Behavioural Economics of Social Preferences

Behavioural Economics of Social Preferences

• Behavioural economics bridges economics and psychology
• The standard economic model, a normative theory, describes how people should make decisions, not how they do make decisions.
• This model assumes humans are rational, calculating, and perfectly selfish (homo economicus)
• Psychologists have challenged these strong assumptions.
• Evidence from experiments suggests people exhibit social preferences.

Learning Objectives

• Behavioural economics is about testing the standard economic model on humans to see if it works, fails, and can be modified
• The goal is not to replace the standard economic model, but to enhance it with psychological insights to improve its predictive and descriptive utility.
• Social preferences include concern for others, desire to uphold ethical norms, generosity, fairness, and honesty

What Is Behavioural Economics?

• Economists have a simple model of decision-making.
• This standard economic model is normative, not descriptive.
• The model posits that humans are driven by self-interest.

What Is Behavioural Economics?

• Behavioural economics is a field that bridges economics and psychology.
• It's about testing the standard economic model on humans and seeing when it works, when it fails, and seeing whether it can be improved.

Today: Focus on Social Preferences

• The self-interest axiom (from the standard economic model) can be questioned.
• Social preferences include positive and negative concern for the well-being of others, adhering to ethical norms, fair outcomes, and virtues like honesty.
• Social preferences challenge the self-interest axiom.

Social Preferences in Natural Settings

• Real-life observations often contradict the standard economic model.
• Societies demonstrate cooperation beyond animal kingdom levels, including acts like voting, collective actions, resource conservation, paying taxes, and charitable donations.
• The self-interest hypothesis is challenged by the observed degree of cooperation.

Laboratory Experiments

• Laboratory experiments provide a degree of control.
• Participants in experiments can earn considerable money, enabling observation of behaviour under controlled circumstances.
• Economic games are used (ultimatum, public goods, dictator, trust game) in these experiments to reveal social preferences.

Key Findings From The Experimental Laboratory

• Economic games highlight key findings, such as strong reciprocity, free-rider behaviour, altruistic punishment, and how punishment effectiveness depends on legitimacy.

1. Strong Reciprocity Is Common

• Strong reciprocators are willing to sacrifice resources to reward fairness and punish unfairness, even without personal gain.
• Positive reciprocity (kindness met with kindness) and negative reciprocity (hostility met with hostility) are common.

Ultimatum Game

• Two players: the proposer and the recipient.
• The proposer has an initial sum of money and proposes how much of it they will give to the recipient.
• The recipient can either accept or reject the offer.
• If accepted, the recipient gets the money offered and the proposer keeps the rest.
• If rejected, both receive nothing.

Ultimatum Game (continued)

•  Self-interest theory predicts low offers will always be accepted.

•  However, the model does not account for responders rejecting low offers or proposers offering more than necessary to secure acceptance.

Proposers Have Social Preferences

•  Proposers often offer a significant portion of the money to the recipient.

Receivers Have Social Preferences Too

•  Receivers frequently reject low offers, highlighting a desire for fairness rather than strict self-interest.

Ultimatum Game (continued)

•  Rejecting low offers reflects a desire to punish unfairness, though this incurs a cost to the responder.

Prisoners' Dilemma Game

• Two players, Alice and Bob, are given a choice to cooperate (C) or defect (D).
• A payoff matrix shows the benefits of cooperating vs defecting.
•  Self-interest might predict that both defect, but cooperating yields higher rewards in some situations.

Prisoners' Dilemma Game (continued)

•  Many experiments reveal that a significant portion of participants cooperate despite the temptation to defect.
• This defies the pure self-interest prediction

2. Free-Riders Undermine Cooperation

• A free-rider is someone who enjoys the benefits of a group's contributions without participating.
• In repeated social dilemmas, cooperation can decline due to the presence of free-riders.
• This is often observed in public goods games.

Public Goods Game

• A group of players is given an initial amount of money.
• Players decide how much to contribute to a shared pool.
• The pool's value is multiplied and distributed equally among all players.

Decay of Cooperation

• Cooperation often declines over time in public goods games when free-riders are present.
• High initial contributions tend to decrease with repeated rounds as subjects learn to maximise their payoffs.

3. Altruistic Punishment Sustains Cooperation

• Altruistic punishment is costly to the punisher but serves to punish free-riders, ensuring cooperation within the group.

Fehr and Gächter (2002): Public Goods With Punishment Game

• A public goods game with an option to punish free-riders is implemented.
• Punishment discourages free-riding and helps maintain cooperation.
• The punishment's cost to the punisher (as well as the target) highlights its altruistic nature.

Fehr and Gächter (2002) - Continued

•  Results show that punishment significantly increases cooperation, demonstrating its positive effect.

4. Effective Punishment Depends On Legitimacy

• Altruistic punishment only works if legitimate.
• Its effectiveness is influenced by social norms and perceptions of fairness.

Altruistic and Antisocial Punishment

• Herrmann et al. (2008) assessed punishment across various societies.
• Legitimacy of punishment varied across cultures.

Herrmann et al. (2008): Summary

•  Legitimacy of punishment affects its effectiveness across diverse groups.

Does Frequency of Interaction Matter?

• Repeated interactions over a larger number of rounds leads to stronger positive effects of punishment.

6. People Punish Those Who Hurt Others

• People are willing to punish those who hurt others in accordance with shared ethical norms, even if this affects their own payoffs.
• This contrasts with mere retaliation for direct damage alone,

Fehr and Fischbacher (2004): Third Party Punishment and Social Norms

•  Three players take part: a dictator, a recipient, and an observer.
• The observer can administer punishment based on the dictator's actions.
•  Punishments are costly to the punisher, highlighting the ethical components.
•  Observed behavior suggests that punishment happens more strongly if there's fairness.

7. Behaviour Is Conditioned on Group Membership

• Cultural and other group influences often affect cooperation and interactions.

Trust Game

• Trust games involve two players where one (Alice) transfers resources to another (Bob).
• Bob can then return some of this augmented amount back to Alice.
• Even anonymous interactions often reveal significant cooperative behaviour, demonstrating social preferences.

8. People Enjoy Cooperating and Punishing Free Riders

•  Neuroscience studies reveal the neural basis associated with cooperation and punishment of violators of social norms in games.

9. Do Experimental Results in the Laboratory Reflect Real-Life Behaviour?

• Evidence suggests that experiments reflect real-world behaviours to some extent (ecological validity) through examples in fields like fishing and resource management.

Summary & Conclusions

• Experimental results frequently differ from the self-interest axiom.
• There is ubiquitous evidence demonstrating social preferences such as generosity towards others, a concern with fairness, and a desire to avoid inequality.