Incentives and Behavior Prof. Dr. Heiner Schumacher KU Leuven 8. Social Preferences Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 1 / 36
Introduction A standard assumption in economics is that individuals only care about their own monetary payo¤. However, there is lots of evidence that individuals do not always act sel…shly. In this lecture, we look at the evidence for pro-social motivations and what it implies for decision making in markets and organizations. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 2 / 36
Introduction Overview Experimental Evidence Behavioral Motives Robustness Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 3 / 36
Experimental Evidence In the dictator game , there are two parties: the dictator and a receiver. The dictator has a certain endowment, say 10 EUR. She decides how much of this endowment she wants to give to the receiver. The receiver is passive, i.e., she has to accept whatever the dictator gives to her (so if the dictator keeps the 10 EUR for herself, the receiver walks away with 0 EUR). Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 4 / 36
Experimental Evidence What will a sel…sh dictator do? What economic situation does this game capture? Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 5 / 36
Experimental Evidence On average, dictators give 20 percent of their endowment. There is substantial heterogeneity. There are many sel…sh dictators (around 30 percent of subjects give nothing). However, there are also many dictators who give 50 percent of their endowment. Almost nobody gives more than 50 percent. These …ndings are robust to anonymity, stakes, cultural background, etc. Behavior in dictator games proves that many individuals care about the welfare of others. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 6 / 36
Experimental Evidence In the ultimatum game we have the same parties as in the dictator game: a dictator and a receiver. The dictator again has a certain endowment, say 10 EUR. She proposes how to split this endowment between her and the receiver, e.g., 10 � x for the dictator and x for the receiver. After observing the dictator’s proposal, the receiver decides whether she accepts or rejects it. If the receiver accepts the o¤er, she gets x , while the dictator gets 10 � x . Otherwise, both players get 0. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 7 / 36
Experimental Evidence What outcomes are Nash outcomes if both players are purely sel…sh? What outcomes can occur in a subgame-perfect Nash equilibrium if both players are purely sel…sh? What economic situation does this game capture? Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 8 / 36
Experimental Evidence Most dictators o¤er something between 40 and 50 percent of their endowment. Few subjects o¤er more than 50 percent. There are few o¤ers below 20 percent. Low o¤ers (20 percent or less) are rejected half of the time. The probability of rejection decreases in x . Again, these results are relatively robust with respect to scale (in some studies the dictators’ endowment were several monthly salaries). Demographic variables such as age, gender, education typically have no in‡uence. The ultimatum game highlights an extreme con‡ict between sel…shness and fairness. The results show that many individuals care for fairness. Dictators seem to anticipate these fairness considerations. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 9 / 36
Experimental Evidence In the trust game (or investment game ), there are two parties: a …rst-mover and a second-mover. The …rst-mover has an endowment that she can keep it for herself or invest into the second-mover. Let x be the amount she gives to the second-mover. The invested amount is tripled by the experimenter before it reaches the second-mover. The second-mover therefore receives 3 x . She then decides how much she gives back to the …rst-mover. Let y be the amount she returns to the …rst-mover. At the end of the game, the …rst mover earns ( 10 � x ) + y , while the second-mover earns 10 + 3 x � y . Economists frequently refer to the amount x as a measure of “trust”, and the amount y as a measure of “trustworthiness” or “reciprocity”. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 10 / 36
Experimental Evidence What should players do in order to maximize the sum of payo¤s? What outcomes can occur in a subgame-perfect Nash equilibrium if both players are purely sel…sh? What economic situation does this game capture? Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 11 / 36
Experimental Evidence First-movers invest on average 50 percent into the second-mover. Second-movers return on average 95 percent of the …rst-mover’s investment (i.e., sometimes trust pays o¤, sometimes not). Again, behavior is very heterogeneous. Half of the second-movers return nothing or a very small amount. The trust game is a simple way to measure peoples’ trust. Behavior in the trust game shows that many individuals trust their anonymous counterparts. On average, second-movers reciprocate this trust. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 12 / 36
Behavioral Motives Experimental evidence suggests that many individuals do not act completely sel…shly. Which motives drive pro-social behavior? We discuss the most important behavioral motivations: altruism, reciprocity, and image concerns. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 13 / 36
Behavioral Motives Altruism The behavior in dictator games implies that individuals derive utility from both their own and others’ payo¤. We have to distinguish between pure and impure altruism (Andreoni 1989). 1 A purely altruistic individual derives utility from the payo¤ of others. For example, if x is one’s own payo¤, and y is the payo¤ of another person, then a purely altruistic individual has the utility function U ( x , y ) , which is strictly increasing in both components. Individuals who engage in impure altruism receive utility from the act of giving (i.e., they experience a “warm glow”). Let g be the amount that an individual gives to another person. If she is an impure altruist, her utility function is given by U ( x , y , g ) , which is strictly increasing in the last component. 1 Andreoni, James (1989): “Giving with Impure Altruism: Applications to Charity and Ricardian Equivalence,” Journal of Political Economy 97(6), 1447 - 1458. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 14 / 36
Behavioral Motives The distinction between pure and impure altruism is important for many applications. Consider, for example, the provision of a public good like donations to a charity. The government can …nance the charity from public funds, or the charity can collect private donations. If all individuals are pure altruists, then an increase in public funding fully crowds out private donations (why?). If some individuals are impure altruists, crowding out is not complete, i.e., funding for the charity increases (why?). Empirical data suggests that crowding out is rather low, an indication for impure altruism. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 15 / 36
Behavioral Motives Reciprocity The behavior in the trust and the gift exchange game suggests that many individuals behave reciprocal manner: they are kind (unkind) to those who previously were kind (unkind) to them. According to sociologists and anthropologists, one of the most widespread norms of human culture is the “rule of reciprocation”. It requires that one person tries to repay, in kind, what another person has provided. We are trained from childhood to comply to the rule or su¤er serious social disapproval. The following experiment shows how the rule of reciprocation enables to mutual cooperation. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 16 / 36
Behavioral Motives Fehr and Gächter (2000) compare behavior in the public good game with and without the option to punish those who do not contribute to the “public good”. 2 The public good game is played in groups of four. Each group member i has an endowment of 20 tokens and can decide what amount g i he wants to contribute to the public good. The payo¤ of group member i is then 4 π i = 20 � g i + 0 , 4 ∑ g j . j = 1 What strategy pro…le maximizes the group’s total payo¤? What is the optimal strategy for each group member (given that all members are purely sel…sh)? 2 Fehr, Ernst, and Simon Gächter (2000): “Cooperation and Punishment in Public Goods Experiments,” American Economic Review 90(4), 980 - 994. Prof. Dr. Heiner Schumacher (KU Leuven) Incentives and Behavior 8. Social Preferences 17 / 36
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