1. Behavioral Economics
This presentation is partially based on Varian’s chapter 30 Intermediate Microeconomics.

2. Behavioral Economics
Let’s play a game (ultimatum game, Guth et al 1982)
Imagine you and another person (anonymous) are going to participate in following experiment:
You (person 1) will receive €100 from me. Now you have to decide how much you want to offer to the other person. If the other person accepts the offer, you share as suggested by you. If he/she rejects, I take the money back!

3. Behavioral Economics
Please write down on your paper what you would offer the other person.
Please fold the paper and send it up to us.
Offer: €

4. Behavioral Economics?
Now take a couple of min to think back on the early lectures of this microeconomics course and write down in a few sentences what is a rational choice?
What would have been a rational offer in the Ultimatum Game and what would have been rational to accept?
Käyttäytymistaloustieteessä tutkitaan kuinka hyvin mikrotalousteoriassa tehdyt oletukset ihmisten rationaalisesta käyttäytymisestä pitävät paikkansa. Tutkitaan siis rationaalisen valintamallin heikkouksia ja vahvuuksia.

5. Behavioral Economics? Rational choice:
Person 2 accepts any offer bigger than 0 as he is better off with one cent than with nothing.
Käyttäytymistaloustieteessä tutkitaan kuinka hyvin mikrotalousteoriassa tehdyt oletukset ihmisten rationaalisesta käyttäytymisestä pitävät paikkansa. Tutkitaan siis rationaalisen valintamallin heikkouksia ja vahvuuksia.

6. Behavioral Economics? Rational choice:
Person 2 accepts any offer bigger than 0 as he is better off with one cent than with nothing.
Therefore the offer would be the smallest possible amount besides 0.
Käyttäytymistaloustieteessä tutkitaan kuinka hyvin mikrotalousteoriassa tehdyt oletukset ihmisten rationaalisesta käyttäytymisestä pitävät paikkansa. Tutkitaan siis rationaalisen valintamallin heikkouksia ja vahvuuksia.

7. Behavioral Economics? Rational choice:
Person 2 accepts any offer bigger than 0 as he is better off with one cent than with nothing.
Therefore the offer would be the smallest possible amount besides 0.
Why did you offer more?
Käyttäytymistaloustieteessä tutkitaan kuinka hyvin mikrotalousteoriassa tehdyt oletukset ihmisten rationaalisesta käyttäytymisestä pitävät paikkansa. Tutkitaan siis rationaalisen valintamallin heikkouksia ja vahvuuksia.

8. What Is Behavioral Economics?
“The study of choices actually made by economic decision makers in an effort to assess the strengths and weaknesses of the rational choice model that is the mainstay of modern economics” (Varian).
Käyttäytymistaloustieteessä tutkitaan kuinka hyvin mikrotalousteoriassa tehdyt oletukset ihmisten rationaalisesta käyttäytymisestä pitävät paikkansa. Tutkitaan siis rationaalisen valintamallin heikkouksia ja vahvuuksia.

9. What Is Behavioral Economics?
Two ways of looking at rationality:
1) Present-aim standard.
”..efficient in the pursuit of whatever aim she happens to hold at the moment of action.”(Frank R., 2008, Microeconomics and Behavior, p. 211)
Any behavior no matter how bizarre can be explained - Drinking “Crankcase oil”. Problem is it explains everything and thus ends up explaining nothing.

10. The Rational Choice Model
2) Self-interest standard – game theory
Narrow material interest.
The rational choice model as explained by Varian is similar to the Self-interest standard.
It assumes among other things: Unbounded rationality, Unbounded willpower and Unbounded selfishness.
Useful in many cases: fewer SUVs sold when gasoline prices increase.
Päätöksentekijän valinta on rationaalinen jos hän valitse vaihtoehdon, jota hän pitää parempana (preferoituna) kaikista tarjoilla olevista vaihtoehdoista.
Useimmiten rationaalinen valintateoria kuvaa hyvin ihmisten valintoja tapauksissa, joissa ei ole epävarmuutta.
Totta kai kyse on kuitenkin mallista, joka vain approksimoi ihmisten käyttäytymistä.

11. The Value of Behavioral Economics
Behavioral economists have demonstrated that the rational choice model systematically predicts behavior less well in specific circumstances.
These demonstrations direct economists to where the rational choice model must be improved.

12. Behavioral Economics Rational Choice model Behavioral Economics
Unbounded rationality
Bounded rationality Rajoittunut rationalisuus
Framing, Anchoring, Default Choice, Status Quo Bias, Increased Choice, Cost of Delay, Uncertainty, Overconfidence and Sunk Cost.
Unbounded willpower
Bounded willpower Rajoittunut itsehillinta
Eat, drink and spend too much
Exercise & save too little, procrastinate too much
(Procrastinate viivytellä, vitkastella, lykätä)
Unbounded selfishness
Bounded selfishness Rajoittunut itsekkyys
Fairness

13. Behavioral Economics; Bounded Rationality, Framing Effects
How a choice is framed (i.e., presented) strongly affects the choice that results.
600 lives are threatened.
Action (a) saves 200 lives.
Action (b) saves all 600 lives with probability 1/3 and saves nobody with probability 2/3.
Which action would you choose? (a) or (b)?

14. Behavioral Economics; Bounded Rationality, Framing Effects
600 lives are threatened.
Action (c) causes 400 to die.
Action (d) causes 600 to die with probability 2/3 and causes nobody to die with probability 1/3.
Which action would you choose? (c) or (d)?

15. Behavioral Economics; Bounded Rationality, Framing Effects
600 lives are threatened.
Action (a) saves 200 lives.
Action (b) saves all 600 lives with probability 1/3 and saves nobody with probability 2/3.
600 lives are threatened.
Action (c) causes 400 to die.
Action (d) causes 600 to die with probability 2/3 and causes nobody to die with probability 1/3.
These problems are identical, apart from how they are framed. Yet the most common (highlighted) choices are different.

16. Behavioral Economics; Bounded Rationality, Anchoring Effects
Anchoring effects are the effects on choices of seemingly irrelevant information.

17. Behavioral Economics; Bounded Rationality, Anchoring Effects
Anchoring effects are the effects on choices of seemingly irrelevant information.
An experimenter used a wheel-of-chance with a group of human subjects. Each person observed the numerical outcome of a roll of the wheel and was then asked if the number of African countries in the United Nations was greater than that outcome. Later, that person was asked to guess the number of African countries in the UN.
The guesses were clearly influenced by the outcomes of the wheel.

18. Behavioral Economics; Bounded Rationality, Default Choice.
Default choices can influence your choice.
Would you like to be an organ donor in case of brain death?
Default = oletus, default choice = oletusvalinta (?)

19. Behavioral Economics; Bounded Rationality, Default Choice
The default choice can influence your own choice.
Would you like to be an organ donor in case of brain death?
83 % of Finnish people say yes, but only 17 % have signed an organ donor card.
In contrast, France has a donor rate of about 97%.

20. Behavioral Economics; Bounded Rationality, Default Choice
The default choice can influence your own choice.
Would you like to be an organ donor in case of brain death?
83 % of Finnish people say yes, but only 17 % have signed an organ donor card.
In contrast, France has a donor rate of about 97%. They achieve it by making organ donation the default choice.

21. Behavioral Economics; Bounded Rationality, Default Choice
In Finland as in many countries you have to “Opt In” to become an organ donor. In France you have to “Opt Out” to avoid donating your organs.

22. Behavioral Economics; Bounded Rationality, Default Choice
In Finland as in many countries you have to “Opt In” to become an organ donor. In France you have to “Opt Out” to avoid donating your organs.
The rational choice model: “X percent of the population will be organ donors no matter how you ask”.
This has environmental applications as well. Can we make the “green” choice a default choice?

23. Behavioral Economics; Bounded Rationality, Endowment effect and Status quo bias
Monty Hall’s Three Doors game. From the American game show “Let’s Make a Deal”.
There are chocolate behind one of these doors and nothing behind the other two doors.
Please choose a door. 1 2 3

24. Behavioral Economics; Bounded Rationality, Endowment effect and Status quo bias
Monty Hall’s Three Doors.
Your choice is door number ___. I will now open one of the other doors that is empty.
Do you want to switch to the other closed door? 1 2 3

25. Behavioral Economics; Bounded Rationality, Endowment effect and Status quo bias
Monty Hall’s Three Doors. 1
Chocolate 2
Nothing 3
Nothing

26. Behavioral Economics; Bounded Rationality, Endowment effect and Status quo bias
In the Monty Hall’s Three Doors game the rational choice model predicts that you “switch your choice”. As the chance of getting the chocolate is 2/3 when switching compared to 1/3 when staying.
Experiments in the Monty Hall’s game has shown that a majority of participants choose to “stay”.
Even after the calculations of predictability was published in the early 1990’s, nearly readers wrote to the paper arguing that the calculations were wrong.

27. Other examples of bounded rationality
Dan Ariely’s video: are in control of our decisions? (from 11:10 to 14:25)

28. Behavioral Economics Rational Choice model Behavioral Economics
Unbounded rationality
Bounded rationality Framing, Anchoring, Default Choice, Status Quo Bias, Increased Choice, Cost of Delay, Uncertainty, Overconfidence and Sunk Cost.
Unbounded willpower
Bounded willpower Eat, drink and spend too much
Exercise & save too little, procrastinate
(Procrastinate viivytellä, vitkastella, lykätä)
Unbounded selfishness
Bounded selfishness Fairness

29. Unbounded will power: Dan Ariely’s experiment (Ariely 2008, 109-117)
Assume that at the beginning of a course you have to decide when you will hand three compulsory papers for the course.
Once you have chosen a deadline, it can’t be changed and if you hand in the paper late, then you would be penalized 1% for each day late.
You can always turn your paper in earlier, before the deadline, but the professor won’t read the paper until the end of the course nor would you get higher grades for submitting your work earlier.

30. Unbounded will power: Dan Ariely’s experiment
The course starts on week 1 and ends on week 12.
What do you choose?
I promise to submit paper 1 on week ………
I promise to submit paper 2 on week……….
I promise to submit paper 3 on week………..

31. Unbounded will power: Dan Ariely’s experiment
A student with unbounded will power will choose to submit the papers the last day of class
She can always hand-in them earlier if she wishes, so why risk being late by picking an earlier deadline?

32. Unbounded will power: Dan Ariely’s experiment
However, if students recognize that they tend to procrastinate (= lykätä) and leave the writing of the papers to the last minute, they may choose earlier deadlines to force themselves to start working on the papers on time.

33. Unbounded will power: Dan Ariely’s experiment
How did Ariely’s students behaved when given the freedom to choose the deadline to hand-in papers?
Did the choice of the dealine affect the quality of the papers and the grades students got?

34. Unbounded will power: Dan Ariely’s experiment
Variations to the experiment:
Class 1: could choose the three dates on which to hand-in the papers with penalty in case of delay, earlier submission allowed.
Class 2: had to submit all papers the last day of the course, but could submit earlier without any grade benefit.
Class 3: students were given three deadlines for the three papers on the 4th, 8th and 12th week, no flexibility on hand-in date at all.

35. Unbounded will power: Dan Ariely’s experiment
Which class do you think did best (gradewise)?
Which had the lowest grade?

36. Unbounded will power: Dan Ariely’s experiment
Which class do you think did best (gradewise)?
Which had the lowest grade?
Class 3 did best (no flexibility, three fixed deadlines)
Class 2 had the poorest results (had to submit all papers the last day of the course)
Class 1 finished in the middle.

37. Unbounded will power: Dan Ariely’s experiment (Ariely 2008, 115)
What do these results suggest
Students do procrastinate
Tighlty restricting their freedom (equally spaced deadlines imposed from above) is the best cure for procrastination.
But the BIGGEST REVELATION is that simply offering the students a TOOL by which they could PRECOMMIT to deadlines helped them achieve better results.

38. Unbounded will power: Dan Ariely’s experiment
Why then did self-imposed deadlines did not achieve as good grades than the deadlines set by the professor?

39. Unbounded will power: Dan Ariely’s experiment
One possible interpretation (Ariely 2008, 115):
Not all students understand their tendency to procrastinate (some choose to hand in on the last day of course).
Those who do understands it, do not understand it fully, thus even when they choose earlier deadlines when given the choice, they do not choose those that help getting the best results.

40. Behavioral Economics; Bounded Willpower
Other examples:
Today you are sure you want to quit smoking cigarettes, and you do. But tomorrow you start smoking again.
Your sincere New Year’s resolution is to exercise regularly, but you don’t.
Some implications for economic theory and economic policy:
Theory: Can we interpret consumer surplus from markets where unbounded will power may be a significant problem, for instance from the markets of cigarettes, as a measure of consumers’ utility/well-being?
Policy: Are so called “sin taxes” (e.g. taxes on cigarettes) justified on the basis of unbounded will-power argument (not on the externality argument)?

41. Unbounded will power and ”success”
The ability to exercise will power and delay gratification as a 4-year old kid is a potent predictor of how well the kid will do once grown up in life (family, school, friends, work).
Experiment: 4-year old kid alone in a room with a marshmallowe. If he can wait 15 minutes without eating it, he will be given two marshmallows after the waiting period.
2/3 of kids eat the marshmallow
See (3.27)

42. Behavioral Economics Rational Choice model Behavioral Economics
Unbounded rationality
Bounded rationality Framing, Anchoring, Default Choice, Status Quo Bias, Increased Choice, Cost of Delay, Uncertainty, Overconfidence and Sunk Cost.
Unbounded willpower
Bounded willpower Eat, drink and spend too much
Exercise & save too little, procrastinate too much
(Procrastinate viivytellä, vitkastella, lykätä)
Unbounded selfishness
Bounded selfishness Fairness

43. Unbound selfishness
Economic rationalty does not presume self interest.
It is possible for an economic agent to have transitive and complete altruistic preferences.
However self-interest is commonly assumed in economics (especially in game theory applications) and sometimes even confused with rationality.
In other words selfd-interest is usually assumed in the practice of economic theory. (Bowles 2004, )

44. Behavioral Economics: Ultimatum game and Bounded Selfishness
Let’s go back to the ultimatum game
A reminder of the game:
You and another person (anonymous) participate in following experiment: You (person 1) will receive €100 from me. Now you have to decide how much you want to offer to the other person. If the other person accepts the offer, you share as suggested by you. If he/she rejects, I take the money back!

45. Behavioral Economics: Ultimatum game and Bounded Selfishness
Rational choice model predicts that the offer will be at most one cent (the smallest amount possible), since one cent is better than the nothing he gets if he refuses.
However experiments show, that participants are willing to punish the first person and themselves and reject the offer if it is considered “unfair.”
Most offers of about 40 % are accepted.

46. Behavioral Economics: Ultimatum game and Bounded Selfishness
General result from the ultimatum game:
almost zero offers where the offererd sum was greater than 50 % or smaller than 20 %.
60-80% of all offers are in the range 40 % < s < 50 %. (Fehr & Schmidt 1999.)
The probability of rejection increases as the offer decreases. (Camerer 2003.)

47. What to do when the laboratory experiments results conflict with theoretical predictions? Check the results
Are the results robust (luotettavia)?
Would you get different results if you changed the experiment slightly?
You can test (once at a time) how the following affect your results:
Number of repetitions (learning)
Different amounts of money to be divided (Cameron 1999)
Different cultures/countries: Italy versus Finland versus Thailand
Different participants: students, retired, men vs women, etc.

48. What to do when the laboratory experiments results conflict with theoretical predictions
Check: are the results robust (luotettavia)?
Same basic results obtained in modified ultimatum games (Camerer & Thaler 1995, ultimatum-pelin kirjallisuuskatsaus)

49. If the restuls are robust, what is their possible interpretation?
Social norms of fairness:
The social norm of “fairness” results in a share and in a desire by the other to punish you if you are “unfair.”
Self-image:
I want to see myself as a generous person, keeping all the money for myself damages this view of myself as a generous person.

50. How can we check this interpretation? E.g. Self-image
Test the self-image explanation by making a small change to the ultimatum game: Now the other person must take what he is given, he cannot reject your offer (dictator game).
Rational choice theory predicts: he will get nothing; i.e., you will take everything.
“Self image theory” predicts: he will behave exaclty as in the ultimatum game.
…..

51. Behavioral Economics, Experiments
In the economy there might be many things affecting the choices we make.
An attempt to measure the impact of each one can be done either through laboratory experiments (as the ultimatum game) or via field experiments (as Ariely’s paper’s deadline experiments)

52. Behavioral Economics, Experiments
Field experiments and laboratory experiments have each one their own strenghts and weaknesses.
Laboratory experiments give more control to the researcher on the conditions under which the experiment takes place.
On the other hand, field experiments may feel more “realistic”.

53. Behavioral Economics: how a laboratory experiment looks like
In the lab participants have a computer each.
The participants can be anonymous and make their choices in private via the computer.
The participants earn different amounts of money depending on their choices
Money incentives in the lab try and mimic (=matkia) the real economic incentives people have in “real life”.

54. Behavioral Economics: how a laboratory experiment looks like
Money incentives in the lab try and mimic (=matkia) the real economic incentives people have in “real life”.
Nowdays many experiments are run in developing countries where the sums paid to participants tend to give higher economic incentives because in these countries people generally have lower income levels.
Unlike psychology experiments, no deception allowed.

55. Behavioral Economics: What Is Its Value?
Science advances by modifying theories when evidence accumulates of inadequacies with current theories (the predictions of the theory conflict with empirical evidence of how people actually behave).
The rational choice model is one such theory.
The value of behavioral economics is that it points out weaknesses of the rational choice model, thereby directing economists to where improvements must be made and so increasing the usefulness of economic science.

56. Behavioral and Experimental Economics in Viikki.
The course starts March 17th (4th period).
4 experiments
Discussion of results and the theory behind in class.
Application to public and environmental economics.
Group assignments
No final exam
If you are interested you can sign up using WebOodi (863051)

57. Reading list - Luettavaa
Ariely, Dan (2008) Predictably Irrational, New York: Harper, ss
Frank, Robert H. (2006) Microeconomics and Behavior, kuudes painos (international edition), New York: McGraw Hill, ss

58. Reading list - Luettavaa
Mullainathan, S. & Thaler, R. H. (2000), Behavioral Economics, Working Paper 7948, National Bureau of Economic Research, saatavilla (haettu )
Varian, Hal R. (2006) Intermediate Microeconomics: A Modern Approach, seventh edition (international student edition), New York: W. W. Norton and company, luku 30, ss

59. Kiinnostuneille (If you want to read more)
Camerer C. (2003) Behavioral game theory: Experiments in strategic interaction. Princeton: Princeton University Press
Camerer, C. & Thaler, R. (1995) Ultimatums, Dictators, and Manners, Journal of Economic Perspectives, 9:
Camerer, C. & Loewenstein, G. (2004) Behavioral Economics: Past, Present, Future teoksessa Advances in behavioral economics Roundtable Series in Behavioral Economics. New York: Russell Sage Foundation; Princeton and Oxford: Princeton University Press, pp
Cameron, Lisa (1999) Raising the Stakes in the Ultimatum Game: Experimental Evidence from Indonesia. Economic Inquiry, 37(1): )
Fehr, E. & Schmidt K (1999) A Theory of Fairness, Competition and Cooperation, Quarterly Journal of Economics 114,
Guth, W., Schmittberger, Rolf, & Schwarze, B. (1982) An Experimental Analysis of Ultimatum Bargaining, Journal of Economic Behavior and Organization 3(4):

60. Tapa Nobelisti Damiel Kahneman
Vuonna 2002 psykologi Daniel Kanhneman sai taloustieteen Nobelin palkinto hänen ja Amos Tverskyn työstä käyttäytymistaloustieteestä rajoittunut rationaalisuus osa-aluella.
Tversky oli kuollut 1996.

61. Tapa Matthew Rabin 2001 Clark mitalisti.
Clark mitali on tärkein palkinto alle 40 vuoden yhdysvaltalaiselle taloustieteilijälle
Tutki erityisesti rajoittunut itse-hillintä
Tärkeä tutkimuskumppanit George Loewenstein and Ted O’Donoghue

62. Tapa Ernst Fehr Sveitsilainen talousteiteiljiä.
Tutki mm. rajattu itsekkyys
Katso esim.
The Nature of Human Altruism, NATURE 425, 23 October 2003, (with Urs Fischbacher).
Fairness Perceptions and Reservation Wages--The Behavioral Effects of Minimum Wage Laws with Falk Armin and Zehnder, Christian; Quarterly Journal of Economics, November 2006, v. 121, iss. 4, pp
Fairness and Contract Design with Klein, Alexander; Schmidt, Klaus M.; Econometrica, January 2007, v. 75, iss. 1, pp