Studies in Economic Decision Making

2009

We rarely hear about some of the more interesting studies done on economic decision making, yet they reveal a lot about how we actually function. Most often it is found that humans are not nearly as rational as they imagine themselves to be. Let's look at a common experiment to see how true this is.

A game called the Ultimatum is used by economists to study economic decision making in individuals. Two players who never meet each other are given money to split between themselves. The first, whom we'll call Player A, is given $20 and told to offer some part of it, from 0$ to $20 to the other player, whom we'll call Player B. If the offer is accepted they get to keep the money, but if not, both go home with nothing. They both know the rules.

Now, an economist will tell you that rationally Player B should accept any offer at all, since it is clear that he or she otherwise gets nothing at all. Even a dollar is better than nothing, as is a penny. Since Player A knows the rules, he or she should plan to keep $19.99 and offer a penny to Player B, assuming that both are rational, both know this, and self interest is the only motivating factor. Of course these are a lot of assumptions - and mostly untrue.

In fact, when this game is played for real, most offers below $3 are refused. The second player apparently feels offended enough by the "unfair" offer that he or she is willing to lose what little money could be gained - just to "punish" the first player. On the other hand, really low offers are rare and the average is more than $6.

The relatively high offer was originally taken by some economists to be a sign of altruism or at least of a sense of fairness. But it can also be interpreted as simply offering enough so as to avoid rejection and the loss of all the money. In other words, we know that low offers could offend, so we offer more out of pure self-interest.

To better understand the issues raised by Ultimatum, the game of Dictator was invented. In this one, Player A is given $20 and told she could split it one of two ways, and in either case the decision was final and both participants kept the money. The first choice was to give half, or $10 to player B, and the second was to give just $2 to the other player and keep $18. Again, the players never met. Interestingly, even though there was no personal advantage and the players were anonymous to each other, 75% chose to do the even split.

Other versions were tried, offering more options. The results consistently showed that people would give more than required to the other player. Some took this to mean that humans are inherently altruistic, at least to some degree (when allowed total free choice, the average given was $4, but could have been $0).

Later experiments cast some doubt on these conclusions. The fact that there were researchers who were watching certainly influenced some people, after all. Experience tells us that when a man finds a $20 on the street he certainly doesn't stop a stranger to share the money with him or her. In fact, a later version of Dictator in which both players were given $20 and Player A was allowed to either give any amount of his or her money to Player B or take any of Player B's money, 40% took all of the other player's money.

It seems that economic decision making is a complicated process, perhaps especially when there are issues of fairness or how we appear to others involved.

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