Contributions published at Microeconomics and Experimental Economic Research (Ernst Fehr)

Neuroeconomics is a new highly promising approach to understanding the neurobiology of decision making and how it affects cognitive social interactions between humans and societies/economies. This book is the first edited reference to examine the science behind neuroeconomics, including how it influences human behavior and societal decision making from a behavioral economics point of view. Presenting a truly interdisciplinary approach, Neuroeconomics presents research from neuroscience, psychology, and behavioral economics, and includes chapters by all the major figures in the field, including two Economics nobel laureates. Carefully edited for a cohesive presentation of the material, the book is also a great textbook to be used in the many newly emerging graduate courses on Neuroeconomics in Neuroscience, Psychology, and Economics graduate schools. This groundbreaking work is sure to become the standard reference source for this growing area of research.

Most economic models are limited to analyzing the behavior of a representative agent and, consequently, make the implicit assumption that either individuals are homogeneous or that individual heterogeneity does not matter for the aggregate outcome. However, recent empirical evidence in experimental economics indicates that under strategic complementarity a minority of irrational agents may, indeed, drive the market's outcome. To avoid potential aggregation bias, researchers in empirical economics should take individual heterogeneity into account, which results in the following trade-off: on the one hand, a representative agent approach, which is parsimonious and easy to interpret, completely neglects heterogeneity, but on the other hand, estimating economic behavior at the individual level, which requires a lot of parameters and results in a plethora of estimates, may demand too much from the data. To escape this dilemma, empirical economists may apply finite mixture models, which offer a compromise between completely ignoring individual heterogeneity and running into difficulties when estimating individual by individual. This thesis comprises four independent applications of finite mixture regression models. The first three experimental studies are part of a comprehensive research project, funded by the Swiss National Science Foundation, and discuss the identification and stability of two different behavioral types of decision makers in the domain of risk. The last essay applies a finite mixture model to the German Socio-Economic Panel to segregate the share of altruists from the rest of the population which is assumed to be selfish. Deutsche Zusammenfassung: Die in der experimentellen Wirtschaftsforschung gängigen ökonometrischen Modelle schätzen häufig das Verhalten eines repräsentativen Individuums. Dem liegt die implizite Annahme zu Grunde, dass sich die Individuen entweder homogen verhalten, oder aber individuelle Heterogenität keinen Einfluss auf das aggregierte Verhalten ausübt. Neuere empirische und theoretische Evidenz zeigt jedoch, dass in imperfekten Märkten - insbesondere unter strategischer Komplementarität - eine Minderheit irrationaler Agenten das Marktgleichgewicht stark beeinflussen kann. Um Verzerrungen bei der Aggregation zu vermeiden, sollten in solchen Situationen individuelle Unterschiede zwingend berücksichtigt werden. Typischerweise stehen aber bei Experimentaldaten zu wenige Beobachtungen pro Individuum zur Verfügung, um komplexe Verhaltensmodelle auf individueller Ebene schätzen zu können. Finite Mixture Modelle bieten hier einen guten Kompromiss zwischen einem Repräsentativen Agenten Modell und einer Schätzung auf individueller Ebene: Sie erlauben es eine bestimmte Anzahl Verhaltenstypen zu identifizieren und jedes einzelne Individuum endogen einem dieser Verhaltenstypen zuzuordnen. Damit erfassen sie einerseits den entscheidenden Teil der individuellen Heterogenität, nämlich die Existenz verschiedener Verhaltenstypen, und benötigen andererseits deutliche weniger Parameter als eine Schätzung auf individueller Ebene. Diese Arbeit umfasst vier unabhängige Anwendungen von Finite Mixture Modellen. Die ersten drei experimentellen Studien sind Teil eines vom Schweizerischen Nationalfonds unterstützten Forschungsprojekts zur Charakterisierung verschiedener Verhaltenstypen bei Entscheidungen unter Risiko. In der vierten Studie wird mit einem Finite Mixture Modell der Anteil an Altruisten in einer Teilstichprobe des Deutschen Haushaltspanels identifiziert.

Human cooperation is unparalleled in the animal world and rests on an altruistic concern for the welfare of genetically unrelated strangers. The evolutionary roots of human altruism, however, remain poorly understood. Recent evidence suggests a discontinuity between humans and other primates because individual chimpanzees do not spontaneously provide food to other group members, indicating a lack of concern for their welfare. Here, we demonstrate that common marmoset monkeys (Callithrix jacchus) do spontaneously provide food to non-reciprocating and genetically unrelated individuals, indicating that other-regarding preferences are not unique to humans and that their evolution did not require advanced cognitive abilities such as theory of mind. Because humans and marmosets are cooperative breeders and the only two primate taxa in which such unsolicited prosociality has been found, we conclude that these prosocial predispositions may emanate from cooperative breeding.

In this paper we show that subtle forms of deceit undermine the effectiveness of incentives.nWe design an experiment in which the principal has an interest in underreporting the true performance difference between the agents in a dynamic tournament. According to thenstandard approach, rational agents should completely disregard the performance feedback of self-interested principals and choose their effort level as if they had not been given any information. However, despite substantial underreporting many principals seem to exhibit lying aversion which renders their feedback informative. Therefore, the agents respond to the feedback but discount it strongly by reducing their effort relative to fully truthful performance feedback. Moreover, previous experiences of being deceived exacerbate the problem and eventually reduce average effort even below the level that prevails in the absence of any feedback. Thus, both no feedback and truthful feedback are better for incentives than biased feedback.

Combining the methods of neuroscience and economics generates powerful tools for studying the brain processes behind human social interaction. We argue that hedonic interpretations of theories of social preferences provide a useful framework that generates interesting predictions and helps interpret brain activations involved in altruistic, fair and trusting behaviors. These behaviours are consistently associated with activation in reward-related brain areas such as the striatum and with prefrontal activity implicated in cognitive control, the processing of emotions, and integration of benefits and costs, consistent with resolution of a conflict between self-interest and other-regarding motives.

Are initial competitive advantages self-reinforcing, so that markets exhibit an endogenous tendency to be dominated by only a few firms? Although this question is of great economic importance, no systematic empirical study has yet addressed it. Therefore, we examine experimentally whether firms with an initial cost advantage are more likely to invest in cost reductions than firms with higher initial costs. Wefind that the initial competitive advantages are indeed self-reinforcing, but subjects in the role of firms overinvest relative to the Nash equilibrium. However, the pattern of overinvestment even srengthens the tendency towards self-reinforcing cost advantages relative to the theoretical prediction. Further, as predicted by the Nash equilibrium, aggregate investment is not affected by the initial efficiency distribution. Finally, investment spillovers reduce investment, and investment is higher than the joint-profit maximizing benchmark for the case without spillovers and lower for the case with spillovers.

Since Durkheim, sociological explanations of social cooperation emphasize the internalization of values that induce norm compliance. Since Adam Smith, economic explanations of social cooperation emphasize incentives that induce selfish individuals to cooperate. Here we develop a general approach – the Beliefs, Preferences, and Constraints approach – showing that each of the above models is a special case. Our approach is based on evidence indicating that pure Homo Sociologicus and pure Homo Economicus views are wrong. We show that self-regarding and norm-regarding actors coexist and that the available action opportunities determine which of these actor types dominates the aggregate level of social cooperation. Our approach contributes to the solution of long-standing problems, including the problems of social order and collective action, the determinants and consequences of social exchanges, the micro-foundations of emergent aggregate patterns of social interactions, and the measurement of the impact of cultural and economic practices on individuals’ social goals.

It has long been recognized that there is considerable heterogeneity in individual risk taking behavior but little is known about the distribution of risk taking types. We present a parsimonious characterization of risk taking behavior by estimating a finite mixture regression model for three different experimental data sets, two Swiss and one Chinese, over a large number of real gains and losses. We find two distinct types of individuals: In all three data sets, the choices of roughly 80% of the subjects exhibit significant deviations from rational probability weighting consistent with prospect theory. 20% of the subjects weight probabilities linearly and behave essentially as expected value maximizers. Moreover, the individuals are assigned to one of these two groups with probabilities of close to one resulting in a low measure of entropy. The reliability and robustness of our classification suggest using a mix of preference theories in applied economic modeling.

Most previous studies on intertemporal labor supply found very small or insignificant substitution effects. It is possible that these results are due to constraints on workers' labor supply choices. We conducted a field experiment in a setting in which workers were free to choose hours worked and effort per hour. We document a large positive elasticity of overall labor supply and an even larger elasticity of hours, which implies that the elasticity of effort per hour is negative. We examine two candidate models to explain these findings: a modified neoclassical model with preference spillovers across periods, and a model with reference dependent, loss-averse preferences. With the help of a further experiment, we can show that only loss-averse individuals exhibit a negative effort response to the wage increase.

When valuing risky prospects, people tend to overweight small probabilities and to underweight large probabilities. Nonlinear probability weighting has proven to be a robust empirical phenomenon and has been integrated in decision models, such as cumulative prospect theory. Based on a laboratory experiment with real monetary incentives, we show that incidental emotional states, such as preexisting good mood, have a significant effect on the shape of the probability weighting function, albeit only for women. Women in a better than normal mood tend to exhibit mood-congruent behavior, i.e. they weight probabilities of gains and losses relatively more optimistically. Men’s probability weights are not responsive to mood state. We find that the application of a mechanical decision criterion, such as the maximization of expected value, immunizes men against effects of incidental emotions. 40% of the male participants indeed report applying expected values as decision criterion. Only a negligible number of women do so.

Economists long considered money illusion to be largely irrelevant. Here we show, however, that money illusion has powerful effects on equilibrium selection. If we represent payoffs in nominal terms, choices converge to the Pareto inefficient equilibrium; however, if we lift the veil of money by representing payoffs in real terms, the Pareto efficient equilibrium is selected. We also show that strategic uncertainty about the other players’ behavior is key for the equilibrium selection effects of money illusion: even though money illusion vanishes over time if subjects are given learning opportunities in the context of an individual optimization problem, powerful and persistent effects of money illusion are found when strategic uncertainty prevails.

Conventional magnetic resonance imaging (MRI) is useful for assessing morphological changes but not for assessing deformations inside homogeneous structures (M. D. Abrà moff, A. P. Van Gils, G. H. Jansen, & M. P. Mourits, 2000). Since no intrinsic contrast can be imaged for distinguishing heterogeneous patterns of muscle contraction, morphological changes along the length of the extraocular muscles (EOMs) are not macroscopically detectable. However, an imaging method that is able to directly encode motion could give evidence about the dynamics of the inhomogeneous deformation of the EOMs. Thus, we developed a method for acquiring motion-encoded MRI images of the EOMs during eye movements. Seven healthy subjects gazed at a horizontal sinusoidally oscillating target. A small surface coil was placed in front of the right orbit. The contracting and relaxing horizontal rectus muscles and the noncontracting optic nerve were reliably tracked. The differential contractility of the EOMs could be distinguished from the third time frame on (=140 ms from the beginning of the right to left eye movement lasting 1 s). The muscle belly of the contracting medial rectus muscle could be distinguished from the posterior and the anterior segment from the sixth time frame on (=350 ms). In conclusion, motion-encoded MRI resolved the heterogeneous contraction of moving EOM segments in healthy subjects without using physical markers.

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All known human societies establish social order by punishing violators of social norms. However, little is known about how the human brain processes the punishment threat associated with norm violations. We use fMRI to study the neural circuitry behind forced norm compliance by comparing a treatment in which norm violations can be punished with a control treatment in which punishment is impossible. Individuals’ increase in norm compliance when punishment is possible exhibits a strong positive correlation with activations in the lateral orbitofrontal cortex and right dorsolateral prefrontal cortex. These activations are also modulated by the social nature of the task. Moreover, activation in lateral orbitofrontal cortex shows a strong positive correlation with Machiavellian personality characteristics. These findings indicate a neural network involved in forced norm compliance that may constitute an important basis for human sociality. Different activations of this network reveal individual differences in the behavioral response to the punishment threat and may thus provide a deeper understanding of the neurobiological sources of pathologies such as antisocial personality disorder.

Imagine you are overweight and you spot your favorite pastry in the storefront of a bakery. How do you manage to resist this temptation? Or to give other examples, how do you manage to restrain yourself from overspending or succumbing to sexual temptations? The present article summarizes two recent studies stressing the fundamental importance of inhibition in the process of decision making. Based on the results of these studies, we dare to claim that the capacity to resist temptation depends on the activity level of the right prefrontal cortex (PFC).