Economic Psychology and Experimental Economics

Simon Kemp, Gabrielle Wall

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781317980056
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The last ten years have seen an enormous surge of interest in issues that are common to psychology and economics. How do people make decisions about economic issues? How should they make such decisions? Does public policy or regulation succeed in its aim of helping people make these decisions? What situations aid cooperation?

This volume explores some of the ways in which economists and psychologists have tried to answer these questions. The authors are an international mix of economists and psychologists, and as such they demonstrate a diverse range of approaches to tackling different aspects of these issues. This is a frontier area for both psychology and economics, and consequently it is relatively free, lawless and, above all, exciting. This collection reflects the diversity and energy that characterise this rapidly growing interdisciplinary field.

This book was originally published as a special issue of New Zealand Economic Papers.

Introduction

Psychology and economics

Simon Kemp and Gabrielle Wall

Psychology Department, Private Bag 4800, University of Canterbury, Christchurch 8140, New Zealand

A little thought will convince you of the potential for economics and psychology to interact in a number of complementary ways. In recent years, a great deal of this potential has been realised and the papers included in this issue illustrate aspects of this symbiosis.

Economics has often been oriented towards producing mathematical theories, while psychology has developed empirical methods. Thus, to some extent, the new sub-disciplines of behavioural economics and economic psychology have used methods developed within psychology to test theories developed by economists. But these areas are not simply defined by an attempt to combine economic theoretical sophistication with psychological methodological expertise. Economics has long had its own methods of data-gathering, and new empirical techniques have been developed within the discipline itself. Particularly striking has been the rise of experimental economics, as seen in the August 2009 special issue of New Zealand Economic Papers and in half of the papers in the present special issue. On the other hand, there is also a long history of mathematical theories in the psychology domain. For example, both economists and psychologists have long been concerned with measurement in general and utility measurement in particular, and such work has often been cross-referenced in both psychological and economic journals.

By all accounts, economists’ interest in psychology has increased greatly in recent years. Particularly influential has been work by Daniel Kahneman and Amos Tversky, culminating in the former – Tversky had died shortly before – sharing the Nobel Prize in economics in 2002 for integrating ‘insights from psychological research into economic science, especially concerning human judgement and decision-making under uncertainty’. As this Nobel citation suggests, decision-making in economic environments has been, and remains, a major area of collaboration between economists and psychologists. Kahneman and Tversky (2000) still provides an excellent introduction to this work. Three books that summarise other areas of collaboration are the edited books by Camerer, Loewenstein and Rabin (2004), Lewis (2008), and Maital (2007).

Much of the earlier work was concerned mostly with such theoretical issues as whether people really optimise or how they gather the information needed to make decisions. This work continues (e.g. Earl, Güth and Weiland in the present issue), but in addition a very wide range of topics has now opened up on the border between economics and psychology, and the topics are often of practical as well as theoretical importance to both disciplines. A prominent example of this tendency is in the interest shown both in New Zealand and overseas in the concepts of choice architecture described in Thaler and Sunstein’s (2009) Nudge.

Research in the area of overlap is usually carried out by both economists and psychologists, a tendency supported by a brief glance at the affiliations of the authors of this volume. Psychologists are rather more likely to say they are working in the area of judgement and decision-making or economic psychology, whereas economists are more likely to describe themselves as behavioural or experimental economists. It is not unknown for people employed in psychology departments likewise to describe themselves as behavioural economists. However, our perception is that, as with the authors in this volume, economists are in the majority. Perhaps economists have learnt more from psychologists than vice versa. Interestingly, where the articles in this issue have been written by multiple authors, those authors have tended to hail from a single discipline. Future growth in this area of overlap may be more dependent on collaboration between researchers from both disciplines.

The first paper in the issue, Peter Earl’s ‘From anecdotes to novels: reflective inputs for behavioural economists’ takes a serious look at what we can learn from reflective materials such as consumer magazines and novels about how people behave in the economy. Earl’s results call into question the simple compensatory models that both economists and psychologists commonly use to describe decision processes.

Although there is a world of difference between Earl’s approach and the experimental economist’s approach of Werner and Thorsten Weiland’s ‘Aspiration formation and satisficing in search with(out) competition’, the papers are similar in describing situations in which the optimal rational-choice model does not hold well. The latter paper investigates the ‘secretary problem’, in which participants search sequentially through alternatives, which, once sampled and rejected, are no longer available. Participants use the first examples to form an aspiration level, which is typically lower than the best example seen in the sample, and then normally continue until this aspiration is satisfied. Such behaviour can be described as satisficing (e.g. Simon, 1957).

The next five papers also describe economic experiments. Vittoria Levati, Matteo Ploner and Stefan Traub’s ‘Are conditional cooperators willing to forgo efficiency gains? Evidence from a public goods experiment’ indicates that, at least within the constraints of this experiment, where contributions to a public good are of unequal efficiency, public good contributions are rather small and that efficiency concerns override inequality aversion. Juan Lacomba, Francisco Lagos and Tibor Neuge-bauer’s ‘Who makes the pie bigger? An experimental study on co-opetition’ investigates a two-stage game in which participants first have the opportunity to cooperate with another participant to decide on the size of the pie available in the second stage, and then the division of the pie is decided by a comparison of contribution size. When the participants play in the knowledge that they are competing directly with the other participant for control of pie division, they cooperate much less than when the control over pie division is contested with some other player.

In ‘An experimental examination of the effect of potential revelation of identity on satisfying obligations’, Lucy Ackert, Bryan Church and Shawn Davis describe an investment (trust) game in which player A is given a sum of money which (s)he can send to an anonymous B. This amount is multiplied and B can choose how much to send back to A. If there is a chance that B’s identity is revealed (by a photograph), then the amount B sends back is considerably increased. Ananish Chaudhuri and Erwann Sbai describe a similar trust game, which is played repeatedly with different partners, in their paper ‘Gender differences in trust and reciprocity in repeated gift exchange games’ and find no marked gender differences in trust. Women initially reciprocate more but this difference decreases with time. Interestingly, in a gift exchange game framed as an employer/employee relationship, women shirk more than men. Overall, the results suggest gender differences are both small and context dependent.

It is not difficult to find real world applications for any of these economic experiments. So, to take Lacomba et al.’s research as a single example, rivals often do cooperate to increase, say, the prestige of their occupation but then compete with each other for business. It is also easy to see connections between these experiments and psychological research and theory. However, the sixth paper from the field of experimental economics, Filip Vesely, Vivian Lei, and Scott Drewianka’s ‘Do separation rules matter? An experimental study of commitment’ considers an issue that has been of central concern to a number of psychologists. They examine who benefits from separation rules that make it harder to leave a partnership (marriage or other close relationships are the most prominent example). The thought-provoking result is that weaker parties appear to benefit more if both parties can unilaterally end the partnership than when the consent of both is necessary.

The next four papers in the issue employ research methods that differ from those of experimental economics and from each other. Ti-Ching Peng surveys Brisbane home renovators in her paper ‘Overcapitalization and cost escalation in housing renovation’. The results are dispiriting for those of us who own and renovate our homes and yet unsurprising in light of the recent Australian and New Zealand housing bubbles: both cost escalation and over-capitalisation are common. On the positive side, the paper identifies means that would-be renovators might use to control their tendency to overspend.

Bernadette Kamleitner, Bianca Hornung and Erich Kirchler also examine tendencies to overspend in ‘Over-indebtedness and the interplay of factual and mental money management: an interview study’. They summarise the findings from 25 in-depth interviews of over-indebted Austrians. As the authors acknowledge, the results obtained from such research are subject to many caveats, but are also quite revealing. Overall, the respondents appear to have difficulty in escaping their situation and use very few money management or budgetary techniques. Interestingly, the results suggest that people might actually benefit from using the non-optimal technique of mental accounting (e.g. Thaler, 1999).

Reasonably enough, most previous decision-making research has asked participants to make relatively simple decisions. By contrast, Gustav Lundberg’s ‘Coherence and bidirectional reasoning in complex and risky decision-making tasks’ confronted professional auditors and graduate business students with either a complex auditing task or with investigations of auditor negligence and investigated how they went about the process of coming to decisions in these complex matters. The findings illustrate increasing divergence between individuals coming to one conclusion or the other, and a tendency for judgements of different aspects of the problem to converge with the overall judgement. There was some success with using neural networks to model this process. Gabrielle Wall also examines something like a complex real decision-making process in ‘Outwit, outplay, outcast? Sex discrimination in voting behaviour in the reality television show Survivor’. Overall, the tendency to vote for the exclusion of same- or opposite-sex tribe members in Survivor is more readily explained by information-based rather than taste discrimination.

The issue concludes with a paper substantially based on empirical psychological research, although with no empirical content. John Fountain and Philip Gunby take seriously the considerable evidence that people have major difficulties in thinking in probabilistic terms (e.g. Gigerenzer, 2002). In ‘Ambiguity, the certainty illusion, and the natural frequency approach to reasoning with inverse probabilities’, they outline these difficulties and then go on to present and demonstrate software they have developed to be used by people (for example, health professionals) that have frequent need to reason probabilistically.

We make no claim that the 12 papers in this issue are in any sense a representative sample of the considerable research that is currently being undertaken in the areas of overlap between psychology and economics. Indeed, it is not clear to us how a representative sample might be obtained or even what it should look like. However, the papers do illustrate the diversity of the overlapping areas. It is not apparent to us that there is any single underlying theme either to these papers or to the overlap as whole, and diversity applies in methods, theories, and topics of interest. This is a frontier area for both psychology and economics, and in consequence it is relatively free, lawless, and, above all, exciting.

References

Camerer, C., Loewenstein, G., & Rabin, M. (Eds.). (2004). Advances in behavioural economics. Princeton, NJ: Princeton University Press.

Gigerenzer, G. (2002). Calculated risks: How to know when numbers deceive you. New York: Simon & Schuster.

Kahneman, D., & Tversky, A. (Eds.). (2000). Choices, values and frames. Cambridge: Cambridge University Press.

Lewis, A. (Ed.). (2008). The Cambridge handbook of psychology and economic behaviour. Cambridge, UK: Cambridge University Press.

Maital, S. (Ed.). (2007). Recent advances in behavioral economics. Cheltenham, UK: Edward Elgar.

Simon, H.A. (1957). Models of man: Social and rational. Oxford, UK: Wiley.

Thaler, R.H. (1999). Mental accounting matters. Journal of Behavioral Decision Making, 12(3), 183–206.

Thaler, R.H., & Sunstein, C.R. (2009). Nudge: Improving decisions about health, wealth and happiness (revised edition). New York: Penguin.

From anecdotes to novels: Reflective inputs for behavioural economics

Peter E. Earl

School of Economics, University of Queensland, St Lucia, Brisbane, QLD 4072, Australia

Thaler’s deployment of anomalous anecdotes has helped raise the profile of behavioural economics. This paper explores possible uses of other narrative materials as aids to economic research. After examining the use of anecdotes in economics, the paper reviews opportunities to use a wide range of more extensive reflective materials. Two text-based applications are then presented: the first uses material from consumer magazines, the second draws from novels by David Lodge. Both applications call into question conventional thinking regarding the degree of substitution between product characteristics, while the second is also instructive regarding the processes by which economic activities are coordinated.

Introduction

The significance of the kind of behavioural economics developed in the 1950s and 1960s at what is now Carnegie-Mellon University was recognized with the award of the 1978 Alfred Nobel Memorial Prize in Economic Sciences to Herbert Simon. Despite this, the Carnegie approach failed to win widespread acceptance. By contrast, there has been an explosion of interest in recent years in a new kind of behavioural economics. Sent (2004) explains this on the basis that ‘new behavioural economics’ incorporates empirically grounded knowledge of a large variety of ‘heuristics and biases’ without abandoning the mainstream core concepts of preference orderings and constrained optimization. The ‘old behavioural economics’, by contrast, was much more radical and sought to replace these concepts with, respectively, hierarchical systems of decision rules and satisficing. However, in trying to understand why the new approach has taken off and won widespread appeal, historians of economic thought would probably be unwise to neglect another factor, namely, Richard Thaler’s skilful use of anecdotes about everyday behaviour at odds with the predictions of traditional economics.

Thaler’s use of anecdotes to motivate his behavioural analysis (e.g. Thaler, 1992; Thaler & Sunstein, 2008) has been persuasive both with those who study his work at first hand and with readers of newspapers articles about his research (most notably Lowenstein’s, 2001, influential New York Times report). Other leading behavioural economists have also been introducing their contributions via quite detailed characterisations of aspects of everyday life. A typical case is the paper on ‘shrouded attributes’ by Gabaix and Laibson (2006). It discusses how consumers end up wasting money as a result of buying cheap printers that require unexpectedly expensive ink cartridges, and then goes on to consider different strategies that hotels may use when specifying and pricing their services and ways in which more savvy consumers respond to these ruses. The trend, in other words, is to try to win an audience by ‘motivating’ economic contributions with something that the wider public might find of interest and that the media might pick up and report.

If behavioural economics is economics that is informed by what economists know about actual behaviour, there is a potential role for anecdotes and real-world vignettes alongside experimental studies in the laboratory and/or the field and research of more conventional kinds. However, if anecdotes are indeed accorded a role in shaping how economics evolves, rather than being dismissed as ‘mere anecdotes’, behavioural economists might also consider using other kinds of qualitative sources of evidence and theoretical inspiration. This paper therefore attempts to examine the potential of what, for want of a better term, I am going to call ‘reflective inputs’, including accounts of behaviour derived from introspection or from flows of information created for other purposes, such as novels, movies and television programmes.

In advocating the use of such reflective inputs, I am following the lead of researchers in marketing but not, perhaps surprisingly, psychology. Marketing has become highly formalized and quantitative in recent decades with the rise of ‘marketing science’. However, there has also occurred the rise of ‘critical marketing’ that has imported ‘Post-modern’ analytical tools from other fields, such as literary studies. By contrast, economists will find little use of reflective inputs in modern psychology despite its widespread use of introspective techniques in the late nineteenth century. Early psychologists, such as Wundt, went beyond just asking untrained subjects to report on how they had made choices. Instead, they worked in a controlled laboratory setting with subjects whom they had trained to become expert self-observers. This research method gave way to observation...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Citation Information
• 1. Introduction: Psychology and economics
• 2. From anecdotes to novels: Reflective inputs for behavioural economics
• 3. Aspiration formation and satisficing in search with(out) competition
• 4. Are conditional cooperators willing to forgo efficiency gains? Evidence from a public goods experiment
• 5. Who makes the pie bigger? An experimental study on co-opetition
• 6. An experimental examination of the effect of potential revelation of identity on satisfying obligations
• 7. Gender differences in trust and reciprocity in repeated gift exchange games
• 8. Do separation rules matter? An experimental study of commitment
• 9. Overcapitalization and cost escalation in housing renovation
• 10. Over-indebtedness and the interplay of factual and mental money management: An interview study
• 11. Coherence and bidirectional reasoning in complex and risky decision-making tasks
• 12. Outwit, outplay, outcast? Sex discrimination in voting behaviour in the reality television show Survivor
• 13. Ambiguity, the certainty illusion, and the natural frequency approach to reasoning with inverse probabilities
• Index