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Essays on thresholds and on relative thinking

Cunningham, Thomas (2011) Essays on thresholds and on relative thinking. PhD thesis, London School of Economics and Political Science.

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The first paper is “Handicapping Politicians: the optimal majority rule in incumbency elections.” The paper examines the incentives of politicians whose position of incumbency allows them to signal their quality through costly effort. Because an election has such a discrete outcome (to win or to lose), politicians will exert the most effort when they expect the election to be close, giving rise to a cluster of signals just above the threshold required to win. Two propositions follow: first, this clustering causes a skew distribution of signals, such that the median expected quality will be above the mean, so more candidates will be re-elected than would be re-elected under full information, i.e. an incumbency advantage. Second, because information is lost when politicians cluster, voters would prefer to handicap the incumbents to make their signals more revealing. In practice this can take the form of a supermajority rule for re-election. The second paper, “Comparisons and Choice”, shows that many apparently unrelated anomolies of choice can be explained as due to relative thinking. I conjecture that observing larger magnitudes of some goods tends to lower sensitivity to that good. This predicts contrast effects, anchoring effects, scope neglect, and common difference effects. We also introduce a technical novelty, evidence from joint choice, allowing us to map out a utility function. The third paper, “Relative Thinking and Markups,” applies the model of relative thinking to choice among retailers, when purchasing a single good. We show that demand curves will tend to be less sensitive for higher price goods, so that in the case of unit demand (where markups, price dispersion, and entry are normally independent of cost) markups will be increasing in cost, price dispersion will be increasing in cost, and entry will be increasing in cost. We show that evidence from the IO literature, especially evidence on price dispersion, is consistent with these predictions. We also introduce a novel dataset of costs and prices from a drugstore in which there is a very tight positive relationship between cost and markup.

Item Type: Thesis (PhD)
Additional Information: © 2012 Thomas Cunningham
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Sets: Departments > Economics
Collections > Economists Online
Supervisor: Caselli, Francesco

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