1. Chapter 18
Social Economics

2. Chapter 18 Outline 18 Social Economics
18.1 The Economics of Charity and Fairness
18.2 The Economics of Trust and Revenge
18.3 How Others Influence Our Decisions
Key Ideas
Many people have preferences that go beyond material wealth.
2. Charity, fairness, trust, revenge, and conforming to those around us represent a few examples.
3. Economic tools can be used to understand when such factors will play an important role.
4. Economists have found that such behaviors are important when their opportunity cost is low.

3. Evidence-Based Economics Example: Do people care about fairness?
18 Social Economics
Evidence-Based Economics Example:
Do people care about fairness?

4. Is economics only about self-interest?
18 Social Economics
Is economics only about self-interest?
Beyond utility maximization and profit maximization, economics is also about altruism and giving, how our preferences are formed, and playing fair.

5. Exhibit 18.1 Volunteering Around the Globe
18.1 The Economics of Charity and Fairness:The Economics of Charity
People can give of their time…
Exhibit 18.1 Volunteering Around the Globe

6. Exhibit 18.2 U.S. Household Giving in 2011 by Recipient Status
18.1 The Economics of Charity and Fairness:The Economics of Charity
…and their money
Exhibit 18.2 U.S. Household Giving in 2011 by Recipient Status

7. Why do people give to charity?
18.1 The Economics of Charity and Fairness: The Economics of Charity
Why do people give to charity?
Have you ever donated your time and/or money to a charitable cause.
What did they get out of it?
In order to promote giving, we need to answer that question so that society can provide the right incentives to encourage people to do more of it.
Why give?
To help others
To help yourself
Pure altruism -- a motivation solely to help others

8. 18.1 The Economics of Charity and Fairness: The Economics of Charity
To help yourself
Impure altruism -- a motivation solely to help oneself
How does giving to charity help the giver? Examples (a).to gain prestige, (b). giving out of guilt, (c ). social pressure (d) religious duty. Do you think it matters
Key: if we want to construct environments that encourage giving, it does matter what motivates people to give.

9. Would you pick Friend or Foe?
18.1 The Economics of Charity and Fairness: The Economics of Fairness
Would you pick Friend or Foe?
How many would pick Friend, how many would pick Foe.
Foe would be the logical choice if you just wanted to maximize the money you got.
In spite of that, only about half of the contestants picked Foe.
That is, some people seemed to have a preference for fairness.
Exhibit 18.3 Friend or Foe TV Game Show: A Variant of the Prisoners’ Dilemma

10. 18.1 The Economics of Charity and Fairness: The Economics of Fairness
Fairness -- willingness of individuals to sacrifice their own well-being to either improve upon the
well-being of others or to punish those who they perceive as behaving unkindly

11. Exhibit 18.4 Friend or Foe TV Game Show with Fairness Preferences
18.1 The Economics of Charity and Fairness :The Economics of Fairness
Play the game with your own “fairness penalty” and assume that Joe is interested in playing fair, too. This payoff matrix reflects the same payoffs as before, except the payoff to picking Foe is reduced by a penalty for not being fair.
How large should the penalty have to be to create Friend as the dominant strategy. (It would have to be at least $8,200.)
Exhibit 18.4 Friend or Foe TV Game Show with Fairness Preferences

12. Exhibit 18.6 The Ultimatum Game
18.1 The Economics of Charity and Fairness: The Economics of Fairness
People may act differently on TV in front of millions of people than they would in normal circumstances.
So to provide a better measure of the extent to which people value fairness, economists use the Ultimatum Game. The rules for the game—the Proposer is given a pot of money that he/she splits, giving the Responder some amount. The Responder is told how big the pot was and how much his/her split is. The Responder then chooses to accept the offer, or reject it, in which case neither player receives anything.
Working backwards, we can see that the Responder should take any positive amount since it is greater than zero. Knowing this, the Proposer should make the lowest positive offer.
Working backwards, we can see that the Responder should take any positive amount since it is greater than zero. Knowing this, the Proposer should make the lowest positive offer.
Exhibit 18.6 The Ultimatum Game

13. But neither Proposers nor Responders act this way.
18.1 The Economics of Charity and Fairness: The Economics of Fairness
But neither Proposers nor Responders act this way.
Would you accept one cent from a Proposer. If it turns out that people typically offer between 25% and 50%, and that Responders often reject offers less than 20%, why these low offers would be rejected.
This is opportunity cost at work, with a “price” being put on fairness. At one cent, the opportunity cost of rejecting (the price of fairness) is low, so the odds of a Responder rejecting the offer are high; i.e., the Responder is demanding more fairness at a low price.
When the opportunity cost of rejecting is higher, the Responder is less likely to reject, reflecting the increased price of fairness.

14. Evidence-Based Economics Example: Do people care about fairness?
18.1 The Economics of Charity and Fairness :The Economics of Fairness
Evidence-Based Economics Example:
Do people care about fairness?
Economics can predict the relationship between low offers and how much fairness is demanded when the size of the pot is relatively small.
But what happens when the pot is very large—does the same relationship hold?
Conducting the Ultimatum Game in a relatively poor country allows economists to offer a large pot to the participants, while not representing a large outlay in cash.

15. Exhibit 18.7 Offers and Rejection Rates in the Ultimatum Game
18.1 The Economics of Charity and Fairness: The Economics of Fairness
As the size of the pot increases, the Proposers’ offers decrease.
Also point out that as the size of the pot grows, Responders are more likely to reject low offers, suggesting that people care less about fairness as the opportunity cost increases.
Exhibit 18.7 Offers and Rejection Rates in the Ultimatum Game

16. 18.2 The Economics of Trust and Revenge: The Economics of Trust
Trust lies behind everything that has been discussed so far. Part of the function of the legal system is to make sure economic transactions occur more efficiently (think of contract law, for example), but not all aspects of every transaction can be subjected to legalities.
Trust, therefore, is critical to making our economy run efficiently.

17. Exhibit 18.8 A Trust Game Between Jen and Gary
18.2 The Economics of Trust and Revenge: The Economics of Trust
Would you trust Gary?
The set-up of this game: Jen must decide whether to trust Gary or not. If she doesn’t, they each get $10.
If she does, Gary decides whether to defect or cooperate. If he cooperates, they both get $15. If he defects, she gets nothing, and he gets $30.
Exhibit 18.8 A Trust Game Between Jen and Gary

18. 18.2 The Economics of Trust and Revenge: The Economics of Trust
Backward induction:
Since Gary’s payoff is greater if he defects ($30 vs. $15), he will choose defection.
Knowing this will be Gary’s choice, Jen will choose not to trust Gary (she gets $10 vs. $0)
Is this the best outcome?
No, this outcome is not the best one—the total benefit is $20 when the total benefit could be $30

19. 18.2 The Economics of Trust and Revenge :The Economics of Trust
We can view being trustworthy as we viewed fairness—some people have a preference for being seen as trustworthy. If Gary has this preference, his payoff to defecting would be lower by some amount, changing his incentives.
Now Gary will choose to cooperate since the payoff to doing so is higher than that for defecting. Knowing this, Jen will choose to trust him, maximizing their payoff.
Exhibit 18.9 A Trust Game Between Jen and Gary with a $20 Guilt Penalty

20. 18.2 The Economics of Trust and Revenge: The Economics of Revenge
What role does revenge play in our economy? What are the costs and benefits of revenge? This game extends the Trust Game by adding another step for Jen. She can decide to impose a penalty on Gary if he defects; i.e., she can get revenge.
If Gary knows that Jen will not get revenge, he will still choose to defect. But if he knows she is vengeful, then he would do better if he cooperates ($15 vs. $10), which is the optimal outcome.
Exhibit A Trust Game Between Jen and Gary with a Punishment Option

21. Preferences are the result of Nature Socialization
18.3 How Others Influence Our Decisions: Where Do Our Preferences Come From?
Preferences are the result of
Nature
Socialization
Indoctrination -- agents imbue society with their ideology or opinion
Peer effects -- influence of the decisions of others on our own choices
Examples of peer effects on their own preferences or behavior. (1) that college freshmen roommates tended to have similar GPAs. Does having a roommate who is studious influence your own behavior? (2). Do you work harder at the gym if the person next to you is kicking it?
18.3 How Others Influence Our Decisions : Following the Crowd: Herding
Herding --- Behavior of individuals who conform to the decisions of others
Why would people engage in herding? 2 reasons

22. Why would people engage in herding?
18.3 How Others Influence Our Decisions: Following the Crowd: Herding
Why would people engage in herding?
They are afraid to be wrong
Assume that if others are doing something, they must have a good reason—they have more (or better) information
The house next door to you is for sale. Should you be worried?
Not one house. But if the house across the street is also for sale, should you worry now? What if 5 more houses are put on the market?
The Idea: the more houses that are put up for sale, the more likely it is that remaining houses will be put on the market.
As more houses are on the market, potential buyers start wondering why everyone wants to leave the neighborhood, meaning that if any houses are going to be sold, the price must be reduced, causing even more homeowners to want to leave.
Information cascade -- when people make the same decisions as others, ignoring their own private information