September 25, 1998. May 28, 2000 G100: Business in the Information Age, Professor Rasmusen, erasmuse@indiana.edu. THINKING TEST This is my master copy. These questions are taken from notes of Professor Michael Metzger, of Indiana University's Department of Business Law. I have modified them quite a bit. Half the class gets AA and half gets BB. I have put in the percentages and medianss from Fall 1998, G100. Ask the class why it is better to use Medians than Averages here. For next semester: Make a handout explaining the bias terms. Reference (a very good book): Robyn Dawes, Rationa Choice in an Uncertain World, Harcourt Brace, 1988. See also D. Kahneman, P. Slovic, and Amos Tversky,editors, Judgements under Uncertainty: Heuristics and Biases, Cmabridge University Press, 1982. AA 1. Here are some reasons why a car might not start in the morning. For each of them, assign percentage probabilities to the best of your knowledge: (a) Insufficient battery charge: ( 60 % ) (b) Defective fuel system:( 10 % ) (c) Engine problems: ( 15 % ) (d) All other problems: ( 10 % ) BB 1. Here are some reasons why a car might not start in the morning. For each of them, assign percentage probabilities to the best of your knowledge: (a) Insufficient battery charge: ( 20 % ) (b) Defective fuel system:( 12 % ) (c) Engine problems: ( 15 % ) (d) Defective starter: ( % ) 55 percent for the next four. (e) Vandalism:( % ) (f) Electrical problems: ( % ) (d) All other problems: ( % ) (Agenda control.) AA 2. A newly hired engineer for a computer firm in the Osaka area has four years of experience and good all-round qualifications. When asked to estimate the starting salary for this person, a freshman in high school said (admitting that he knew nothing about the industry) $23,000, translating yen into dollars. What is your guess? ($ 33 ) BB 2. A newly hired engineer for a computer firm in the Osaka area has four years of experience and good all-round qualifications. When asked to estimate the starting salary for this person, a freshman in high school said (admitting that he knew nothing about the industry) $82,000, translating yen into dollars. What is your guess? ($ 53 ) (Anchoring by irrelevant information.) AABB 3. You own shares in Myco Petroleum. Your broker calls you and says that Myco's share price has risen on rumors that it's about to hit it big in a new oilfield in Alaska. You can sell right now, for a $5 million gain, or you can hold onto your shares and hope the rumors are true. If they are, your broker estimates your stock will be wroth $12 million more than you paid for it. But if the rumors turn out to be false, the price falls again and you will just break even. The broker estimates that the rumors are true with probability .50. What do you do? (Circle one) SELL NOW 76 percent WAIT AND SEE IF THE RUMOR IS TRUE 24 percent (See question 9) AABB 4. Your company has factories in Altoona and Beloit. Your capital budget this year allows you to invest in a filtration system in just one of these two cities. Circle your choice. Altoona. There's a 20 percent chance that the chemicals in this plant might be causing 10 cancer related illnesses per year. The filtration system would reduce this to a 5 percent probability. Beloit. There's a 10 percent chance that the chemicals in this plant might be causing 10 cancer related illnesses per year. The filtration system would entirely eliminate this risk. 28 percent chose Altoona. 72 percent chose Beloit. (In class, change the 20 percent to 90 percent and see if students then agree that Altoona should get the filtration system.) AA 5. As a hurricane approaches Florida, there is a shortage of gasoline- powered electrical generators. Smith's Hardware had been selling them at list price before, but now Smith sells them at $200 above list price. Is this ethical? YES NO BB 5. As a hurricane approaches Florida, there is a shortage of gasoline- powered electrical generators. Smith's Hardware had been selling them at $200 below list price before, but now Smith sells them at list price. Is this ethical? YES NO (In 1998, this question didn't work well, so I modified it to its present form.) AABB 6. A dairy lobby hires you to do a public opinion poll for them to use in their campaign to get government help. Which the following two questions should you ask in your poll? QUESTION A. Do you agree that dairy farmers deserve at least the level of protection against unfair competition from foreign producers that they are getting now? QUESTION B. Are you willing to pay an extra $250 per year in higher prices to subsidize the dairy industry? 87 percent chose A; 13 percent chose B. AABB 7. How would you evaluate your safety and skill as a driver? BOTTOM QUARTER OF THE POPULATION 25th-50th PERCENTILE OF THE POPULATION 50-75th PERCENTILE OF THE POPULATION 75th-100 PERCENTILE OF THE POPULATION 0, 16, 56, 28. (Tell them about the Australian study of people in hospitals after car accidents who were asked this.) AA 8. Your company must decide whether to market one of two new potential products. The available marketing research data, which was done at a university and is freely available to the public, indicates that Product A has a 50 percent chance of succeeding, while Product B has a 60 percent chance. In both cases, if the product succeeds, the company earns $1 million in profits, and if it fails, the company earns nothing. Your company's CEO chooses to market Product B, and it fails. Your main competitor chose A, and it succeeded. On a scale from 1 (fire him) to 7 (give him a bonus), what should the Board of Directors do about the CEO? 1 2 3 4 5 6 7 Median: 4. BB 8. Joe must decide whether to flip one of two coins, each of which will yield $1 million if it comes up Heads, and 0 if it comes up Tails. Coin A has a 50 percent chance of Heads, while Coin B has a 60 percent chance. Joe chose B, but it came up Tails. Someone else tossed A, and it came up Heads. On a scale from 1 (What an idiot!) to 7 (clearly did the right thing), what do you think of Joe? 1 2 3 4 5 6 7 Median: 6.5. (Hindsight Bias. Blame the victim.) AABB 9. You are the defendant in a lawsuit in which the plaintiffs suing you are seeking to be paid $10 million. Your lawyer, Hugo Lewis Dewey (of Dewey, Cheatham & Howe) calls you to say that the plaintiff's lawyer, "Slick Willie", has offered to settle the case for $4 million. When you ask him his best estimate of your chances of winning outright (so you don't have to pay Slick's clients a penny), he replies, "It's a coin toss at this point" (i.e., 50-50). What do you do? (Circle one) SETTLE FOR 4 MILLION FIGHT THE CASE ALL THE WAY (This pairs with question 3, to illustrate loss aversion. In each case, there is a certain 5 million dollars, or a gamble on 0 or 10 million. 44 percent 56 percent. AABB 10. For each of the following questions, provide low and high estimates such that you are 80 percent certain that the correct answer falls between the limits. You should aim to have 8 hits and 2 misses. Getting the brackets right is what matters, not getting the right answers. Note that you should try to get an 80 percent bracket for each question, not for all 10 together (in which case you could use [1, 10 trillion] for the first 8, and [1,2] for the last two to get 8 out of 10). A. How many patents did the U.S. Patent Office issue in 1990? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 96,727 B. How many of Fortune's 1990 Global 500, the world's biggest industrial corporations, were Japanese? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 111 C. In 1989, how many passenger arrivals and departures were there in Chicago's O'Hare Airport? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 59,130,007 D. What was the total audited circulation of the Wall Street Journal, worldwide, during the first half of 1990? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 2,076,713 E. In 1987, how many master's degrees in management or business were awarded in the United States? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 67,496 F. What was the population of the United States in 1992? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 255 million G. In 1992, how many immigrants were legally admitted into the United States? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 974,000. H.In 1993, what was the median price of a new one-family house in the U.S.? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 126,000. I. What percentage of GDP were exports in 1994? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 12 percent J. How many abortions were performed in 1992? LOW ESTIMATE: HIGH ESTIMATE: BEST GUESS: 1.6 million My source for items F through J is the Statistical Abstract of the United States, 1994, 114th edition, U.S. Dept. of Commerce, pp. 15 (population), 12 (immigration), 732 (houses), 446 (exports), and 85 (abortion). Median: 2. Overconfidence, vanity, reluctance to show uncertainty. For ease of gradingg, alternate answers in the millions with percentages, etc.