Economics Homework Help

Please prepare an essay of about 400-550 words in length to
give two examples -different from the readings- of how the prospect theory
influences the policymaking of central banks.

You may come up with a well-crafted hypothetical example. The examples
may be from the areas of, but not limited to, macro stability, monetary stability, payment
systems, regulation and supervision, as well as legal decisions. The examples can also be from
the perspective of fiscal policymakers and other agencies that are related to the central bank.

Be sure to point to the specific characteristics of this theory that are being applied to the
situation. It is recommended that your two examples draw from different aspects of this
preference.

The prospect-theory investors don’t earn utility from the final wealth but from gains and losses
relative to a reference point. The aversion to loss is steeper than the joy from gain of an equal
size (loss aversion). The preference builds in “subjective probability” which means that
investors put their own belief into evaluating how likely the events occur, and more often than
not, the belief does not match with the objective probability. For example, the subjective
probability leads to an overemphasis on small-probability events, while under-weigh the likely
ones.

-What are the policy implications to different involved parties? If
applicable, what would the policy decisions have been like under the expected
utility framework? What are the welfare implications?

These are only some of the guiding questions. You do not have to address all of them. At the
same time, you are also encouraged to go above and beyond these.

The writing style should be a memo report to your directors and your senior colleagues, who
have background in economics but may not have heard of the prospect theory and are curious
about how it can be applied to policy decisions. Please cite all references.

-Reference

Barberis, Nicholas C. (2013). Thirty Years of Prospect Theory in Economics: A Review and
Assessment. Journal of Economic Perspectives 27(1), 173-196.

Kahneman, Daniel and Amos Tversky (1979). Prospect Theory: An Analysis of Decision under
Risk. Econometrica 47(2), pp. 263-291.
Available at https://www.uzh.ch/cmsssl/suz/dam/jcr:00000000-64a0-5b1c-0000-
00003b7ec704/10.05-kahneman-tversky-79.pdf