Altruism and rationality Based on Frank (1992, chapters 7-8)

Behavior & contracting in a nutshell ▪ Rationality: “bounded”  costly to be rational ♦Chess playing ▪ Self-interest + Info asymmetry  “opportunism” ♦Gaming incentives ▪ Orientation towards: ♦Opportunism ex post ♦Efficiency ex ante  “farsighted contracting”—Does it work?

Human conduct ▪ Economics ♦ Self-interest ♦ Rationality ▪ Observable behavior ♦ Altruistic cooperation: tips by tourists ♦ Failures of rationality: emotions (revenge etc.) ▪ Two dimensions when analyzing conduct ♦Self-interested Altruist ♦Rational Emotional

1. Altruism

Questions ▪ Does selfishness "pay“? ♦Examples: trust problems Prisoners’ dilemma Kidnapping ▪ Are there genuine altruists out there? ▪ Could they exist, compete, survive?

Let us see why different types of individuals could exist

Returns from cooperation for different types HonestDishonest Honest46 40 Dishonest02 62

In a population with both types ▪ Proportion of honest persons = h ▪ Return for honesty = 4h + 0 (1-h) = 4h ▪ Return for dishonesty = 6 h + 2 (1-h) = 2 + 4h HonestDishonest Honest46 40 Dishonest02 62

Identification impossible Dishonest Honest Proportion of honest people

Identification at no cost Honest Dishonest Proportion of honest people

Costly identification (cost = 1) (if h>0,75 honest guys gain more without identifying) Dishonest Honest Proportion of honest people Dishonest Honest

Mental experiment ▪ Do you know someone, not a relative of yours, who, finding a wallet with 100€, would give it back to the owner? ▪ Why do you trust this person? ▪ How would she feel if she did not return the wallet?

The role of emotional commitment ▪ Emotional problems and features that can avoid the corresponding problem: ♦Deceit  honesty ♦Dissuasion  vindictive ♦Exploitation  averse to suffer injustice

Biological mechanisms of commitment: Emotional recognizable predispositions ▪ Emotional  automatic, not “rational”: “they suspend” rational calculation ▪ Recognizable ♦by others (so that they trust us) ♦by oneself (to avoid to be deceived) ▪ Physiological examples: ♦face expression, tone of voice, breathing, blush, visual contact, smiling, dilated pupils, etc.

What does this say to you? Only a 15% of the population can do it voluntarily…

Examples of emotional commitment

Permanent problem: mimicry ▪ Viceroy ▪ Monarch (poisonous)

Mimicry ▪ Conditions ♦Costly or slow for imitator ▪ Importance of being pioneer ▪ Between people, it is advantageous: ♦To be honest and to seem it ♦To pretend it without being it ♦To distinguish both types

Size of primates’ brains is positively correlated to groups’ size

2. Rationality

Bounded rationality ▪ It is costly to gather & process the information needed to make optimal decisions  we “satisfy” ♦E.g.: chess with clock: 40 plays in 2,5 hours ♦To satisfy = to optimize with information cost ▪ Systematic “errors” = violations of the “rational” rules of decision ♦Example: Do people respond the same when going to the movies if they discover that they have lost: (a) their ticket or (b) a 10 € bill?

Sunk costs ▪ New shoes, too tight: Do people react the same if they bought them as if they received them as a gift? ▪ Pizza buffet: pay 3€ you eat all you want ♦We give back 3€ to lucky tables: Will these eat more or less that the other tables? ▪ Firms keep investing in ruinous investments

Asymmetric value function (Prospect Theory) - defined on changes of wealth - aversion to losses  steeper for losses - decreasing marg. utility  concave in gains, convex in losses

Rules ▪ Segregate gains: wrap gifts separately ▪ Combine losses: “blood sweat & tears” ▪ Combine small loss with greater gain ▪ Detach small gains form large losses: cash rebates ▪ Exercise: examine marketing tricks

Rejection of a Dominant Insurance Plan

The Benefit of Segregating Gains

The Benefit of Combining Losses

The Benefit of Offsetting …

The Silver-Lining Effect and Cash Rebates

Are opportunity costs equally costly than money outlays? ▪ We bought ticket to 100 € ▪ On arrival, resale price 1,000 € > max we had paid ▪ Do we sell the ticket? ▪ Prospect theory: it seems that we consider ♦Opportunity cost as a “lost gain” ♦Payments a “losses” ▪ Other explanations?

Two types of “errors” ▪ To know & decide badly ▪ To use heuristic (approximate) rules to select the information and decide ♦Availability ♦Representativeness ♦Anchoring ♦Perception ♦Irrelevant options *Are not they errors only in an specific context? E.g., think of possible evolutionary explanations

Availability ▪ We considered frequency by the memory of examples ♦Dangerous when evaluating subordinates ▪ If easier to recover from memory (more salient, recent, etc.) it affects decisions more ♦How many words (1) begin by “r”; (2) have "r" like 3 rd letter? ♦Plane crashes?

Representativeness ▪ A brilliant soccer player, is more likely to be Brazilian or not? ♦10,000 players altogether, 100 of them brilliant ♦50 players are Brazilian, 25 of them brilliant ▪ We underestimate the “regression to the average” ♦Fans complain that their team plays worst after a goal or success when in fact the team is falling back into average performance

Anchoring & adjustment ▪ X = % of African countries in the UN ♦Lottery  number (anchor) = n = 10 or 65 ♦People estimates different X: If n = 10  E(X) = 25% If n = 65  E(X) = 45% ▪ To consider products ♦8 x 7 x 6 x 5 x 4 x 3 x 2 x 1  ♦1 x 2 x 3 x 4 x 5 x 6 x 7 x 8  512 ▪ Conjecture: ♦Are these experiments artful but irrelevant traps, to our “Bayesian” mind, designed to produce probabilities from unique events, not to handle frequencies, that require great samples?“Bayesian” mind

Perception is proportional to the intensity of the initial stimulus ▪ Luminosity ♦We did not perceive the small differences ♦We do not see difference between bulbs of 100 and watt ♦But we see a 0.5 watt bulb ▪ Price differences between stores: they influence more if they are important with respect to the price of the article ♦Does it explain transactions costs in real estate?

Irrelevant options ▪ When adding “dominated” option C (“irrelevant”), the proportion of people inclined to a near option (B) increases PriceDistance A B C ▪ But, although C is dominated, ♦Is it truly irrelevant? ♦Could not it be informing that the next option is relatively better? (in similar, real, situations)