Behavioral economics Chapter 30 Niklas Jakobsson Click to add notes

Introduction “Traditionally, much of economic research has relied on the assumption of a ‘homo economicus’ motivated by self interest and capable of rational decision making. Economics has also been considered a nonexperimental science, relying on observation of real world economies rather than controlled laboratory experiments. Nowadays, however, a growing body of research is devoted to modifying and testing basic economic assumptions; moreover, economic research relies increasingly on data collected in the lab rather than in the field.” - From the press release for the Bank of Sweden Price in Economic Sciences in Memory of Alfred Nobel, 2002. 2009

Main findings in experimental economics Experiments involving market institutions usually find consistency with rational and self interested behavior. E.g. market experiments yields prices predicted by supply and demand. Experiments involving cooperation and bargaining problems usually find divergence from predictions based on a rational and self interested individual. 2009

Potential reasons for non selfish behavior Warm-glow: utility from the pure act of giving Altruism: give something to someone without strategic motives Relative concerns: people compare to a mental reference Intentions: not only outcomes are important (kindness) Social capital: norms and networks that enable collective action (simplifying collective actions and reduce transaction costs) 2009

Overview Framing Uncertainty Time Strategic interaction and social norms Experiments Summary 2009

Framing People are affected by how choices are presented Positive framing compared to negative framing: the disease dilemma Anchoring: choices affected by spurious information; lock in (Swedish church) Bracketing: choices in different circumstances, people do not know what they would like in another setting Too much choice; costs of choosing, people not happier with many choice possibilities (retirement portfolio) Constructed preferences; not preexisting 2009

Uncertainty People systematically misjudge randomness Law of small numbers: people are much influenced by small samples, especially if they experience them themselves. Underestimate randomness. Asset integration: individuals care about total amount of wealth that they end up with (expected utility). Not true. Excess risk aversion: over insure against small events People are loss averse more than risk averse: high weight for status quo Sunk cost fallacy: not so much for professionals 2009

Time Discounting: valuing benefits now and in the future Exponential discounting: people discount the future at a constant fraction. Time consistent. Hyperbolic discounting: today’s plan about future consumption will change in time. Time inconsistent. Derivation of the MRS An individual with hyperbolic discounting discounts the long term future more heavily than the short term future. 2009

Time Self control One way to deal with self control is to commit yourself to future actions; make it costly to deviate You like to know about a subject but do not study without an exam Overconfidence: men more than woman. Can have results on career etc. 2009

Strategic interaction and social norms Behavioral game theory examine how actual people interact The ultimatum game with a proposer and a responder Proposer gives then responder accept or deny Responders reject what is unfair; less than 30 percent is rejected in 50 percent of the cases Men receive more, some cultural differences This reflect a concern for fairness People will enforce fairness norms even when it is not in their financial interest to do so 2009

Two person experiments Dictator game A selfish player would send nothing Sender gives on average 20 percent (anonymously) Social distance and “deserving” increase donations Higher stake and earned money decrease donations Ultimatum game Higher stakes give more equal split, and small decrease in rejection rate as stake increase Offers similar between genders but females reject less often Higher offers in USA and Slovenia, lower rejection in Japan and Israel 2009

Two person experiments Trust game A selfish player would send nothing Send about half of the money, and get about as much back Power to take game Responder destroy zero and authority take largest possible share More destruction with effort 2009

Summary Behavioral economics study how people actually behave People are often not very rational People are usually interested in fairness Experiments are important in this field 2009

One minute paper What is the most important thing you learned today? What is the muddiest point still remaining at the conclusion of today’s class? 2009