Lecture 2 Economic Actors and Organizations: Motivation and Behavior

What motivates people? How do these motivations translate into economic behavior? How do people and organizations behave?

Motivations Extrinsic motivation An action is motivated by outside forces (i.e. reward or punishment) Ex: financial motivation (money), fear, high social status, increased power –Incentives: A reward or punishment that motivates action (monetary or non-monetary) Intrinsic motivation An action is motivated by inside forces Ex: Enjoyment of an activity, ethical values such as honesty, loyalty

Motivations Self-interested motivation Motive for action based on the goal of improving one’s own well-being Altruistic motivation Motive for action that reflects concern only with the well- being of others Motivation to serve the common good Motive for action with the goal of improving social well- being, including one’s own well-being

Behavior: Habit, constraint, or choice? Habitual behavior Behavior performed repetitively and almost automatically, without conscious thought; often based on social custom Constrained behavior Behavior of a person subject to limits set by others, who usually have some power over the person Choice behavior Behavior selected by a person from a range of alternatives; generally involving the person’s conscious deliberation

How do people choose? Rational choice Thoughtful choices that would normally be expected to move people toward their goals Rational behavior in the traditional model Behavior that best moves a person toward his or her goals

Optimization vs. bounded rationality Optimization To choose, out of all available options, that option which best achieves what is desired Bounded rationality Identification of some arbitrarily defined subset of information to consider when making decisions Ex: to satisfice (Herbert Simon, 1978, Nobel Memorial Prize in Economics)

Now or Later? High time discount rate The economist’s phrase for describing a strong preference for present benefits over those that might be enjoyed in the future Low time discount rate The economist’s phrase for describing a strong concern with future benefits, even if getting them is costly in the present

Coordination Economic coordination by custom Economic questions of what, how, and for whom are determined by tradition and habit, by beliefs about obligations and by reciprocity Economic coordination by consent Agreement among a group of people reached through discussion or negotiation Economic coordination by administration A means of organizing an economic unit that gives decision-making authority to some person or agency

Coordination Economic coordination by exchange Economic actors make individual decisions to trade the resources under their control for the things they want to get (direct exchange or mediated by money) –Markets: Social organizations set up to facilitate exchange –Market failure: Markets may yield inefficient or inappropriate outcomes

The traditional model The economy is assumed to be made up only of individual economic actors It consists of just three economic activities: –Production is accomplished by firms –Exchange is performed in markets –Consumption is done by households Households and firms engage in –extrinsically motivated –self-interested –perfectly rational, and –perfectly informed choice behavior

Traditional model Perfect rationality The assumption that actors can optimize, arriving at the decision that maximizes profit or utility Perfect information The assumption that economic actors know with certainty everything that is important to their decision making

Circular Flow Diagram A graphical representation of the traditional view that an economy consists of households and firms engaging in exchange Factor markets: markets for the services of land, labor, and capital Product markets: markets for newly produced goods and services

You and another person are given 10 TL. You are the Proposer. The other person is the Responder. That means, you will propose how to divide this money between you and the Responder. If you have proposed to give X TL to the Responder, and the Responder accepts it, the Responder gets X TL and you get the rest, ie. 10-X TL. But if the Responder rejects your proposal of X, both you and the Responder will get 0 TL MY ANSWER: I offer ______ TL to the Responder. If the Responder accepts my offer, he/she gets this amount. If the Responder does not accept my offer, both the Responder and I will receive 0 TL.

You are the Responder. Knowing all the rules of this game, answer the below question: Do you accept this offer? YESNO

Ultimatum Game - Results What we typically observe is that –Modal (most common) offers are 40-50%. –The mean offer is 30-40%. –Offers below 20% are rejected about half the time. –High stakes, reputation and anonymity do not change the results. –Demographic variables have weak effects Low offers create a negative response. ‘I would rather have nothing than accept such an unfair offer.’ A fear of provoking a negative response can increase offers. ‘I need to give him enough that he will not reject’

Experimental Economics John Nash – 1994 Nobel Prize in Economics for his work in game theory Game Theory – the study of interactions in which the results of one person’s choices depend not only on his own behavior, but also on the choices made by another person. Vernon Smith – 2002 Nobel Prize in Economics for experimental economics, which builds on game theory.

Self-interest only? A fundamental assumption of the traditional model is that economic man is a rational decision-maker who acts in his self-interest. Are the results of this experiment consistent with this theory of homo economicus (economic man)? These experiments create an empirical challenge to what we call the selfishness axiom — the assumption that individuals seek to maximize their own material gains in these interactions and expect others to do the same.

Proposed explanations “ Other-regarding” behavior is one of our preferences – we gain satisfaction not only from our lives (as the homo economicus model predicts), but also from the lives of others. Players demand fairness, and punish unfair behavior on the part of proposers. –Responders take into account not just the amount of money offered but also the percent of the total. More equal splits may be less the result of fearing punishment for being unfair than they are the result of individuals’ concern for their reputations.