weeks.

Would you sell this stock?  Yes  No More people choose to sell the stock when gain 500USD Proportion of people chose to sell the stock 90% 85% 80% 75% 70% 65% 60% 55% 50% 45% 40% 85% 83% Gain 55% Class 58% Loss Mturk Question 8 You purchased an apartment in Hong Kong Island a year ago with only 2 million HKD/with 4 million HKD (suppose that you bought it with cash), which was an unusually good deal. The current market value of this apartment is 3 million HKD. You will be leaving Hong Kong soon. Someone is willing to rent your apartment for 20000HKD per month. The lease must be for two years. No one can predict what the realty market will be like in two years. Would you choose to:  A rent it out for 2 years, or  B sell it now for 3 million HKD More people choose to sell the apartment when gain 1 million HKD Proportion of people chose to sell the apartment 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 81% Gain 33% Loss 12% Class 17% Mturk Proportion bias People based on relative value (proportional value) rather than absolute value to make decision.

The initial value influences people’s judgement of the subsequent value. Question 9 Large Proportion: You are shopping for a fan at a local store. You decide to buy a fan that costs 130HKD. When you are about to pay for it, a friend comes by and tells you that the same fan sells for 100HKD at another store 20 minutes away. Small Proportion: You are shopping for an air conditioner at a local store. You decide to buy an air conditioner that costs 4250HKD. When you are about to pay for it, a friend comes by and tells you that the same air conditioner sells for 4200HKD at another store 20 minutes away.

Would you go to the other store? Would you go to the other store?  Yes  No More people choose to go in large proportion condition Proportion of people chose to go 60% 52% 48% 50% 40% 30% Large proportion 26% 23% Small proportion 20% 10% 0% Class Mturk 20 minutes for 30 HKD 60% 52% 48% 50% 40% 30% Large proportion 26% 23% Small proportion 20% 10% 0% Class Mturk 20 minutes for 50 HKD Reliance on irrelevant reference price Reference price is what the customer is used to paying for a product and expect to pay despite the value they get. People start with the information that one does know (even irrelevant reference price) and then adjust until an acceptable value is reached. Reference price Question 10 You are in Singapore now preparing for a job interview and you want to perform well.

You know that a nutritional supplement, called Mind-Boost, containing herbal ingredients and concentrated caffeine can improve your performance in the interview. Mind-Boost is made in Hong Kong. It would cost 100HKD a pill in Hong Kong, but it costs 1000HKD a pill in Singapore. / It would cost 2000HKD a pill in Hong Kong, but it costs only 1200HKD a pill in Singapore. You have 2000HKD on you. Will you buy it in Singapore?  Yes  No More people choose to buy if the pill sells more expensive in HK Proportion of people chose to buy 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 80% 71% 54% Priced 100 HKD in HK 27% Class Mturk Priced 2000 HKD in HK Singapore price: 1200 HKD 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 80% 71% 54% Priced 100 HKD in HK 27% Class Singapore price: 1000 HKD Mturk Priced 2000 HKD in HK This Session Some important biases – Hindsight bias – False consensus – Mental accounting – Proportion bias – Reliance on irrelevant reference price The Value Heuristic Men and woman on the street in Paris CUHK Business School Study 1  80 face pictures of equal size (400 x 475 pixels), with 40 male faces and 40 female faces.

 Respondents were asked to evaluate the faces, one by one, on the computer screen. and then at the end, unexpectedly, they were asked to estimate how many male and female faces they had evaluated. CUHK Business School Examples of face pictures CUHK Business School 4 Study 1: results Figure 1 Frequency Estimation Mean judgment 44 female faces male faces 42 40 38 36 Male respondents CUHK Business School Female respondents 5 Study 2: varying the desirability of picture sets Two condition between subject design Two sets of pictures: one set includes only attractive faces and the other only unattractive faces. Each set includes 28 pictures, 50% females. Respondents were asked to evaluate the faces, one by one, on the computer screen. and then at the end, unexpectedly, they were asked to estimate how many male and female faces they had evaluated. CUHK Business School Attractive faces CUHK Business School 7 Unattractive faces CUHK Business School 8 Study 2:

Attractive vs. Unattractive Faces Unattractive Faces Attractive Faces 15 15 Female pic 12 12 male pic 9 9 6 6 3 3 male repsondents female respondents CUHK Business School male repsondents female respondents 9 Study 3: Monetary Incentive Study 3: Monetary Incentive Value manipulation Study 3: Monetary Incentive Value manipulation Incentive for accuracy Frequency Estimation Study 3: Monetary Incentive Mean estimation flower pic bird pic 40 35 30 25 20 flower as incentive bird as incentive Results from Session 4 Questionnaire CUHK Business School 14 Question 11 Recently, space scientist found a new planet called X-5-8. They also found that this planet has reserves of all kinds of diamonds we can find on Earth. They also accurately measured and estimated the total reserve of each kind of diamond. Purple Diamond is one of the most expensive kinds of diamond because the color can remain the same after long usage.

A one-carat sized purple diamond could be priced at US$20,000/US$1,000, much higher than the average diamond price of US$5,000. Please, without checking other source of information, estimate the reserve of this kind of diamond (range from 10 million to 100 million carats) on this new planet Please carefully think about it and pick a best estimate below. People estimated reservation of the diamond less when the price is high 6 Estimated reservation of the diamond (in million carats) on this new planet. 5.67 5 4.46 4 3 2 1 0 Price US$20,000 Price US$1,000 The value heuristic  People perceive what is more attractive, or more valuable, as more scarce

 This bias is very robust across different domains and with different measures of scarcity CUHK Business School 17 Implication  Price & demand  Auction of antiques  Consumer search  Helping to save endangered species of attractive vs. unattractive animals (appearance) CUHK Business School 18 Supply-Demand Dynamics CUHK Business School 19 Implication  Price & demand  Auction of antiques  Consumer search  Helping to save endangered species of attractive vs. unattractive animals (appearance) CUHK Business School 21 Session 3 Heuristics & Biases II Heuristics in Judgement Heuristic ———–Mental shortcut Heuristic ———–Rule of Thumb Heuristics in Judgement Simplified cognitive strategy, used to save time & effort, allowing decision-maker to make acceptable decisions. Satisficer vs. Optimizer This Session Four heuristics – Availability Heuristic – Representativeness Heuristic – Anchoring and Adjustment Heuristic – Evaluability Heuristic Two sets of data Mturk: Data from the Amazon Mturk (100 Participants) Class: • Data from the previous class (145)

• Data from this class (65); in total (210) The availability heuristics We estimate probabilities by how easy we can recall the event: easiness of recall as a cue The availability heuristics We estimate probabilities by how easy we can recall the event: easiness of recall as a cue Actual Probability Easiness in Mind The availability heuristics We estimate probabilities by how easy we can recall the event: easiness of recall as a cue Vividness Actual Probability Easiness in Mind Recency Primacy The availability heuristics After seeing news through media, people may judge that the likelihood of this event to be greater. The availability heuristics Vividness Events that stand out in our minds have more influence on our beliefs about the world than statistics and graphs. Recency effect The most recently presented items or experiences will most likely be remembered best. Primacy effect The first items presented in a series is remembered better or more easily, or for them to be more influential than those presented later in the series.

Question 1 Please rank order the following causes of death worldwide in 2014, with 1 being the most common cause, and 4 the least common one. Please drag the options to rank order them. War and civil conflict ___________ Accident by vehicles ___________ Cancers of the trachea, bronchus, and lung ___________ Respiratory infections ___________ War and civil conflict Accident by vehicles 0.03 million 1.48 million Cancers of the trachea, bronchus and lung 1.64 million Respiratory infections 2.66 million 49.33 times 88.67 times Mturk: Class: • 87% did not consider war and civil conflict as the least common cause. • 53% did not consider war and civil conflict as the least common cause. • 47% thought war and civil conflicts cause more death than respiratory infections • 34% thought war and civil • 55% did not consider respiratory infections as the most common cause. • 83% did not consider respiratory conflicts cause more death than respiratory infections infections as the most common cause. Question 2 The following companies are listed in 2014’s Fortune 500. Please estimate their revenues in 2014 (in millions; the range is between 10,000 million and 90,000 million)

Company Actual Revenue Fortune (millions) Rank Rank in this list AmerisourceBergen Comcast 89140 64657 28 44 1 2 United Technologies Lowe Ingram McDonald Nike Colgate-Palmolive Gap Starbucks 62953 53417 42554 28106 25836 17420 16148 14892 45 52 69 108 115 167 178 196 3 4 5 6 7 8 9 10 Company Actual Revenue Rank in (millions) this list AmerisourceBergen Comcast 89140 64657 1 2 United Technologies Lowe Ingram McDonald Nike Colgate-Palmolive Gap Starbucks 62953 53417 42554 28106 25836 17420 16148 14892 3 4 5 6 7 8 9 10 Familiar Group: McDonald Nike Gap Starbucks Comcast Unfamiliar Group: AmerisourceBergen United Technologies Lowe Ingram Colgate-Palmolive Actual and Estimated Revenue 65000 59097 60000 55000 49764 50000 48233 45000 40337 Familiar 40000 35000 30000 Unfamiliar 34373 29928 25000 Actual Mturk Class Actual and Estimated Revenue 7.5 7.0 7.2 6.8 6.8 6.5 6.0 5.5 Fam…

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