Behavioral economics takes the limitations of the rational choice model seriously. Economic actors are often boundedly rational and not merely motivated by their material self-interest. Cognitive limitations preclude that actors use the laws of statistics to process information and act on them optimally. Actors tend to use heuristics and display systematic biases. They are over-confident in their judgements, overvalue information that is readily available, and read information in a self-serving manner. In evaluating outcomes decision makers are sensitive to context. They weigh losses more heavily than gains and their attitude towards risk varies accordingly. They tend to be myopic and fall prey to procrastination. People care about equity and fairness. They evaluate their position relative to others, are disposed to be reciprocal, and follow social norms.
In this course we survey the evidence, from both field data and experiments. We will see how behavioral economics combines insight from economics and psychology to develop more realistic and more relevant models of behavior. We discuss applications in various field, including game theory, industrial organization, labor economics, macroeconomics, finance, and law and economics.
6 ECTS For each lecture of the course, there are one or two core papers (see below). At the beginning of the course each core paper (apart from the first one) will be allocated to a student, and this student will give a brief presentation of that core paper in class.
All students are required to read the core papers before the lecture and write a brief report on the paper (no summary!) of 200 words maximum. In the report you formulate one or two comments (“I think … is not plausible, reasonable, valid, important, …”) and you can also formulate clarrifying questions (“I do not understand why, how, …”). You send your report to the lecturer before the class. A selection of the questions and comments will be discussed in class So, each week we have 2 one-hour lectures, in which the core paper is presented by a student (15 minutes), discussed in class (20 minutes), and put in perspective by the lecturer (10 minutes).
weekly reports: 25 percent paper: 50 percent 1. Introduction 2. Judgment I. Heuristics 3. Judgment II. Overconfidence and self-serving
biases 4. Reference dependence choice I. Prospect theory,
endowment effect 5. Reference dependence choice II. Sunk costs, mental
accounting 6. Choice over time I. Overview 7. Choice over time II. Applications 8. Behavioral game theory I. Iterated dominance 9. Behavioral game theory II. Social preferences 10. Neuroeconomics 11-12. Selection of additional concepts, methods, applications: e.g., Evolution of preferences, Culture, Learning, Happiness, Soft Paternalism, Field experiments
Credits
Prerequisites
Examination
presentations: 25 percent
Course OutlineLiterature
Items indicated with A or B are core material for that lecture and will be presented and discussed in class.
1. Introduction
A. Rabin, M. (1996), Psychology and Economics, Journal of Economic Literature 34, 11-46.
2. Judgment I. Heuristics
A. Tversky, A., and Kahneman, D. (1974), Judgement under Uncertainty. Heuristics and Biases,
Science 185, 124-1131.
B Camerer, C., (1995), Individual Decision Making, Part I. Judgement, in: A. Roth and J. Kagel, eds.,
Handbook of Experimental Economics, Princeton: Princeton University Press.
3. Judgment II. Overconfidence and self-serving bias
A. Babcock, L., and Loewenstein, G. (1997), Explaining Bargaining Impasses: the Role of Self-Serving Biases,
Journal of Economic Perspectives 11, 109-126. Reprinted in Advances in Behavioral Economics, C. Camerer, G. Loewenstein, M. Rabin 2004.
B. Malmendier, U., and Tate, G. (2004), CEO Overconfidence and Corporate Investment, forthcoming
Journal of Finance.
4. Reference dependence choice I. Prospect theory, endowment effect
A. Kahneman, D., and Tversky, A. (1979), Prospect Theory: An Analysis of Decision Under Risk,
Econometrica 47, 263-291.
B. Kahneman, D., Knetsch, J., and Thaler, R. (1990), Experimental Tests of the Endowment Effect and the Coase Theorem,
Journal of Political Economy.
5. Reference dependence choice II. Sunk costs, mental accounting
A. Potters, J., and Offerman, T. (2000), Does Auctioning of Entry Licenses Induce Collusion? An Experimental Study, CentER Discussion Paper 2000-53.
B. Bernartzi, Shlomo, and Richard Thaler (1995), Myopic Loss Aversion and the Equity Premium Puzzle,
Quarterly Journal of Economics 110, 75- 92.
6. Choice over time I. Overview
A+B. Frederick, S., Loewenstein, G., O’Donoghue, T. (2004), Time Discounting and Time Preference. A Critical Review, forthcoming
Journal of Economic Literature.
7. Choice over time II. Applications
A. Laibson, D., (1997), Golden Eggs and Hyperbolic Discounting, Quarterly Journal of Economics.
B. DellaVigna, S., and Malmendier, U. (2003), Overestimating Selfcontrol: Evidence from the Health Club Industry, working paper Stanford.
8. Behavioral game theory I. Iterated dominance
A. Camerer, C. (2003), Iterated Reasoning in Dominance Solvable Games, Chapter 5 in
Behavioral Game Theory.
B. Goeree, J., and Holt, C. (2001), Ten Little Treasures of Game Theory and Ten Intuitive Contradictions,
American Economic Review.
9. Behavioral game theory II. Social preferences
A. Rabin, M. (1993), Incorporating Fairness into Game Theory and Economics,
AER.
B Fehr, E., and Schmidt, K. (1999), A Theory of Fairness, Competition, and Cooperation,
Quarterly Journal of Economics 114, 817-868.
10. Neuroeconomics.
A+B. Camerer, C., Loewenstein, G., Prelec, D. (2005) Neuroeconomics, Journal of Economic Literature 43, 9-64.
11-12. Selection of additional concepts, methods, applications: e.g., Evolution of preferences, Culture, Learning, Happiness, Soft Paternalism, Field experiments
General background reading on Behavioral Economics
There still are no text books on Behavioral Economics. There are a couple of volumes:
Baron, J., (2000), Thinking and Deciding, 3rd ed, Cambridge University Press. [Introductory textbook with a psychological perspective on judgment and decisionmaking mainly targeted at non-psychology graduates and researchers.]
Camerer, C. (2003), Behavioral Game Theory, Princeton: Princeton University Press. [Superb overview of experimental studies on games, including recent theoretical developments.]
Gigerenzer, G., and Selten, R. (eds.), Bounded Rationality. The Adaptive Toolbox, MIT Press. [An interesting collection original papers outlining an approach to bounded rationality that moves a further away from the standard rational choice model than much other work in BE does.]
Roth, A. and Kagel, J. (eds.) (1995), Handbook of Experimental Economics, Princeton University Press. [Excellent book. Six chapters with thorough overviews of experimental research in different fields.]
Shleifer, A. (2000), Inefficient Markets. An Introduction to Behavioral Finance, Oxford University Press.
Edited books (collections of previously published papers)
Camerer, C., Loewenstein, G., Rabin, M., (eds.) (2004), Advances in Behavioral Economics, Princeton University Press. [Good selection of quality papers in BE, most of them previously published.]
Kahneman, D., Tversky, A. (eds.) (2000), Choices, Values, and Frames, Cambridge University Press. [Selection of 42 excellent papers, many of them classics.]