Thursday, 24 November 2011

Micro-Economics and Behavior II

Explaining tastes: the importance of altruism and other non-egoistic behavior:

The central assumption of microeconomic analysis is that people are rational. Two important definitions of rationality are the so-called present-aim and self-interest standards. (Derek Parfit, Reasons and Persons, Oxford:Clarendon,1984.).A person is rational under the present-aim standard if she is efficient in the pursuit of whatever aims she happens to hold at the moment of action. No attempt is made, under this standard, to assess whether her aims themselves make any sense.Under the self-interest standard, by contrast, it is assumed at the outset that people’s motives are congruent with their narrow material interests.

In textbook accounts of rational choice, economists often embrace the present-aim standard. The difficulty with the present-aim standard is what we might call the ‘crankcase oil’ problem. If we see a person drink the used crankcase oil from his car, and he then writhes in agony and dies, we can assert that he must have really liked crankcase oil.

With this difficulty in mind, most economists assume some version of the self-interest standard of rationality in their actual research. It helps explain, for example, why car pools form in the wake of increases in gasoline prices. Without question, self-interest is an important human motive.

Yet narrow self interest is surely not the only human motive. Travelers on interstate highways leave tips for waitresses they will never see again. Participants in bloody family feuds seek revenge even at ruinous cost to themselves. People walk away from profitable transactions whose terms they believe to be “unfair.” In these and countless other ways, people do not seem to be pursuing interests of the usual egoistical sort.

An application of the present-aim standard: altruistic preferences

Because we know from experience that not everyone has the narrowly selfish preferences assumed by the self-interest model, it is tempting to broaden the analysis by simply adding additional tastes-by assuming, for example, that people derive satisfaction from a variety of behaviors that conflict with narrowly defined self interest, such as donating money to charity, voting, disposing of litter properly, and so on.Let us explore how the notion that some people have altruistic preferences can be incorporated formally into our model of rational choice.

Consider, for example, the case of Tashu, who cares not only about her own income level but also about Mun’s. Such preferences can be represented in the form of an indifference map defined over their respective income. Tashu’s indifference curves are negatively sloped, which means that she is willing to tolerate a reduction in her income in return for a sufficiently large increase in Mun’s.Her indifference curves exhibit diminishing MRS, which means that the more income Tashu has, the more she is willing to give up in order to see Muns have more.

The question that Tashu confronts is whether she would be better off if she gave some of her income to Muns. Suppose her initial income level is $50,000/yr and that Mun’s is $10,000.What are Tashu’s options? She can retain all her income. Or she can give some of it to Muns, in which case she will have $1 less than $50,000 for every $1 she gives him.

If Tashu keeps all her income, her MRS exceeds the slope of her budget constraint,it is clear that she can do better. The fact that MRS greater than one at the original point tells us that she is willing to give up more than a dollar of her own income to see Muns have an extra dollar. But the slope of her budget constraint tells us that it costs her only a dollar to give Muns an extra dollar. She is therefore better off if she gives some of her income to Muns.

The Strategic Role in Preferences

The attractive feature of the present-aim standard of rationality is that it lets us broaden our analysis to embrace nonegoistic motives whose existence is well documented. Yet as noted, the lingering methodological difficulty is that unless we impose some constraints on ourselves, the present-aim standard allows us to explain virtually any bizarre behavior by simply positing a taste for it. Our dilemma is how to expand our view of human motives without at the same time becoming vulnerable to the crankcase oil objection.

Biologists have discovered a way out of this dilemma, one that rests on an analysis that is quintessentially microeconomic in character. In biology, an organism’s tastes are not arbitrarily given as they are in economic models. Rather, biologists assume that tastes are forged by the pressures of natural selection to help organisms solve important problems in their environments. For example in the biologist’s account, our taste for sweets is a characteristic we inherited from our ancestors, in whom it evolved for functional reasons.

There is evidence that this particular taste is no longer functional in our current environment. In earlier times, the sugar found in ripened fruits were sufficiently scarce that there was no practical danger of over consuming them. Now, with sweets so plentiful, our taste for them sometimes leads us to overindulge,with various adverse consequences.

The taste for sweets is a simple preference, in the sense that it would have been useful to an individual irrespective of whether others in the population shared that taste. Other tastes, however, are more complex, in the sense that the usefulness of having them depends on the fraction of other individuals in the population who share them. This second type we call a strategic preference, one that helps the individual solve important problems of social interaction.

A Parable of Hawks and Doves
Consider a population which differs in its taste for aggressive behavior. Thus it is divided into hawks, the aggressors and doves, the pacifists. If these two types engage in a fight for scarce resources which one will win out? Well, at first glance one would assume that the hawks who are more aggressive would win out, but this precludes a confrontation between two hawks. Since both individuals are predisposed to be aggressive a bitter confrontation might ensue. Depending on the consequences of such a fight, it may indeed be costly to be a hawk.

The potential disadvantages of being a hawk become even clearer, when we consider what happens when two doves confront each other over sharing of a resource, in this case the costs of a bloody battle are avoided and the two decide to share the resource.

In our hypothetical population pairs of individuals interact with one another at random and there are three possible pairings 1) two hawks, 2) a hawk and a dove, 3) two doves. To see how this population will evolve we need to know the payoffs for each of these three types of interaction.

Suppose the conflict involves food that contains 12 calories. When two doves interact, they share the food so that each receives a payoff of 6 calories. When a hawk and a dove interact, the dove defers to the hawk so that the hawk gets 12 calories the dove gets none. Finally, when two hawks interact, the winner gets twelve calories the loser gets none. The confrontation however, consumes ten calories for both the hawks, which means the winner gets 12-10=2 calories, and the loser gets -10 calories. Of course over the course of many interactions, any given hawk can be expected to win half the time, and lose half the time. Thinking of hawks as a whole then, the average payoff for the hawk-hawk encounters is expected to be (2-10)/2=-4 calories per individual.

Thus summarizing: when two hawks meet, a fight ensues that consumes 10 calories each, leaving an average net payoff of -4 calories per hawk. When doves and hawks meet, doves defer, so hawks get 12 calories, doves 0.When two doves meet, they share the food, so each gets 6 calories.

With the working of the hawks and doves model in mind, we will focus on how certain unselfish motives often help people solve an important class of problems that arise in economic and social interaction.

The Commitment Problem

One of the most frequently discussed examples in which the pursuit of self-interest is self defeating is the so called prisoners dilemma. Two prisoners are held in separate cells for a serious crime that they did, in fact commit. The prosecutor, however has only enough hard evidence to convict them of a minor offense, for which the penalty is, say, 1 year in jail. Each prisoner is told that if one confesses while the other remains silent, the confessor will go scot free while the other will spend 20 years in prison.If both confess, they will get an intermediate sentence, say, 5 years. The two prisoners are not allowed to communicate with one another.

The dominant strategy in the prisoners dilemma is to confess.No matter what Y does, X gets a lighter sentence by speaking out-if Y too confesses, X gets 5 years instead of 20; and if Y remains silent, X goes free instead of spending a year in jail.The payoffs are perfectly symmetric, so Y also does better to confess no matter what X does. The difficulty is that when each behaves in a self-interested way, both do worse than if each had shown restraint. Thus, when both confess, they get 5 years, instead of the 1 year they could have gotten by remaining silent.

Although the prisoners are not allowed to communicate with one another, it would be a mistake to assume that this is the real source of difficulty. Their problem is rather a lack of trust. A simple promise not to confess does not change the material payoffs of the game.(If each could promise not to confess, each would still do better if he broke his promise.)

The prisoners dilemma is an example of a broader class of problems called commitment problems. The common feature of these problems is that people can do better if they can commit themselves to behave in a way that will later be inconsistent with their own material interests. In the prisoners dilemma, for example, if the prisoners could commit themselves to remain silent, they would do better than if left free to pursue their narrow material interests.

Illustration:The Cheating Problem

The functional role of unselfish motives can be seen more clearly with the help of the example of a simple ecology in which egoists are pitted against nonegoists in a struggle to survive. The commitment problem they face arises in joint business ventures, each of which consist of a pair of individuals. In these ventures each person can behave in each of two ways. He can “cooperate” which means to deal honestly with his partner, or he can”defect:” which means to cheat his partner. The payoffs to each of the partners, depend on the combination of the behavior of both. Thus if they both defect, each gets a payoff of 2, each gets 4 by cooperating. The defector gets 6 if the other person cooperates and the cooperator in turn gets zero

These payoffs thus confront the partners with a monetary version of the prisoners dilemma.. They get a higher payoff by defecting no matter what the other does. If one believes the other will behave in a self interested way, he will predict that the other will defect. And, if only to protect himself he may feel compelled to defect as well. When both defect, each gets only a 2-unit payoff. The frustration as in all dilemmas of this sort, is that both could have done better. Had they cooperated, each would have gotten a 4 unit payoff.

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