Question

Label each of the following examples as a case of time inconsistency, limited processing capacity, statusquo bias, or framing. [LO 23.2] a. A person buys a nice bottle of wine for $$\$ 50$$ and leaves it in the pantry for 20 years. At that point, the wine has aged and the value has appreciated to $$\$ 250 .$$ Although he would never be willing to buy a bottle of the same wine for $$\$ 250$$, the person plans to drink his old bottle rather than sell it. b. Every night, a person sets her alarm for 7 a.m. the next morning, and every morning, she hits the snooze button at least four times. c. People who are told the survival rate for a surgical procedure are more likely to undergo it than people who are told the death rate (even though the death rate is actually the same in both cases).

Short answer

a) Status quo bias; b) Time inconsistency; c) Framing.

Step-by-step solution

Analyze the Example of the Wine Bottle

In this case, the person has a nice bottle of wine that they bought for \( \\(50 \) and left it for 20 years until its value increased to \( \\)250 \). Despite the increase in price, the person plans to consume the wine rather than selling it. This demonstrates a loss aversion effect where the person sticks to their initial plan of keeping the wine instead of cashing in on the appreciated value. This scenario is a classic example of a status quo bias.

Analyze the Example of the Snooze Button

In this scenario, the person consistently sets an alarm for 7 a.m., intending to wake up at that time each night. Nevertheless, the person hits the snooze button multiple times in the morning. This indicates a conflict between their intentions (intentions set at night) and their actions (actions taken in the morning). This behavior is an example of time inconsistency as the person's preferences change over time.

Analyze the Example of the Surgical Procedure

People's decisions about undergoing a surgical procedure change based on how the outcome is presented, either focusing on survival (positive framing) or death rates (negative framing). Even when the statistics are the same, the framing affects perception and decision-making. This is a clear illustration of framing effect, where the way information is presented influences decisions.

Key concepts

Time Inconsistency

Imagine planning to wake up early to kickstart a productive day, yet you find yourself repeatedly hitting the snooze button when the alarm goes off. This illustrates the concept of time inconsistency. Time inconsistency happens when your preferences change over time, in ways that your earlier self might not have predicted. At night, your preference is to wake up early but come morning, your preference shifts towards getting more sleep.

Time inconsistency is a common trait in human behavior, where short-term temptations derail long-term goals. Overcoming it often requires strategies like commitment devices or setting stricter timelines. Some individuals may set an alarm far from reach, so they have to physically get up to turn it off, effectively removing the temptation to snooze.

In economics and psychology, understanding time inconsistency helps explain decisions that may seem contradictory, such as planning to save money but splurging spontaneously. Recognizing this tendency can lead to better planning and goal setting in both personal and professional realms.

Status Quo Bias

Consider buying a bottle of wine for $50 and keeping it for 20 years, after which its value has appreciated to $250. Even if you wouldn't buy it for $250 now, you still choose to drink it instead of selling. This behavior exemplifies the status quo bias, a preference for the current state of affairs.

Status quo bias occurs when individuals prefer things to remain the same by doing nothing or sticking with a decision made previously. This bias can lead to irrational decision-making, where people resist change even if it would benefit them. The fear of loss or making a mistake often underpins such preferences. In the wine example, the individual is holding onto the past decision to keep the wine despite its higher value, reflecting this bias.

Overcoming status quo bias involves recognizing its presence and consciously weighing the benefits and drawbacks of change. By doing this, you can make more informed, rational decisions, especially in matters of personal finance, career choices, or lifestyle changes.

Framing Effect

Imagine deciding whether to undergo surgery. Your choice might sway based on whether you hear about the survival rate versus the mortality rate. This illustrates the framing effect, where the presentation of information influences decision-making.

The framing effect shows that people's decisions depend not just on information itself, but on how it is presented. A surgical procedure with a 90% survival rate sounds reassuring compared to hearing it has a 10% mortality rate, though numerically, both convey the same risk. This cognitive bias highlights how wording or context can skew perception and judgement.

To combat the framing effect, strive to take a broader perspective by reframing the information yourself. Consider alternative ways the data could be presented and focus on the absolute facts rather than the presentation style. This approach aids in making balanced, objective decisions, important in fields ranging from healthcare to business management.