Behavioral Economics 1st Term - Academic Year 2014/2015

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1 Behavioral Economics 1st Term - Academic Year 2014/2015 Professor Luigi Mittone luigi.mittone@unitn.it Teaching Assistant Viola Saredi violaluisa.saredi@unitn.it Course Overview The course aims to provide students with a grounding in the main areas of behavioral economics, by focusing on behavioral implications of theoretical models and on experimental evidence in economics. These main areas include bounded rationality, decision-making under risk and uncertainty, other regarding preferences, inter-temporal decision-making, behavioral game theory, emotions and libertarian paternalism. For each area, the focus will be on three points: (i) review of standard economic models and evidence that indicates that such models do not capture some important behavioral aspects or anomalies; (ii) study of the behavioral models that have been developed to capture these aspects; (iii) application of these models to different economic fields, especially with respect to more recent contributions. In particular, lectures will deal with the first two points, while the third one will be developed by means of assignments over the semester. Preparatory and General Readings By and large, the course will be based on academic papers (which are available online) and lecture notes (slides). However, besides the assigned reading list, there are some books that you may find useful, if you are interested in getting a deeper knowledge about behavioral and experimental economics. The first is 'Advances in Behavioral Economics' (2004) by Colin Camerer, George Loewenstein and Matthew Rabin. The second is 'An Introduction to Behavioral Economics' (2012) by Nick Wilkinson and Klaes. The third is 'Behavioral Game Theory' (2003) by Colin Camerer. Finally there is 'Handbook of Experimental Economics' (1995) by John Kagel and Alvin Roth. Here you can also find the suggestion of some interesting readings: 'Gut Feelings' (2008) by Gerd Gigerenzer, 'Nudge' (2009) by Richard Thaler and Cass Sustein, 'Predictably Irrational' (2009) by Dan Ariely, 'The Upside of Irrationality' (2010) by Dan Ariely, 'The Honest Truth about Dishonesty' (2013) by Dan Ariely, 'Thinking, Fast and Slow' (2011) by Daniel Kahneman, and 'The Power of Habit' (2012) by Charles Duhigg. Course Requirements and Assessment Method Students will be expected to be familiar with Mathematics, Statistics, Microeconomics, and Game Theory.

2 Assessment for Master Students There will be a final written exam. The final grade will depend also on homeworks: indeed, there will be (approximately) six assignments and a classroom presentation on the covered topics. More details on the structure of the assignments will be given during the course. Assessment for PhD Students There will be a final written exam. The final grade will depend also on homeworks: indeed, there will be (approximately) six assignments on the covered topics. More details on the structure of the assignments will be given during the course. In addition to this, students will be expected to write a research proposal. Such a proposal should include a brief and clear review of the existing (and also recent) literature, a description of the novelty of the proposed work, research questions, and research methodology. Proposals can be organized in groups. Course Outline The course will cover the following topics. Introduction to Behavioral Economics Information about the structure of the course, and the assessment method What is Behavioral Economics? (Camerer and Loewenstein, 2004; Rabin, 1998; Rubinstein, 2005) Behavioral Economics and the Standard Economic Models (The Neoclassical Repair-shop) Evaluating Economic Theories (Ho, Lim and Camerer, 2006) Behavioral Economics o History and Evolution: the Neoclassical Approach. The Resurgence of Psychology. Birth of Behavioral Economics as we know it (Kahneman and Tversky, 1979; Thaler, 1980) o Methodology and Data Sources (Economics and Psychology); Introduction to Experimental Economics (Loewenstein, 1999; Hertwig and Ortmann, 2001; Guala and Mittone, 2005); Introduction to Neuroeconomics o Domains of interest Bounded Rationality The notion of Bounded Rationality (Simon, 1955, 1956, 1957, 1992) o The emergence of bounded rationality o Simon's Bounded Rationality Does Bounded Rationality need to be understood? o Ecological Bounded Rationality (Selten, 1998; Gigerenzer, Todd and the ABC Research Group, 1999; Gigenrenzer and Selten, 2001; Todd and Gigerenzer, 2003) o Fast and Frugal Heuristics

3 A formal model of Bounded Rationality Models of Decision-making and Anomalies in Preferences Rationality Issue: Axioms and Assumptions under Standard Economic Models (SEM) Weaknesses of Standard Economic Models: Some Examples of Behavioral Phenomena in the Lab (Kahneman and Tversky, 1974; Greter and Plott, 1979; Tversky and Kahneman, 1981; Tversky and Kahneman, 1986; Kahneman, Knetsch and Thaler, 1990; Kahneman, Knetsch, and Thaler, 1991; Benartzi and Thaler, 1995; Sha r, Simonson and Tversky, 1993; Genesove and Mayer, 2001; Plott and Zeiler, 2005; Della Vigna, 2009) o Failure of Transitivity, Reference Dependence (Context Effect, Loss Aversion, Endowment Effect, Anchoring Effect, Diminishing Sensitivity), Failure of Cancellation, Failure of Invariance, and Failure of Dominance and Invariance Reason-based Choice (Shafir et al., 1993) o Choice between equally valued alternatives o Choosing to accept vs. choosing to reject o Seeking option o Adding option Biases in Judgment (Kahneman, 2003) The Architecture of Cognition (Kahneman, 2003) Heuristics: a comparison Some Examples of Behavioral Phenomena in the Field (Gilovich, Valolone and Tversky, 1985; Camerer, Babcock, Loewenstein and Thaler, 1997; Della Vigna and Malmendier, 2006; Leonard, Frederick and Ariely, 2006; Mazar and Ariely, 2006; Shampanier, Mazar and Ariely, 2007) Decision-making Under Risk and Uncertainty Expected Utility Theory (Axioms) Anomalies in Expected Utility Theory: The Common Consequence Effect, The Common Ratio/Certainty Effect Conventional alternatives to Expected Utility Theory (Starmer, 2000): Disappointment Theory, Decision-Weighting Theories, Rank-dependent Utility Non-conventional alternatives to Expected Utility Theory (Starmer, 2000): Regret Theory (Loomes and Sugden, 1982), Prospect Theory (Kahneman and Tversky, 1979, 2000) Prospect Theory o Editing Phase and Comments o Evaluation Phase o Reference Point o Loss Aversion o Shape of the Utility Function o Decision Weighting Decision From Description vs. Decision From Experience (Barron and Erev, 2003; Hertwig et al., 2004; Hertwig and Erev, 2009)

4 Other-regarding Preferences The standard self-interest hypothesis. Evidence from the lab (Ultimatum Game, Gift Exchange Game, Trust Game, Public Good Game). Possible interpretations: learning models? Social norms? (Camerer and Thaler, 1995). Social Preferences (Fehr and Schmidt, 2002; Engelmann and Strobel, 2004). o Altruism (Andreoni and Miller, 2000) and quasimaximin preferences (Charness and Rabin, 2000; Charness and Rabin, 2002). o Relative income and envy (Bolton, 1991). o Inequity Aversion (Fehr and Schmidt, 1999; Bolton and Ockenfels, 2000). o Altruism and Spitefulness (Levine, 1998). Intention-based Reciprocity. o Fairness Equilibrium (Rabin, 1993). o Intentions in Sequential Games (Dufwenberg and Kirchsteiger, 1998). o Merging Intentions and Social Preferences (Falk and Fischbacher, 1999). o Brief introduction to Guilt Aversion. Applications (Fehr and Gachter, 2000; Gneezy and Rustichini, 2000; Gneezy and List, 2006) Intertemporal Decision-Making Introduction: Discounted Utility Model, Time Discounting, Time Preferences (Frederick et al. 2002) Origins of Discounted Utility Discounted Utility Model: Integration of new alternatives; Utility independence; Consumption independence; Stationary instantaneous utility; Stationary discounting; Independence of discounting from consumption; Constant discounting and time consistency; Diminishing marginal utility and positive time preferences Discounted Utility Anomalies (Loewenstein and Prelec, 2000; Mittone, Manzini and Mariotti, 2006). o Sign Effect o Magnitude Effect o Delay-Speedup asymmetry o Preference for Improving Sequences o Date/delay effect o Violations of independence and Preference for Spread Alternatives to Discounted Utility Model o Model of Hyperbolic Discounting (time-inconsistent preferences) Quasi-hyperbolic Function (Laibson, 1998) Problems of Self-Awareness and Self-Control (Thaler and Shefrin, 1981; O'Donoghue and Rabin, 1999, 2000): Some Examples Sub-Additivity (Read, 2003) o Modifying the instantaneous utility function

5 Habit formation models Reference-point models Models incorporating utility from anticipation. The value of waiting: savoring and dread (Loewenstein, 1987; Loewenstein and Prelec, 1991). Visceral influences o More radical models Construal Level Theory (Liberman and Trope, 2003; Sagristano et al., 2002) Projection bias (Loewenstein, O'Donoghue and Rabin, 2003) Mental accounting models (Thaler, 1985; Prelec and Loewenstein, 1998): choice-bracketing (Read, Loewenstein, and Rabin, 1999) Dual-Self Models Libertarian Paternalism (Thaler and Sunstein, 2003; Thaler and Sunstein, 2008; Della Vigna, 2009) Consumption Decisions Health (Johnson and Goldstein, 2003) Retirement Saving (Benartzi and Thaler, 2004) Labor (Gneezy and List, 2006) Behavioral Game Theory (Camerer, 2002 and 'Behavioral Game Theory: Predicting Human Behavior in Strategic Situations' in 'Advances in Behavioral Economics' by Camerer) Introduction: What is Game Theory good for? From Game Theory (GT) to Behavioral Game Theory (BGT)? Experimental Regularities o Dictator, Ultimatum, and Trust Games o Mixed Strategies o Bargaining o Dominance-Solvable Games o Coordination Emotions and Decision-making What are Emotions (Elster, 1998) Visceral Factors (Loewenstein, 1996) Emotions and Economics (Elster, 1996; Loewenstein, 2000) Conclusions and Criticisms Criticisms (Pesendorfer, 2006; Levine, 2012) Conclusions (Wilkinson and Klaes, 2012, Ch.10)

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