Microeconomicsand Psychology

Microeconomics and Psychology
Author(s): Steven Beckman, Lanxin Chen, Greg DeAngelo, W. James Smith and Xieting
Zhang
Source: The Journal of Economic Education, Vol. 42, No. 3 (July-September 2011), pp. 255-
269
Published by: Taylor & Francis, Ltd.
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THE JOURNAL OF ECONOMIC EDUCATION, 42(3), 255-269, 2011
Copyright © Taylor & Francis Group, LLC
ISSN: 0022-0485 print/2152-4068 online
ij Routledge
| ^ Taylor & Francis Group
DOI: 10.1080/00220485.2011.581943
ECONOMIC INSTRUCTION
Microeconomics and Psychology
Steven Beckman, Lanxin Chen, Greg DeAngelo, W. James Smith

and Xieting Zhang
Psychologists such as the Nobel Prize-winner Daniel Kahneman challenge the major ass
microeconomics: the rational pursuit of self-interest given unchanging tastes. One may
issues through a questionnaire that may be distributed in class. How many of your stu
as the psychologists predict? Should economists adapt their theories of the market to
findings? Prospect theory, changes in reference points, fairness, framing effects, loss
ultimatum game, herding, context dependence, the dictator game, preference reversals
ture of the human brain are all illustrated through simple questions. The body of this a
the questions to the literature and introduces the debates between economists and psyc
Keywords behavior, loss aversion, psychology, rationality
JEL codes C91.D03
Economics and psychology offer contrasting theories of human behavior on virtually every ma
point. Economists posit a rational self-interested agent with unchanging tastes, while psych
ogists see a social animal with cognitive limitations that adapts rapidly to new environmen
Psychologists are interested in documenting human behavior as it is; economists are intereste
in constructing useful abstractions from the complexity of individual behavior that will yiel
tractable theories of market behavior. Given the difference in goals, the difference in theorie
understandable, but this should not induce complacency among economists. As evidence moun
on the limited rationality, social interactions, and malleability of humans, we should be open
The authors thank Richard Chaney for distributing an early version among his students. Michael Zinser and
anonymous referees provided both encouragement and highly useful comments.
Steven Beckman is an associate professor of economics at the University of Colorado, Denver, and the correspondi
author (e-mail: steven.beckman@ucdenver.edu). Lanxin Chen is an economics student at the International College Beij
and the University of Colorado, Denver (e-mail: lanxin.vicky@gmail.com). Greg DeAngelo is an assistant professo
economics at the Rensselaer Polytechnic Institute (e-mail: deangg@rpi.edu). W. James Smith is a professor of econom
at the University of Colorado, Denver (e-mail: jim.smith@ucdenver.edu). Xieting Zhang is an economics student at th
International College Beijing and the University of Colorado, Denver (e-mail: xie.zhang@ucdenver.edu).
256 BECKMAN, CHEN, DEANGELO, SMITH, AND ZHANG
the proposition that our abstractions may be a bit too abstract, and we should search for ways to
include some of the better documented findings of psychologists.
As instructors, our goals are more immediate: Our students should be aware that some of
our most basic precepts are under challenge and that psychologists and marketers are learning
to manipulate human behavior. Fortunately, many of the research findings may be demonstrated
simply by having your students complete a questionnaire. The questionnaire below has two
versions, and distributing each version to half of your class offers the opportunity to assess if
the psychologists' findings are consistent with your students' behavior. The questions have been
presented to several classes and have always stimulated much thought and discussion—although
the answers do not always follow the literature.1
We believe the best way to use the questionnaire is to pass it out early in the semester and
discuss some of the expected results in a general way, as students are likely to be engaged and
curious. More-detailed discussions may follow, either in breaks during unrelated lectures or close
to material that is directly relevant as the semester proceeds.
The questionnaire and the survey by Rabin (1998) focus rather heavily on the work of cognitive
psychologists and the responses of economists. This is due to the highly influential work of
Kahneman and Tversky (1979), and Kahneman, Knetsch, and Thaler. As Elster (1998) points
out, the entire field of emotions has been ignored, and we do nothing to remedy this flaw.
Neuroscience and behavioral finance also receive only brief mention. Furthermore, to date the
process has been rather one-sided with economists learning from psychologists. Glaeser (2003)
argues this should change because economists are better at aggregating behavior, and Glaeser
(2002) tries his hand at analyzing large-scale hate movements. We make no attempt to train
psychologists, but we will make periodic comments on how the particular skills of economists
might be usefully applied.
All we can say in our defense is that the questions we do ask form a coherent whole and
introduce students to a broad literature through a method we believe is both fun and educational.
THE QUESTIONS AND THE RELATED RESEARCH FINDINGS
Both versions of the questions are repeated below and then followed by a brief discussi
relevant literature and findings. Some questions have only one version. The appendix
both questionnaires to simplify photocopying and distribution. In the subsequent qu
material [in square braces] is replaced by material (in parentheses) to form the second
the question.
Question 1: Imagine that the community is preparing for the outbreak of an unusual disease,
is expected to kill 600 people. Two alternative programs to combat the disease have been prop
Assume that the exact scientific estimate of the consequences of the programs are as foll
Program A is adopted, [200 people will be saved] (400 will die). If Program B is adopted, th
a 1/3 probability that [600 people will be saved](nobody will die), and a 2/3 probability th
people will be saved] (600 people will die). Do you favor program A or B?
It is transparent that if 200 of 600 live, then 400 die and that the two versions desc
same objective facts, but the decisions are often different. Tversky and Kahneman (
report that of the 152 people asked, 72 percent prefer A if framed in terms of lives sav
MICROECONOMICS AND PSYCHOLOGY 257
percent prefer B if framed in terms of the number that die. Researchers think that the diffe
in responses reflect a deep-seated aversion to losses and that framing the question either in
of gains or losses reveals the asymmetric way in which people respond. It has been shown
even doctors are subject to framing effects (see McNeil, Pauker, Sox, and Tversky 1982).
Kahneman (2003, 162) explains that "My first exposure to the psychological assumptio
economics was ... [that] the agent of economic theory is rational and selfish, and that his
do not change. I found this list quite startling, because I had been professionally trained
psychologist not to believe a word of it." Framing effects, like the one in the question, qu
unchanging tastes. If preferences change as the reference point changes, then we need a t
of the reference point.
Kahneman believes this is simply an application of a well-known principle in psycholo
People experience sensation as change. Our hands become rapidly adapted to the temperatu
a bucket of water and experience warmth or cold if the temperature rises or falls. Changin
metaphor to pleasure and pain, we experience losses and gains relative to a reference point
adapts to present circumstances.
Question 2. Which do you prefer:

a) an 80 percent chance to [gain] (lose) $4,000 and a 20 percent chance to [gain] (lose) nothing.
b) to [gain] (lose) $3,000for certain.
Most people choose option a if phrased in terms of gains and option b if phrased in te
of losses. This question illustrates the gains from operating in the intersection of econo
and psychology. Kahneman and Tversky (1979) developed this and several other questions
borrowing concepts from both fields. From psychology, they took the idea that we exper
gains and losses relative to a reference point. From economics, they took diminishing mar
utility (although if this review were written by psychologists, they would probably lay cla
both concepts). This creates a value function that is concave for gains and convex for losses
figure l.2
This implies people are risk-averse in the gain domain and risk-seeking in the loss domain,
with both defined relative to a reference point. In question 2, zero is taken as the reference point,
although there are many recent theories that define the reference point as an expected gain with
subpar performance evaluated as a loss.
A less formal explanation is simply that once the $3,000 has been gained, the additional value
from $4,000 is seen as small and not worth the 20-percent chance that nothing is gained. On the
FIGURE 1 The Prospect Theory utility function.
other hand, having lost $3,000, losing an extra thousand is not very bad, especially given the
possibility you might lose nothing.
Question 3: Which do you prefer:

a) An online subscription to the Economist at $59 a year.
b) A print subscription to the Economist at $125 a year.
c) A subscription to the print and web editions of the Economist at $125 a year.
The question is taken from Ariely (2009,6), who reports that if the question consists of options
a and c, then 68 percent choose option a, but if option b is added, 84 percent choose option c even
though no one chooses option b!
Once again, relative decision-making offers an explanation. With all three choices present,
option c is clearly better than option b, making option c more likely. Ariely (2009) goes on to
explain that many optical illusions operate on the same principle: By surrounding a dot with large
dots, the original dot seems small, and surrounding a dot with small dots makes it seem large,
even if the dots are exactly the same, as in figure 2.
This example has generated the strongest reaction among the students we have tested. Students
generally do select as Ariely (2009) predicts and find the potential for a sly marketer to manipulate
choice unsettling. Are we really this easy to manipulate? And if we are, should we not be taught
the techniques if only to protect ourselves?3
From the point of view of economists, this is also one of the more challenging observations.
Apparently preferences may be reversed by adding an option that is not selected. How can we
say that option a is preferred to option c or that option c is preferred to option a if the item
selected depends on the context of choice? According to Ariely (2009, 14), these ideas are used
by firms. Williams Sonoma had difficulty in selling a bread-making machine for $275 until they
introduced a larger more-expensive model. The larger model did not sell well, but the original
machine priced at $275 did.
Ariely tested the theory by presenting students with three photographs and asking them whom
they would prefer to date (Ariely 2009, 12-14). Two pictures were of real students (rated by other
students to be about equally attractive), and a third was a distorted version created in Photoshop
FIGURE 2 An illusion based on relative size.
(nose slightly to one side, eyebrow arched ... ) of one of the original two. So if Ariely incl
a distorted image of Zachary, students picked Zachary, but if a distorted image of Adrian
included, students preferred Adrian. What was Ariely's advice? When out at a singles event
along a less-attractive friend.
Question 4: A bet is played on a roulette wheel with 36 slots numbered 1 to 36.

A: If the ball drops in slots 1-28 you win $10, otherwise you win nothing.
B: If the ball drops in slots 1-3 you win $100, otherwise you win nothing.
[I prefer bet .]
(The smallest price for which I would sell my ticket to play A is $
The smallest price for which I would sell my ticket to play B is $ )
Most subjects prefer A but place a higher price on B. This is inconsistent, if

more money to less. This form of preference reversal has been studied extensive
work was done by Lichtenstein and Slovic (1971). Grether and Plott (1979) quite c
out to show how proper procedures and monetary incentives reveal the reversals t
of unmotivated choice. To their surprise, their subjects exhibited the same rever
proportion. Some economists developed theories of choice that weakened one or a
in an attempt to accommodate the phenomenon. In response, Tversky, Slovic, a
(1990) conducted a series of experiments that, among other things, rule out violat
axioms as the cause. They find that the reason for the reversal is that subjects who h
to provide a dollar amount will overweight the amount to be won. As a test of th
the researchers repeat the experiment but instead of asking for prices of the two
ask subjects to rate the gambles on a scale from 0 to 20. These ratings are fully c
preferences. In many ways, the finding that responses vary according to the format
(and therefore violate procedural invariance) is a more difficult finding for econo
than a direct violation of any axiom—like independence or transitivity.4 Indeed, T
and Kahneman (1990, 215) close their article with the following:
Because invariance—unlike independence or even transitivity—is normatively unassa

scriptively incorrect, it does not seem possible to construct a theory of choice that is both
acceptable and descriptively accurate.
Question 5: Would you take small [items from work: pens, paper... ] (amounts from the
at work) if you knew you would not be caught? (Yes / No)
Ariely (2009, 219-22) has conducted a series of ingenious experiments that tes
of honesty over material goods and cash. Students at the Massachusetts Institute
cafeteria were offered 50 cents for each of 20 simple math problems they solved
group took their sheets up to an experimenter who tallied the correct answers an
on the spot. A second group tore up their answers, stuffed the bits and pieces in t
reported the number they got correct, and then received cash on the spot. A thi
up their answers, stuffed the bits and pieces in their backpacks, and reported th
got correct. However, instead of being paid in cash immediately, they were giv
students then walked 12 feet to another experimenter who exchanged the tokens for
group, whose answers were checked, were correct on an average of 3.5 question
group, whose members tore up their answer sheets, claimed 6.2 questions were
third group, initially paid in tokens, claimed 9.4 answers were correct. Ariely arg
is directly involved, the social norms for honesty are stronger, and even separating the decision
from cash by holding tokens briefly weakens the norm for honesty. This is important because
cash is becoming less and less common, and tokens such as stocks, bonds, and credit default
swaps are becoming far more important. Although in the aftermath of the 2008 market collapse
and bailout, most economists argue for better regulation of banks, investment banks, and rating
agencies, there are also those who favor better ethics and stronger social norms. Testimony in the
U.S. Congress clearly indicated the lack of any shared concept of ethics between senators and
investment bankers.
Question 6: There are two subjects in an economics experiment and one subject, the proposer, is
given ten %1 bills. [The proposer] (A computer) decides how much to keep and how much to offer
to the other subject. The responder has the right to accept or reject. If the proposal is rejected, both
subjects get nothing.
[As the proposer, I would offer the other person and keep ] ().
As the responder, unless I get at least I would reject the deal.
This is one of the most extensively studied games in experimental economics and is known as
the "ultimatum game." Even various species of animals have been tested.6 Humans tend to offer
$3 or $4, and offers below $2 are generally rejected. High-testosterone men are more likely to
reject low offers (Burnham 2007), but chimpanzees will accept any positive offer (Keith, Call, and
Tomasello 2007). This seems to be a direct challenge to the concept of the rational self-interested
decision-maker whom economists typically assume. Why do humans reject positive amounts?
Why do proposers offer anything beyond $1? If the computer makes the split, rejection rates
fall but do not disappear. So, the response is not simply to the amounts, but to some concept of
procedural fairness as well. Standard references include Henrich et al. (2005) and Kahneman,
Knetsch, and Thaler (1986).
Question 7. [An experimenter gives you, and several other subjects, ten $1 bills and lets you decide
how many to keep and how many to place in an envelope to be given randomly to subjects in another
room. The envelopes are unmarked and the subjects and the experimenter will never know what you
do.] (You find ten $7 bills on the sidewalk.) How many $/ bills do you keep?
Giith, Schmittberger, and Schwarze (1982) invented the dictator game as a way of dividing the
ultimatum game into component parts. The proposers in the ultimatum game might give money
because they care about the responder, or they may fear rejection. There is no rejection in the
dictator game, so small positive offers (which are common) cannot be due to fear of retaliation.
However, if we care about anonymous others, why do we not leave a fraction of found money on
the sidewalk for whoever comes after us? Rules of fairness seem to be complex and depend on
the precise social context. Indeed, behavior in the dictator game is unusually sensitive to context,
with several articles reporting significant effects from minor variations (Bardsley 2008).
Question 8. Take the last three digits of your phone number and add two hundred. Write the number
down Now, when do you think Attila the Hun sacked Europe ? Was it before or after that year?
What year is your best guess?
The question is taken directly from Thaler and Sunstein (2009, 23) and is offered as an
example of the limited rationality of humans. People asked to estimate an uncertain value will
often anchor on some irrelevant number and then underadjust. The process is called "anchoring
and adjustment." According to the theory, there should be a statistically significant correl
between the phone number listed and the guess about the year when Attila attacked. (It wa
411 AD.) If Thaler and Sunstein had simply asked you to use the last three digits of your p
number, the anchor would have been close to the correct answer,while adding 200 introduc
bias. Therefore, most guesses should be high.
Ariely (2009, 29) reports the results from a classroom experiment where subjects bid fo
actually purchased items such as a cordless trackball, a cordless keyboard, chocolates, and w
Students wrote down the last two digits of their Social Security numbers as an amount in do
say $23 or $67. They were then asked to state if the price was too high or too low and to then
down the price they would in fact pay for the item. The person with the highest bid purchased
item but paid the price of the second highest bid. This assures that the bidder should reve
true value of the product, and it is called a Vickrey Auction after its inventor, William Vi
(also a Nobel winner.)
The correlation between the purchase price and the Social Security number ranged from
to .52 for the half-dozen items auctioned off.
This line of research does not seem to lead to useful abstractions that might help predict market
behavior. Behavior is clearly less than rational, and there is quite a bit of evidence in favor of
anchoring, but unless there is an application with an obvious anchor, the information does not
lead to predictable behavior outside the laboratory. Glaeser (2003) makes this point more broadly:
A theory of how these errors are aggregated, mitigated, or magnified by market interaction is
necessary to make the results of widespread use to economists.
Ariely (2009, 39^18) argues the theory is already useful and claims that Starbucks uses
anchoring and adjustment in its marketing campaigns. In order to get people to anchor on a high
price, Starbucks surrounds its coffee with high-priced goods. He also argues that anchors help
explain habit formation: Once we anchor on a high- or low-priced product, we tend to continue
with our purchases. He suggests we need to periodically rethink our habits. However, other
potential explanations of Starbucks' marketing behavior and habit formation suggest themselves.
(What alternative theories can you think of? Do they relate to Veblen?)
Question 9. There are two people who own goods they value at 10, but the other person values at
20. Trade would be mutually advantageous but there are no courts or police. Assume A is rational
in the way economists assume; A cares only for A and lies if it results in personal gain. Assume B is
trustworthy and honest, but fully understands A, and A fully understands B. [If the deal is that both
put their items in the mail at the same time, will A, B or neither put the item in the mail?](Ifthe deal
is that A puts the item in the mail first and B puts the item in the mail upon receipt ofA's item, will A
put the item in the mail?)
The question is adapted from Camerer and Fehr (2006, 47).7 They argue that the fact there is
more than one personality type is socially quite useful. In this example, if everyone is type A,
then no system, either simultaneous or sequential choice, can overcome the fact that type As do
not trust type As. Courts, police, property rights contracts, and a superstructure that ties them all
together are required before type As may engage in mutually beneficial trade. The existence of
type Bs benefits both. As long as A trusts B, then A may confidently put the item in the mail, and
mutually beneficial trade may take place.
The categories above are a bit crude. Camerer and Fehr (2006) tend to categorize people either
as strong reciprocators or as self-regarding. Economic man is self-regarding. Strong reciprocators
punish bad behavior and reward good behavior by others. Both types are useful in different situ
ations. For example, the strong reciprocator makes sequential exchange possible in the question
above. Adam Smith makes a strong case that once market institutions exist, society is better
served by appealing to self-interest: Self-regarding people will be led, as if by an invisible hand,
to do the public good. If both types are useful, then evolution should favor groups where both
types exist.
Question 10. Three homeworks are due during the class. You are allowed to set the deadlines at any
time but if you miss the deadline, your grade is reduced. Do you A: set the deadline at the last day of
class or B: set the deadlines spaced throughout the semester?
When Ariely and Wertenbroch (2002) offered the option to 51 professionals in an executive
education course, 68 percent set deadlines within the semester.8 This is odd if the executives
trust themselves because they could complete the assignments at any time during the semester
without fear of deductions if they choose to turn papers in on the last day. Apparently these
professionals do not trust themselves and believe some sort of commitment device will be useful.
Ariely and Wertenbroch (2002) test this by having groups of experimental subjects complete three
proofreading assignments in 21 days. One group sets their own deadlines, another has deadlines
each week, and a third has no deadlines. The performance on the proofreading assignment is
better when deadlines are self-imposed than if there are no deadlines, but performance is best
with weekly deadlines.
Some corporations have begun to apply these insights to payroll savings plans. The plan that
seems to work best is one that increases savings as raises are given so that income only rises over
time. These plans combine two sets of results from the literature. If people are loss-averse, they
will resist increasing savings all at once and will prefer to tie higher savings to higher income.
And, if people have a hard time in saving today but want to save more tomorrow, then these
commitment devices can be helpful (Thaler and Sunstein 2009, 115). As long as it is easy to opt
out or change plans, then the commitment devices do not impose large losses on the fully rational
person. (There is even some evidence that separate parts of our brains evaluate immediate and
delayed rewards, so that it may be a question of which part of our brain is in control (McClure,
Laibson, Loewenstein, and Cohen 2004).
Question 11: On a flip of a fair coin you either earn %X or lose $100. How much must X be before
you would take the gamble?
The question comes from Thaler and Sunstein (2009, 34). It is a direct measure of loss
aversion. Most people say X must be around $200, and psychologists believe monetary losses
have roughly twice the emotional impact as gains.
Odean (1998) tests the theory by examining stock portfolios and finds people hang on to
money-losing stocks for too long and sell winners too soon. He argues people want to experience
the profitable sale and do not want to realize a loss.
Question 12: There are two new energy drinks on the market with essentially the same ingredients.
You know that A is selling better than B. Would you try A first or B first?
Most of us would try the more popular product first, perhaps thinking that others have tried
both and that most like A better.9 However once we start with the popular brand because it is
popular, it becomes possible that no information is contained in the popularity of the product. It
may simply be a herd effect. To test how strong the effect might be, Salganik, Dodds, and Wat
(2006) created a Web site where people could download and listen to new songs from unknow
bands. Eight different groups were created, and each group was informed about which song
were more popular in their group, but not which songs were popular in other groups. In a contr
group, subjects were given no information about the popularity of songs. The control group
preferences gave no clue as to the preferences in the eight different worlds, which differed widel
The first few downloads tended to have inordinate influence on the group's behavior.
One possible application is to investments. If investors invest in popular products, then bubbl
or fads may develop and asset values may only reflect popularity. However, from an economist
point of view, this is only half the question. Once values diverge from the long-run equilibrium
will smart traders take advantage of the herd? Or can herd behavior be so strong that the sma
investor loses too much money before the herd changes course?
Question 13: Answer with the first thing that comes to mind. A ball and bat costs $1.10 in total. The
bat costs $1 more than the ball. What does the ball cost?
The question comes from Thaler and Sunstein (2009,21) and is taken as evidence that we hav
at least two parts to our brains. One part is effortless and automatic, and the other is consciou
deliberate, slow, and reflective. If we answer quickly, 10 cents springs to mind, but if the bat
$1 more, it must cost $1.10, and the total is $1.20. A moment's thought uncovers the error.
While this example is trivial, the facts that we have two brains and that one is automatic a
not. Bernheim and Rangel (2004) use the concept to develop a theory of addictive behavior and
a set of appropriate policies. They claim it is possible for control to pass from the reflective an
conscious part of our brains to the automatic part and that the probability of loss of control may
either high or low depending on the environment. People are able to manage risk by controllin
their exposure to environmental cues that make loss of control more likely, but they do not ha
full control. Government policies may be helpful by removing environmental cues likely to lea
to loss of control.
Question 14: The experimenter gives [a mug] (a pen) to you. A bit later the experimenter offers you
the opportunity to trade the [mug] (pen) for [a pen] (a mug) of equal monetary value. Do you make
the trade?
Knetsch (1989) reports a highly influential experiment. Students are given either mugs or
chocolates and then allowed to make trades. Very few do so regardless of what they are originally
given. The standard interpretation has been that the receipt of either the chocolates or the mugs
created a property right, so that giving up either is coded as a loss. Therefore, once people acquire
something, they tend to keep it so as not to experience a sense of loss.
Using mugs and pens, Plott and Zeiler (2007) conducted a series of experiments testing this
hypothesis against the hypothesis that transaction costs, herding behavior, or the social response
to receiving a gift—rather than prospect theory—might explain the behavior. They reproduce the
Knetsch result that few make exchanges if the instructions include the phrase "I am giving X to
you." (Of mug owners, 84 percent choose mugs, whereas 28 percent of pen owners choose mugs.)
Those researchers find that herding behavior and transaction costs do not offer explanations for
the strong asymmetries observed. However, if subjects are told they received either mugs or
pens according to a coin flip, then 54 percent of mug owners choose mugs, and 67 percent of
pen owners choose mugs. The difference is not statistically significant and does not support the
hypothesis that receiving an item shifts the reference point. Plott and Zeiler are careful to point
out that this does not refute prospect theory; only the hypothesis that the reference point shifts
immediately on the receipt of an item is challenged. If Plott and Zeiler are correct, then perhaps
the wording of the questionnaire will also trigger a social response to receiving a gift. It may
simply be impolite to exchange a gift received in the presence of the person who gave it, or the
subjects may believe the giver has special knowledge that one item is superior to the other.
Our primary point with this last question is to warn readers that interpretations shift with new
results and that interpretations of underlying motives from observed behavior or questionnaires
may shift as a broader range of hypotheses is considered.
CONCLUSION
The preceding questions and related research are convincing evidence that there are im
limits to rationality. How these should be incorporated in economics will likely occupy
for decades. However, there is a more fundamental question: Why do the limits
are, at base, living organisms with evolutionary pressures, limited brain cases, and
social interactions. Considering the millennia of human development, market intera
relatively recent development, and it would be surprising if we were well-adapted t
environment. Recent advances in medical imaging offer the prospect of examining how
are constructed, offering for the first time the opportunity to directly observe our limi
abilities. These are clearly not developments that lend themselves to simple questionn
they are concepts and possibilities that we ought to discuss with students of princi
therefore close with a brief discussion and a few links to literature.
Neuroscientific research has provided significant advances in our understanding of
making (economic decision-making specifically) due to imaging techniques that perm
temporal and spatial location of brain activity (Camerer and Lowenstein 2003).10 Mo
neuroscientific research challenges the rationality and deliberation components of sta
nomic theory. A significant amount of research displays that there is an automatic p
the brain that responds rather quickly and without much deliberation (Bargh et al. 19
and Chartrand 1999). In challenging the standard rationality assumptions, behaviora
roeconomists have been able to elucidate interesting findings about the organization of
and the decision-making process."
These researchers have found that many of our preferences are adapted toward r
us to a preferred state: If we are too hot, we enjoy cold; if we are too cold, we enjo
Such systems are by their nature reference-dependent, and this is indeed the found
prospect theory. Different parts of our brains respond to gain and loss with far mo
activity associated with losses than gains (Camerer, Lowenstein, and Prelec 2004
lennia of social interaction appear to have created little-understood mechanisms of s
hesion. For example, the menstrual cycles of females living together tend to conver
time (Carmerer, Lowenstein, and Prelec 2004, 653). The context dependence illustrat
advertisement for the Economist is also characteristic of honey-bee behavior, suggest
perfection is deep within the automatic portions of our brains (Carmerer, Lowenstein,
2004, 569).
As the areas of cognitive psychology, behavioral economics, and neuroeconomics continue to
expand and challenge the assumptions of the economics discipline, candid discussions will begin
occurring in even the most basic, introductory course. The surveys provided in this essay shou
provide an excellent sample of questions to facilitate classroom discussions.
NOTES
1. It is not logical to expect the population norms to be reproduced in every small sample. Even
suspect that at least some of the responses we observed do not match the literature. If you de
the same suspicion, we would like to hear from you. In any event, the questionnaire remains a v
learning tool as skepticism toward received results is an essential element of the scientific method
2. See Holt (2007, 354—59) for a discussion of prospect theory.
3. Hanson and Kysar (1999) offer an extensive list of market manipulations practiced by cigarette m
facturers, gas stations, and supermarkets among others.
4. An anonymous referee argues that the new behavioral economics has been successful by downpla
how much of a challenge it is to traditional economics. The referee offers Sent (2004), Simon (19
Payne, Bettman, and Johnson (1993), and Berg and Gigerenzer (2010) as support. To take the phr
from Payne, Bettman, and Schkade (1999), economists think of themselves as archeologists uncove
preferences, while psychologists think of the architecture of preference construction and caref
consider how the mode of choice affects the preferences constructed. Berg and Gigerenzer (2
argue behavioral economists often do no more than add variables that improve model fit wit
challenging the underlying model. Our favorite reference is Rubinstein (2003, 1215), who conc
that "Doing 'economics and psychology' requires much more than citing experimental results
marginally modifying our models. We need to open the black box of decision making, and com
with some completely new and fresh modeling devices." We hope this article will encourage man
take up the challenge.
5. The fact that Massachusetts Institute of Technology students got only 3.5 of 20 problems correct m
Ariely's (2009) assertion that the problems were simple highly suspect. The failure of econom
to adequately consider the cognitive limitations of average humans is itself one of the insigh
psychology.
6. If you have the time, it may be worthwhile to conduct dictator and ultimatum games. Holt (2007,
147-53) summarizes and offers a form to conduct ultimatum games (2007, CE29). Our preference for
dictator games is to give half the class an envelope and 10 dimes (or pennies or quarters or a card
with a hypothetical split of $10). Each student divides the coins between the envelope and his or her
pocket and places the envelope at the front of the room. Once all the students have completed this
task, the other half is allowed to claim an envelope, open it, and write the contents on the board. A
variation for the ultimatum game would be to hand out two envelopes to half the class. Each envelope
in the pair has a number. The proposers make the split, write their names on the envelope they wish
to keep, place this envelope in a box for proposers, and place the other in a pile for responders.
Responders select an envelope from the pile, write the contents on the board, and reject or accept. If
the choice is rejection, the instructor collects the envelope and pulls the envelope with the matching
number from the box of proposals. At the end, all remaining envelopes in the proposer box are
returned.
7. See Holt (2007, 150-62) for a discussion of trust games.
8. Early examples of the binding commitment literature include Elster (1977) and Thaler and Shefrin
(1981). Thaler and Shefrin propose the following test of the theory: Observe some intertemporal choice
that implies a discount rate and then regress that discount rate against the individuals' borrowing rate,
age, marital status, and income. The traditional theory asserts that only the opportunity cost of borrowing
matters; commitment issues suggest these other variables, and several more will be important.
9. See Holt (2007, 389-96) for a discussion of information cascades.
10. For example, electroencephalograms, positron emission topography scans, and functional magnetic
resonance imaging have been used in neuroscientific research.
11. See the works of Colin Camerer (Camerer, Loewenstein, and Prelec 2004) and Ernst Fehr (Fehr,
Fischbacher, and Kosfeld 2005) among others for in-depth discussions and findings in the area of
neuroeconomics.
BECKMAN, CHEN, DEANGELO, SMITH, AND ZHANG
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APPENDIX
THE TWO QUESTIONNAIRES
Form A
Question 1: Imagine that the community is preparing for the outbreak of an unusual d
which is expected to kill 600 people. Two alternative programs to combat the disease hav
proposed. Assume that the exact scientific estimate of the consequences of the programs
follows: If Program A is adopted, 200 people will be saved. If Program B is adopted, th
1/3 probability that 600 people will be saved, and a 2/3 probability that no people will b
Do you favor program A or B?
a. an 80 percent chance to gain $4,000 and a 20 percent chance to gain nothing
b. to gain $3,000 for certain
a. An online subscription to the Economist at $59 a year.
b. A subscription to the print and Web editions of the Economist at $125 a year.
I prefer bet
Question 5: Would you take small items from work: pens, paper ... if you knew you would not
be caught? (Yes / No)
Question 6: There are two subjects in an economics experiment and one subject, the proposer, is
given ten $ 1 bills. The proposer decides how much to keep and how much to offer to the other
subject. The responder has the right to accept or reject. If the proposal is rejected, both subjects
get nothing.
a. As the proposer, I would offer the other person and keep
b. As the responder, unless I get at least I would reject the deal.
Question 7: An experimenter gives you, and several other subjects, 10 $1 bills and lets you decide
how many to keep and how many to place in an envelope to be given randomly to subjects in
another room. The envelopes are unmarked and the subjects and the experimenter will never
know what you do. How many $1 bills do you keep?
Question 8: Take the last three digits of your phone number and add two hundred. Write the
number down Now, when do you think Attila the Hun sacked Europe? Was it before
or after that year? What year is your best guess?
Question 9: There are two people who own goods they value at 10 but the other person values at
in the way economists assume; A cares only for A and lies if it results in personal gain. Assume
B is trustworthy and honest but fully understands A, and A fully understands B. If the deal is that
both put their items in the mail at the same time, will A, B, or neither put the item in the mail?
Question 10: Three homeworks are due during the class. You are allowed to set the deadlines at
any time but if you miss the deadline, your grade is reduced. Do you A: set the deadline at the
last day of class or B: set the deadlines spaced throughout the semester?
Question 7/: On a flip of a fair coin you either earn $X or lose $100. How much must X be before
Question 13: Answer with the first thing that comes to mind. A ball and bat costs $1.10 in total.
The bat costs $1 more than the ball. What does the ball cost?
Question 14: The experimenter gives a mug to you. A bit later the experimenter offers you
the opportunity to trade the mug for a pen of equal monetary value. Do you make the trade?
Form B
Question 1: Imagine that the community is preparing for the outbreak of an unusual disease,
which is expected to kill 600 people. Two alternative programs to combat the disease have been
proposed. Assume that the exact scientific estimate of the consequences of the programs are as
follows: If Program A is adopted, 400 will die. If Program B is adopted, there is a 1/3 probability
that nobody will die, and a 2/3 probability that 600 people will die.
Do you favor program A or B?
a. an 80 percent chance to lose $4,000 and a 20% chance to lose nothing.
b. to lose $3,000 for certain.

a. An online subscription to The Economist at $59 a year.
b. A print subscription to The Economist at $125 a year.
c. A subscription to the print and Web editions of The Economist at $125 a year.
The smallest price for which I would sell my ticket to play A is $
The smallest price for which I would sell my ticket to play B is $
Question 5: Would you take small amounts from the petty cash at work if you knew you
not be caught? (Yes / No)
Question 6: There are two subjects in an economics experiment and one subject, the prop
is given ten $1 bills. A computer decides how much to keep and how much to offer to the
subject. The responder has the right to accept or reject. If the proposal is rejected, both su
get nothing.
Unless I get at least I would reject the deal.
Question 7: You find ten $1 bills on the sidewalk. How many $1 bills do you keep?
Question 8: Take the last three digits of your phone number and add two hundred. Write the
number down. Now, when do you think Attila the Hun sacked Europe? Was it before
or after that year? What year is your best guess?
Question 9: There are two people who own goods they value at 10 but the other person values at
in the way economists assume; A cares only for A and lies if it results in personal gain. Assume
B is trustworthy and honest but fully understands A, and A fully understands B. If the deal is that
A puts the item in the mail first and B puts the item in the mail upon receipt of A's item, will A
put the item in the mail?
Question 10: Three homeworks are due during the class. You are allowed to set the deadlines at
any time but if you miss the deadline, your grade is reduced. Do you A: set the deadline at the
last day of class or B: set the deadlines spaced throughout the semester?
Question 11: On a flip of a fair coin you either earn $X or lose $100. How much must X be before
Question 13: Answer with the first thing that comes to mind. A ball and bat costs $1.10 in total.
The bat costs $1 more than the ball. What does the ball cost?
Question 14: The experimenter gives a pen to you. A bit later the experimenter offers you the
opportunity to trade the pen for a mug of equal monetary value. Do you make the trade?

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Microeconomics and Psychology

Microeconomics and Psychology

Steven Beckman, Lanxin Chen, Greg DeAngelo, W. James Smith

Keywords behavior, loss aversion, psychology, rationality

JEL codes C91.D03

THE QUESTIONS AND THE RELATED RESEARCH FINDINGS

Question 2. Which do you prefer:

FIGURE 1 The Prospect Theory utility function.

Question 3: Which do you prefer:

FIGURE 2 An illusion based on relative size.

Question 4: A bet is played on a roulette wheel with 36 slots numbered 1 to 36.

Most subjects prefer A but place a higher price on B. This is inconsistent, if

Because invariance—unlike independence or even transitivity—is normatively unassa

Ariely, D. 2009. Predictably irrational. New York: Harper Collins.

THE TWO QUESTIONNAIRES

Question 3: Which do you prefer:

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