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Chapter 1: Problem 14

The same article referenced in Exercise 1.13 also described a study which concluded that people tend to respond differently to the following questions: Question 1: Would you rather have \(\$ 50\) today or \(\$ 52\) in a week? Question 2 : Imagine that you could have \(\$ 52\) in a week. Would you rather have \(\$ 50\) now?

Short Answer

Expert verified
These two sets of choices are identical in terms of financial gain, but the impact of context and phrasing greatly influences how people perceive and respond to them. Question 1 puts emphasis on 'immediate gain' which tests impulsive behaviour and the ability to delay gratification. Question 2 uses 'potential loss' of the future gain as a psychological tool to sway decision-making, thus testing loss aversion factor.

Step by step solution

01

Observing the Problem

The first thing to note is the two different questions provide the same financial options but in different contexts. In Question 1, the choice is presented between an immediate gain of \(\$ 50\) or a delayed gain of \(\$ 52\) in a week. In Question 2, the possible gain of \(\$ 52\) in a week is established as a fact first, then the option of an immediate \(\$ 50\) is introduced.
02

Analysis of Question 1

Question 1 directly contrasts the idea of having money now versus having more money later. In this question, the emphasis is on the immediacy of the gain. With no other context, it can implicate that having money now might be preferable for some. It indirectly asks the degree of a person's impulsivity or their ability to delay gratification.
03

Analysis of Question 2

For Question 2, a future gain of \(\$ 52\) is already implied before the option of \(\$ 50\) now is even presented. This phrasing can make the immediate gain seem like a sacrifice or loss of potential higher gain. This question is subtly testing a person's loss aversion.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Time Value of Money
The concept of the time value of money is a cornerstone of financial decision-making. It states that a particular amount of money today is worth more than the same amount in the future due to its potential earning capacity. This foundational principle underlies many financial concepts and decisions regarding investment, savings, and loans.

Essentially, money can earn interest or be invested, generating more money over time. That is why \( \$50 \) today could be worth more than \( \$52 \) in a week if the \( \$50 \) is invested immediately in a profitable venture. Conversely, if the \( \$50 \) cannot earn enough in interest to exceed \( \$52 \) within a week, waiting for the higher amount might be the better option. Understanding this principle helps explain why people might choose immediate gains over delayed ones, especially if the future benefit is only slightly higher.
Delayed Gratification
Delayed gratification refers to the ability to resist the temptation for an immediate reward and wait for a future reward that’s potentially larger or more fulfilling. It's a crucial skill in personal finance because it can affect savings, investments, and overall financial well-being.

The textbook exercise highlights this concept by comparing the desire for a smaller, immediate reward (\( \$50 \) today) versus a slightly larger, delayed reward (\( \$52 \) in a week). The study associated with these questions presumably investigates the propensity of individuals to delay gratification. Willingness to delay can indicate a disciplined approach to financial decisions, which may lead to more substantial long-term benefits. For students, understanding this concept can provide the foresight to save for tuition or invest in a study fund.
Loss Aversion
Loss aversion is a concept in behavioral economics suggesting that people feel the pain of losing money more intensely than the joy of gaining the same amount. This psychological phenomenon plays a significant role in the decision-making processes, affecting how people perceive potential gains and losses.

In the context of the textbook exercise, viewing the decision from the standpoint of loss aversion can influence the outcome. When presented with the second question, individuals may perceive choosing the \( \$50 \) today as a loss of \( \$2 \) they could have received. This shift in perspective can lead to a different decision than one might make without considering the potential ‘loss’. Being aware of loss aversion can help students understand why they might prefer to avoid losses rather than acquiring equivalent gains, impacting their decisions on financial matters like investments and savings.
Impulsivity in Financial Decisions
Impulsivity in financial decisions refers to the tendency to make quick, unplanned, and often short-sighted choices regarding money. This behavior can be driven by an emotional response or a desire for instant gratification, without fully contemplating the longer-term outcomes.

Questions in the textbook exercise serve as a tool to measure impulsivity. Opting for \( \$50 \) today might reflect an impulsive decision, favoring an immediate reward over a greater one that could be obtained by patience. Helping students recognize their impulsive tendencies can be valuable in teaching them to pause and consider the full ramifications of financial decisions, like expensive impulse buys or hasty investment choices, which could compromise their future financial health.

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Most popular questions from this chapter

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