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Rational
.
Choice
.
Theory
Tutorial 4
1
To describe the basics of a theory
we can use as an example in our
applications: Rational Choice Theory
!
To understand some empirical
findings that modify the theory:
social preferences
Aim
2
Up Until Now
Social Problems are to be explained scientifically
A theory of action is necessary
* We will use Rational Choice Theory for this purpose *
3
Central Assumption
Rational Choice Theory
Decision-makers have logically consistent goals
(whatever they are), and, given these goals, choose the
best available option.
4
Rational Choice
The Model
AIM:
To explain the decisions of individuals and
the individual, and, in particular, the social
consequences of those decisions.
5
Core Elements
Rational Choice Model
Preferences	

Constraints	

Beliefs
Optimal	

Decision
Outcome	

(Prediction):	

Equilibrium
Decision Theory
Social
Interactions
6
Choice Depends On
How individuals rank the available alternatives according to
their subjective tastes
Preferences:
In which stock you invest will probably depend on your expectations
about the future earning potential of that stock
Beliefs:
The set of alternatives that are available to an individual (i.e.,
Ferrari vs Ford)
Constraints:
7
Utility Maximization
Choose a feasible option that best
satisfies the individual’s preferences
Individuals
8
Conditions on
Preferences
An individual can compare all relevant alternatives and rank
them
1. Complete
If you prefer A over B, and B over C, then you should prefer A
over C
2. Transitive
The relative attractiveness of two options does not depend on
other options available to the decision-maker
3. Independent of irrelevant alternatives
9
Sociology
Social outcomes of the interaction
of individuals
Interested in:
Social outcomes from the Equilibrium perspective
10
Equilibrium Analysis
Economics
Biology
Non-Life related sciences
Common to other fields
11
What is it?
It is a situation in which several things that have
been interacting, adjusting to each other and to each
other’s adjustment, are at last adjusted, in balance,
at rest!
!
(Schelling, Micromotives & Macrobehavior)
Equilibrium:
12
Examples Equilibrium
If prices from place to place do not differ more than transport
costs between those places
Market for gasoline:
If, considering where everybody else is sitting, nobody is
motivated to move to another seat
The seating pattern
13
The selfish
assumption
Decision-makers are SELF-REGARDING
A common assumption in RCT is that:
(+) TRACTABILITY IN MODELING
Exact predictions, which can be confronted with appropriate
data, that might refute the selfishness assumption
Experiments
14
The selfish
assumption
If people are selfish what else should I see?
IMPLICATION:
Should people vote?!
Should they contribute to public goods?
15
Is it violated?
It seems to be violated by the fact that many
people vote, even in anonymous situations,
take part in collective actions, often manage
not to overuse common resources, care for the
environment, mostly do not evade taxes on a
large scale, donate, and so forth...
The selfish assumption
16
Don’t discard it yet!
Many factors might give even selfish
individuals an incentive to behave pro-socially,
although they are not so motivated.
In reality
Repeated interactions
This is widely studied in laboratory experiments
17
Experimental
Studies
Social Sciences
in
18
What’s Experimental
Economics?
Data are collected in a controlled enviornment
Discipline in which
becoming experimental sciences like physics or biology
Social Sciences
Like theory
running experiments is an established method to explain and/or
describe social activity
19
Experimental Method
Advantages of the experiments
Control
Institutions (i.e., voting rules, communication, etc)
Incentives (payoffs) - not always complete control (i.e., altruism)
Randomization - avoids some self-selecting problems
Replication
Check for robustness, experimental effects, etc
Gives an incentive to do it right
Make available: data, instructions, program, and procedures
20
Example
“Coherent Arbitrariness”
Dan Ariely, George Lowestein, Drazen Frelec
Are preferences stable or are they
affected by irrelevant information?
How do people evaluate the value of a good?
Do we have preferences over
goods we have not consumed?
Are preferences completely random?
21
Ordinary Goods
Valuing ordinary goods
Collection of sessions to evaluate a research question
Are preferences stable or are they affected by irrelevant information?
Are preferences completely random?
Description of the task performed by subjects
Ask subjects if they want to buy the good for a price equal to a
random anchor
Random anchor: !
Last two digits of their Social Security Number (SSN)
Experiment:
Design:
22
Laboratory
Experiments
They create decision-dependent financial incentives
To measure
People’s behavior in situations in which true
opportunity cost for their decisions exists, and are
known by the researcher
Collection of sessions to evaluate a research question
23
Ordinary Goods
Description of the task performed by subjects
Ask subjects if they want to buy the good for a price equal to a
random anchor
Random anchor: Last 2 digits of their Social Security Number (SSN)
Previous slideResearch Question:
Design:
Give monetary value to 4 goods (market value around $70)
Elicit their willingness to pay (WTP) for the good
24
Ordinary Goods
Environment/parameters of interest varied by the experimenter
High, middle, low anchors
Treatment Variables:
Between-subjects variations: different subjects get different parameters
avoids “contamination” between treatments
+
Different qualities of similar goods+
Within-subjects variations: same subjects get different parameters
Control for individual characteristics!
Must control for sequence effects (i.e., due to learning)
Session: Group of subjects doing the experiment at the same time
One session with 55 students25
Ordinary Goods
Subjects with high SSNs pay more
Arbitrariness
Coherence:
Subjects pay more for better goods
Cordless trackball < Cordless keyboard!
Average wine < Rare wine
Last digits 	

SSN
Cordless	

Trackball
Cordless	

Keyboard
Average	

Wine
Rare	

Wine
01-20 $8.64 $16.09 $8.64 $11.73
41-60 $13.45 $29.27 $12.55 $18.09
81-100 $26.18 $55.64 $27.91 $37.55
26
Novel Goods
Subjects listen to annoying sounds for 30 seconds!
Hypothetical question asking whether they are willing to listed
to the sound for 300 seconds for a payment equal to the anchor!
Anchor: First 3 digits of their SSN!
Elicit their willingness to accept (WTA) “X” seconds of the
sound
Research Question:
Design:
How do we form preferences of goods we have not consumed?
Is there a stable valuation of hedonic experiences (pleasure or pain)?
Ascending x=100, 300, 600
Descending x=600, 300, 100
27
Novel Goods
High, middle, low values of “X”
Treatment Variables:
Between-subjects treatment variables:
+
Ascending or descending sequences of “X”+
Within-subjects treatment variables:
Session:
One session with 90 students
High and low anchors (above or below the median)+
28
Novel Goods
Subjects willingness to accept
is lower for low anchors
Arbitrariness
Coherence:
Willingness to accept increases
with duration
If subjects have little idea about how to price
initially, and hence rely on the random anchor in com
FIGURE III
Mean WTA (in Dollars) for the Three Annoying Soun
The data are plotted separately for subjects whose three-digit an
the median (low anchor) and above the median (high anchor). Erro
on standard errors.
29
Coherence
Arbitrariness
Valuations are highly sensitive
to arbitrary anchor values
Summary
For all goods?
After an initial valuation,
choices are coherent
Initial choices exert a large effect
on subsequent choices
30
Back to
experimental design
Partners: always play with same group+
More Jargon
Matching Procedures: way of grouping subjects
in repeated games
Strangers: randomly rematched before playing each game+
Absolute Strangers: Subjects do not play with the same
subject more than once
+
Incentive Compatible:
Monetary incentives are aligned with
the variable of interest (it doesn’t pay
to lie)31
The Experimental
Method
Theory testing/selection+
Goals for an experiment
Search for empirical regularities+
Advice policy makers+
32
The Experimental
Method
Lack of realism+
Some objections:
Representativeness of subjects+
33
Can lower costs+
Deception
Easier to study rare situations (Milgram-authority obedience)+
Advantages
Easier to design experiments+
Lost of control of+
Disadvantages
Subjects don’t believe the instructions
Subjects try to outguess the experimenter
Experimental Method
34
Classwork
Deterrence and Crime
35
Pro’s+
Con’s+
Main assumptions+
Would you become a criminal? When would you commit a crime?
Note: It is important to understand the object of your study,
not only look at it through a ``scientific microscope’’. It is also
important to step aside and speculate beyond your opinions.
Anything about criminals?
Rational Choice theory
Opportunity cost!
36
Exercise:
L1: The more utility an individual perceives, to obtain from
choosing a particular action, the more likely the individual
will choose this action.
Two studies on drug dealing
Levitt and Venkatesh (2000) Muñoz-Herrera and Palacio (2006)
Agents involved: drug dealers, consumers, and police, government.
Country:!
U.S.A. (Drug consuming country)
Country:!
Colombia (Producing country)
Law: In both countries, drugs are illegal.
37
General Law:
L1: The more utility an individual perceives, to obtain from choosing a
particular action, the more likely the individual will choose this action.
Two studies on drug dealing
Antecedent Conditions:
C1: Prices of illegal drugs in drug producing countries are very low
C2: Prices of illegal drugs in drug consuming countries are very high
Observed Phenomenon:
E1: In U.S. the drug dealing market is organized by gangs and they make
use of violence between them
E2: In Colombia. the drug dealing market is organized individual
dealers and they do not make use of violence between them
38
Questions?
39

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AppTheories_T4

  • 2. To describe the basics of a theory we can use as an example in our applications: Rational Choice Theory ! To understand some empirical findings that modify the theory: social preferences Aim 2
  • 3. Up Until Now Social Problems are to be explained scientifically A theory of action is necessary * We will use Rational Choice Theory for this purpose * 3
  • 4. Central Assumption Rational Choice Theory Decision-makers have logically consistent goals (whatever they are), and, given these goals, choose the best available option. 4
  • 5. Rational Choice The Model AIM: To explain the decisions of individuals and the individual, and, in particular, the social consequences of those decisions. 5
  • 6. Core Elements Rational Choice Model Preferences Constraints Beliefs Optimal Decision Outcome (Prediction): Equilibrium Decision Theory Social Interactions 6
  • 7. Choice Depends On How individuals rank the available alternatives according to their subjective tastes Preferences: In which stock you invest will probably depend on your expectations about the future earning potential of that stock Beliefs: The set of alternatives that are available to an individual (i.e., Ferrari vs Ford) Constraints: 7
  • 8. Utility Maximization Choose a feasible option that best satisfies the individual’s preferences Individuals 8
  • 9. Conditions on Preferences An individual can compare all relevant alternatives and rank them 1. Complete If you prefer A over B, and B over C, then you should prefer A over C 2. Transitive The relative attractiveness of two options does not depend on other options available to the decision-maker 3. Independent of irrelevant alternatives 9
  • 10. Sociology Social outcomes of the interaction of individuals Interested in: Social outcomes from the Equilibrium perspective 10
  • 11. Equilibrium Analysis Economics Biology Non-Life related sciences Common to other fields 11
  • 12. What is it? It is a situation in which several things that have been interacting, adjusting to each other and to each other’s adjustment, are at last adjusted, in balance, at rest! ! (Schelling, Micromotives & Macrobehavior) Equilibrium: 12
  • 13. Examples Equilibrium If prices from place to place do not differ more than transport costs between those places Market for gasoline: If, considering where everybody else is sitting, nobody is motivated to move to another seat The seating pattern 13
  • 14. The selfish assumption Decision-makers are SELF-REGARDING A common assumption in RCT is that: (+) TRACTABILITY IN MODELING Exact predictions, which can be confronted with appropriate data, that might refute the selfishness assumption Experiments 14
  • 15. The selfish assumption If people are selfish what else should I see? IMPLICATION: Should people vote?! Should they contribute to public goods? 15
  • 16. Is it violated? It seems to be violated by the fact that many people vote, even in anonymous situations, take part in collective actions, often manage not to overuse common resources, care for the environment, mostly do not evade taxes on a large scale, donate, and so forth... The selfish assumption 16
  • 17. Don’t discard it yet! Many factors might give even selfish individuals an incentive to behave pro-socially, although they are not so motivated. In reality Repeated interactions This is widely studied in laboratory experiments 17
  • 19. What’s Experimental Economics? Data are collected in a controlled enviornment Discipline in which becoming experimental sciences like physics or biology Social Sciences Like theory running experiments is an established method to explain and/or describe social activity 19
  • 20. Experimental Method Advantages of the experiments Control Institutions (i.e., voting rules, communication, etc) Incentives (payoffs) - not always complete control (i.e., altruism) Randomization - avoids some self-selecting problems Replication Check for robustness, experimental effects, etc Gives an incentive to do it right Make available: data, instructions, program, and procedures 20
  • 21. Example “Coherent Arbitrariness” Dan Ariely, George Lowestein, Drazen Frelec Are preferences stable or are they affected by irrelevant information? How do people evaluate the value of a good? Do we have preferences over goods we have not consumed? Are preferences completely random? 21
  • 22. Ordinary Goods Valuing ordinary goods Collection of sessions to evaluate a research question Are preferences stable or are they affected by irrelevant information? Are preferences completely random? Description of the task performed by subjects Ask subjects if they want to buy the good for a price equal to a random anchor Random anchor: ! Last two digits of their Social Security Number (SSN) Experiment: Design: 22
  • 23. Laboratory Experiments They create decision-dependent financial incentives To measure People’s behavior in situations in which true opportunity cost for their decisions exists, and are known by the researcher Collection of sessions to evaluate a research question 23
  • 24. Ordinary Goods Description of the task performed by subjects Ask subjects if they want to buy the good for a price equal to a random anchor Random anchor: Last 2 digits of their Social Security Number (SSN) Previous slideResearch Question: Design: Give monetary value to 4 goods (market value around $70) Elicit their willingness to pay (WTP) for the good 24
  • 25. Ordinary Goods Environment/parameters of interest varied by the experimenter High, middle, low anchors Treatment Variables: Between-subjects variations: different subjects get different parameters avoids “contamination” between treatments + Different qualities of similar goods+ Within-subjects variations: same subjects get different parameters Control for individual characteristics! Must control for sequence effects (i.e., due to learning) Session: Group of subjects doing the experiment at the same time One session with 55 students25
  • 26. Ordinary Goods Subjects with high SSNs pay more Arbitrariness Coherence: Subjects pay more for better goods Cordless trackball < Cordless keyboard! Average wine < Rare wine Last digits SSN Cordless Trackball Cordless Keyboard Average Wine Rare Wine 01-20 $8.64 $16.09 $8.64 $11.73 41-60 $13.45 $29.27 $12.55 $18.09 81-100 $26.18 $55.64 $27.91 $37.55 26
  • 27. Novel Goods Subjects listen to annoying sounds for 30 seconds! Hypothetical question asking whether they are willing to listed to the sound for 300 seconds for a payment equal to the anchor! Anchor: First 3 digits of their SSN! Elicit their willingness to accept (WTA) “X” seconds of the sound Research Question: Design: How do we form preferences of goods we have not consumed? Is there a stable valuation of hedonic experiences (pleasure or pain)? Ascending x=100, 300, 600 Descending x=600, 300, 100 27
  • 28. Novel Goods High, middle, low values of “X” Treatment Variables: Between-subjects treatment variables: + Ascending or descending sequences of “X”+ Within-subjects treatment variables: Session: One session with 90 students High and low anchors (above or below the median)+ 28
  • 29. Novel Goods Subjects willingness to accept is lower for low anchors Arbitrariness Coherence: Willingness to accept increases with duration If subjects have little idea about how to price initially, and hence rely on the random anchor in com FIGURE III Mean WTA (in Dollars) for the Three Annoying Soun The data are plotted separately for subjects whose three-digit an the median (low anchor) and above the median (high anchor). Erro on standard errors. 29
  • 30. Coherence Arbitrariness Valuations are highly sensitive to arbitrary anchor values Summary For all goods? After an initial valuation, choices are coherent Initial choices exert a large effect on subsequent choices 30
  • 31. Back to experimental design Partners: always play with same group+ More Jargon Matching Procedures: way of grouping subjects in repeated games Strangers: randomly rematched before playing each game+ Absolute Strangers: Subjects do not play with the same subject more than once + Incentive Compatible: Monetary incentives are aligned with the variable of interest (it doesn’t pay to lie)31
  • 32. The Experimental Method Theory testing/selection+ Goals for an experiment Search for empirical regularities+ Advice policy makers+ 32
  • 33. The Experimental Method Lack of realism+ Some objections: Representativeness of subjects+ 33
  • 34. Can lower costs+ Deception Easier to study rare situations (Milgram-authority obedience)+ Advantages Easier to design experiments+ Lost of control of+ Disadvantages Subjects don’t believe the instructions Subjects try to outguess the experimenter Experimental Method 34
  • 36. Pro’s+ Con’s+ Main assumptions+ Would you become a criminal? When would you commit a crime? Note: It is important to understand the object of your study, not only look at it through a ``scientific microscope’’. It is also important to step aside and speculate beyond your opinions. Anything about criminals? Rational Choice theory Opportunity cost! 36
  • 37. Exercise: L1: The more utility an individual perceives, to obtain from choosing a particular action, the more likely the individual will choose this action. Two studies on drug dealing Levitt and Venkatesh (2000) Muñoz-Herrera and Palacio (2006) Agents involved: drug dealers, consumers, and police, government. Country:! U.S.A. (Drug consuming country) Country:! Colombia (Producing country) Law: In both countries, drugs are illegal. 37
  • 38. General Law: L1: The more utility an individual perceives, to obtain from choosing a particular action, the more likely the individual will choose this action. Two studies on drug dealing Antecedent Conditions: C1: Prices of illegal drugs in drug producing countries are very low C2: Prices of illegal drugs in drug consuming countries are very high Observed Phenomenon: E1: In U.S. the drug dealing market is organized by gangs and they make use of violence between them E2: In Colombia. the drug dealing market is organized individual dealers and they do not make use of violence between them 38