BS3373 Assessment Questions Answer Any Two (2) Out Of The Three (3) Questions.
Question 1: Possibility Effect Word Limit: 1500 Words
(a)Suppose you are a producer of antibiotics which carry a 10% risk of digestive system side effects (indigestion). You currently sell 500,000 packs a year for £5 each. You are considering improving your production technology to decrease the risk of indigestion. In order to investigate potential gain from such an improvement, your marketing research team ran focus groups and found that on average consumers would be happy to pay £1 more for an antibiotic which carries a 2% risk of indigestion and £3 more for an antibiotic which carries no risk of indigestion. Your production team informs you that the marginal cost of producing an antibiotic with less frequent side effects is increasing. In particular, a reduction in risk of indigestion by x% would increase your per-pack cost by £0.02×2. Should you invest in reducing the risk of indigestion, and if so, should you reduce it by 8% or by 10%? Why are consumers happy to pay more to reduce the risk from 2% to 0%, compared to reducing the risk from 10% to 2%? [15 marks]
(b) Critically evaluate empirical evidence of the possibility effect with reference to an academic study. Explain whether the study has complied with the five experimental principles studied in the module. [15 marks]
(c) With reference to a real-life company, discuss how firms can exploit potential errors made by consumers arising from the possibility effect; in particular, consumers whose probability weighting is as distorted as it is in part (a) of the question. In your answer, contrast these behaviours with the choices of a rational agent in the same situation and suggest ways consumers can be protected from the potential errors arising from the possibility effect. [20 marks]
Question 2: Law Of Small Numbers Word Limit: 1500 Words
(a) Suppose you are choosing a wealth manager out of three candidates:
Wealth manager No of clients % of clients retained last year Alys 3 100% Bethan 5 50% Ceri 4 60% Suppose client retention is due to pure chance. The probability of each client staying with their wealth manager in any given year is 0.5 (different clients’ decisions to stay are independent from each other). Calculate the probability of each wealth manager retaining 100% of their clients last year. What is the relationship between the sample size and the probability of an extreme outcome occurring in that sample? Which wealth manager would be chosen by a client who suffers from the Law of Small Numbers? Comment on whether it is a good choice. [15 marks]
(b) Critically evaluate empirical evidence of the Law of Small Numbers with reference to an academic study. Explain whether the study has complied with the five experimental principles studied in the module. [15 marks]
(c) With reference to a real-life example, discuss potential errors economic agents can make due to the Law of Small Numbers, in particular, when facing sample sizes like those in part (a) of the question. In your answer, contrast these errors with the judgement of a rational economic agent, and suggest potential remedies for the errors. [20 marks]
Question 3: Fairness Word Limit: 1500 Words
(a) Consider the asymmetric Prisoner’s Dilemma game below:
Player 1 – cooperate defect Player 2 – cooperate defect
6, 12 2, 14 8, 6 4, 10 Suppose both players are motivated by fairness. That is, each player acts to maximise the weighted average of their own payoff and their opponent’s payoff:
Calculate the utility of each player in all four outcomes (cells) of the game. In this transformed game, find each player’s best responses to both strategies of the opponent. What is the predicted outcome of the game if players are motivated by fairness? Is it a realistic prediction in an asymmetric Prisoner’s Dilemma? What can we conclude about the predictive power of the fairness model in this game? [15 marks]
(b) Critically evaluate empirical evidence of fairness with reference to an academic study. Explain whether the study has complied with the five experimental principles studied in the module. [15 marks]
(c) With reference to a real-life company, discuss how employees’ effort level or productivity can be affected by their preference for fairness, and suggest how firms can optimally respond to it. In particular, consider employees whose preferences can be described by the utility function in part (a) of the question. In your answer, clearly explain why you think employees’ behaviour was influenced by preference for fairness and contrast it with rational agents’ behaviour in the same situation. [20 marks]
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