Problem 3 [3p] Show that Samuelson's model of intertemporal choice is inconsistent with the behavior commonly observed in Thaler's 1-apple/2-apple experiment.
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This means that if an individual prefers one option over another at one point in time, they will always prefer that option over the other, regardless of when the choice is made. Show more…
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Madhur L.
Problem 3. Recall the Allais paradox from lecture. Question 1: ($1,1) or ($1,0.89; $5,0.10; $0,0.01) Question 2: ($1,0.11; $0,0.89) or ($5,0.10; $0,0.90) Most people prefer the first lottery in Question 1 but the second lottery in Question 2. Suppose someone chooses according to prospect theory with value function: if x >= 0, v(x) = x^0.1 if x < 0, v(x) = 2x where all units are in millions of dollars. The probability weighing function they use is: pi(p) = sqrt(p) / (sqrt(p) + sqrt(1-p))^2 Show that even without any editing, this can explain the Allais paradox (set reference point to $0 in both questions).
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