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Camerer and Fehr: When does 'economic man' dominate social behavior

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Camerer and Fehr. 2006. When does 'economic man' dominate social behavior?. Science 311 (January): 47-52.

Main Point

Individuals who violate the assumptions of economics (via altruism or bounded rationality) may create powerful economic incentives for Economic Man to change his behavior, but depending on the economic structure, the existence of Economic Man may also create strong incentives for those with bounded rationality or other-regarding preferences to behave like Economic Man (48).

  • Strong reciprocators are characterized as caring about fairness. They reward others for cooperating, and punish others for violating norms, even though they derive no economic benefit from doing so (and would seem to lose out on the cost of rewarding or punishing itself).
  • The presence of strong reciprocators can alter a prisoner's dilemma (PD) in systematic ways. In a simultaneous PD with perfect information between a self-regarding player and a strong reciprocator, the reciprocator anticipates the self-regarding player's decision to defect, and himself defects. But in the sequential version, the self-regarding player knows that if he cooperates the strong reciprocator will do likewise, and so finds it in his interest to cooperate.
  • The presence of strong reciprocators does not have to be direct to affect games between self-regarding players. If they have reason to believe there is a positive probability of facing a strong reciprocator in any particular interaction, they will tend to cooperate.
  • Even in one shot PD's, a minority of strong reciprocators with the power to punish defectors tends to induce cooperation in the group.

Ultimatum Game: A Puzzle

Why do strong reciprocators make low offers as buyers in a competitive market, and why do they accept low offers as sellers? As the number of sellers goes up, the probability that there exists one self-regarding seller goes up as well. If there is one such seller, then the punishment mechanism of rejecting the buyer's offer by the seller is futile, since she will always be undercut. Therefore, self-regarding agents are inducing reciprocal agents to behave self-regardingly.

Some key terms:

  • Strategic substitutability: goods are substitutes if they satisfy similar needs, like beef and chicken; they tend to stand in an inverse relation.
  • Strategic complementarity: goods are complements if having more of one requires having more of the other, like peanut butter and jelly.

When economic choices are substitutes, rational agents have an incentive to behave in the opposite way to that of less-rational agents. In these cases, aggregate behavior tends to follow the equilibrium model. When economic choices are complements, rational agents have an incentive to mimic the actions of less-rational agents. Here, the aggregate is pushed far from equilibrium, where small changes in initial conditions can have an inordinately great impact on outcomes.

  • 2/3 game (or the "beauty contest," or the race to pick undervalued stocks) (49) is an example of complementarity, since the rational thing to do, given accurate beliefs of what others will do, is not to choose 0, as the rational choice model predicts, but to follow the crowd, attempting to determine what the less-rational will choose, and base my choice on my calculation of that figure.
  • The cognitive hierarchy model predicts a distribution of guesses, based on the number of steps people will have gone through in determining their guess. There is a spike at 35, which expresses the idea that a large number of people went through only one step (2/3 of the average, 50, of a random distribution of numbers from 1 to 100). There is another, smaller spike at the predicted value for two and three steps--hardly anyone is beyond that. This model predicts the actual data better than the rational choice prediction of a stable equilibrium at 0.
  • The same model can be used to explain strategic substitutability in the business entry game. Because there is a particular moment when rationality will pay off, i.e. meeting the capacity c, the more rational players will tend to crowd out the less rational ones.
  • Prediction markets v. stock markets: prediction markets forecast accurately because better-informed traders can make money off poorly-informed traders by buying undervalued or selling overvalued stock, thus adjusting the forecast. In stock markets, there is no horizon at which less-rational agents will receive their comeuppance. Markets can stay irrational longer than you can stay liquid (Royal Dutch Shell).

In Sum

The population contains a mix of homo economicus and strong reciprocators (and individuals also mix these traits). When homo economicus mimics the strong reciprocator (as occurs under strategic complementarity), collective action occurs. When the reciprocator mimics homo economicus (as occurs under strategic substitution), you get a competitive marketplace.

You can make analagous arguments using bounded rationality (instead of a strong reciprocator).