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In: Economics

Dr. Matthew Friedman designed an experiment for unknown purposes. It consisted of showing research subjects two...

Dr. Matthew Friedman designed an experiment for unknown purposes. It consisted of showing research subjects two gambles, one at a time. The first gamble (”Gamble A”) offered participants an 80% chance of winning $5 (otherwise nothing). The second gamble (”Gamble B”) offered participants a 10% chance of winning $40 (otherwise nothing). They were shown to subjects who were asked which they preferred. Then the gambles were considered one at a time and subjects were asked to price them. In this part, the research subjects were told that they would ”own” the gamble in questions and could sell it back to the researcher for sure cash. Given those terms, they were asked to identify the minimum price they would accept to sell each gamble. Out of 789 test subjects, 653 always chose Gamble A as their preferred option, yet always assigned a higher price to Gamble B. These results were confirmed through repeated surveys of the same research participants. Are the prices participants quoted consistent with their choices? Are these choices consistent with accepted models of rational decision-making? Use concepts from behavioral economics to explain what is going on here and why.

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