We study an interactive framework that explicitly allows for nonrational behavior. We do not place any restrictions on how players' behavior deviates from rationality, but rather, on players' higher-order beliefs about the frequency of such deviations. We assume that there exists a probability p such that all players believe, with at least probability p, that their opponents play rationally. This, together with the assumption of a common prior, leads to what we call the set of p-rational outcomes, which we define and characterize for arbitrary probability p. We then show that this set varies continuously in p and converges to the set of correlated equilibria as p approaches 1, thus establishing robustness of the correlated equilibrium concept to relaxing rationality and common knowledge of rationality. The p-rational outcomes are easy to compute, also for games of incomplete information. Importantly, they can be applied to observed frequencies of play for arbitrary normal-form games to derive a measure of rationality p that bounds from below the probability with which any given player chooses actions consistent with payoff maximization and common knowledge of payoff maximization. ; Germano acknowledges financial support from the Spanish Ministry of Economy and Competitiveness (Grant ECO2014-59225-P), as well as from the Barcelona GSE Research Network and the Generalitat de Catalunya. Zuazo-Garin acknowledges financial support from the Spanish Ministry of Science and Technology (Grant ECO2009-11213), from the Spanish Ministry of Economy and Competitiveness (Grant ECO2012-31326) and from the Basque Government (Grants IT568-13 and POS-2015-1-0022).
In economics, players are assumed to be rational: they exhibit self interested behavior and play equilibrium strategies. However, in laboratory games or actual markets, players often manifest behavior that is rather consistent with bounded rationality. This thesis consists of two chapters, which relax the standard assumptions on rationality and allow for bounded rationality of players.The first essay weakens the assumption that players are self interested. In this essay, a retail market is empirically investigated under the relaxed assumption that firms may not be purely self interested or profit maximizing. Standard models of price competition stipulate that firms are pure profit maximizers; this assumption can be sensible and empirically useful in inferring product markups in a market with no direct government intervention. However, in markets for essential goods such as food and healthcare, a government may wish to address its consumer surplus concerns by imposing regulatory constraints or actively participating as a player in the market. As a consequence, some firms may have objectives beyond profit maximization and standard models may induce systematic biases in empirical estimation. This essay develops the structural model of price competition where some firms have consumer surplus concerns. Our model is applied in order to understand demand and supply behaviors in a retail grocery market where the dominant retailer publicly declares its consumer surplus objective. Our estimation results show that the observed low prices of this retailer arise indeed as a consequence of its consumer surplus concerns instead of its low marginal costs. The estimated degree of consumer surplus concerns suggests that the dominant retailer weighs consumer surplus to profit in a 1 to 7 ratio. The counterfactual analysis reveals that if the dominant retailer were to be profit maximizing as in the standard model, its prices would increase by 6.09% on average. As a consequence, its profit would increase by 1.16% and total consumer surplus would decrease by 7.18%. To the contrary, competitors lower their prices in response to the dominant retailer's increased prices, i.e., become less aggressive as if they are strategic substitutes. Interestingly, even though profit of all firms increases, total social surplus would decrease by 3.21% suggesting that profit maximization by all firms induces an inefficient outcome for the market.The second essay relaxes the rationality assumption that players exhibit equilibrium behavior, and develops a model that explains nonequilibrium behavior of players in laboratory games. In standard nonequilibrium models of iterative thinking, there is a fixed rule hierarchy and every player chooses a fixed rule level; nonequilibrium behavior emerges when some players do not perform enough thinking steps. Existing approaches however are inherently static. In this essay, we generalize models of iterative thinking to incorporate adaptive and sophisticated learning. Our model has three key features. First, the rule hierarchy is dynamic, i.e., the action that corresponds to each rule level can evolve over time depending on historical game plays. Second, players' rule levels are dynamic. Specifically, players update beliefs about opponents' rule levels in each round and change their rule level in order to maximize payoff. Third, our model accommodates a continuous rule hierarchy, so that every possible observed action can be directly interpreted as a real-numbered rule level r . The proposed model unifies and generalizes two seemingly distinct streams of nonequilibrium models (level- k and belief learning models) and as a consequence nests several well-known nonequilibrium models as special cases. When both the rule hierarchy and players' rule levels are fixed, we have a static level- r model (which generalizes the standard level- k model). When only players' rule levels are fixed, our model reduces to a static level- r model with dynamic rule hierarchy and captures adaptive learning. When only the rule hierarchy is fixed, our model reduces to a dynamic level- r model and captures sophisticated learning. Since our model always converges to the iterative dominance solution, it can serve as a model of the equilibration process. Using experimental data on p -beauty contests, we show that our model describes subjects' dynamic behavior better than all its special cases. In addition, we collect new experimental data on a generalized price matching game. The estimation results show that it is crucial to allow for both adaptive and sophisticated learning in predicting dynamic choice behaviors across games.
Given the falling returns in share markets and the comparative safety of savings accounts protected by the deposit insurance provided by the Australian Government, there was a significant surge in deposits made in savings ac counts. According to an article published in The Australian , Australian households deposited an estimated $38 billion into savings accounts over a period of six months ending on the 31 st of March, 2009. Among the various deposit-taking institutions, Westpac received the largest part of this growth. (Jimenez, 2009). Interestingly, there have been no major changes in the interest rates offered on savings accounts by the major banks recently. If the savings account market is examined , the first thing that one notices is the large number of options available to a prospective customer. There are more than fifty savings accounts on offer by various banks, building societies and credit unions. These include regular savings accounts, high interest savings accounts with more stringent conditions on deposits, withdrawals and usage and exclusively online savings accounts. Any given savings account product can have different combinations of attributes apart from the interest rate offered such as the minimum balance requirements, the minimum lock-in period, etc. For an average consumer who wants to open a savings account, there is a plethora of choices available. This paper considers how a typical consumer might make a choice among so many options and whether this choice is "right".
Bounded rationality provides a fundamental economic explanation for non-rational modes of behavior. These non-rational modes underlie both the erratic perturbations of entrepreneurship and the systematic waves of diffusion they initiate which in turn guarantee that the economy operates out of equilibrium. Continuing adjustments out of equilibrium are made possible by financial intermediation. They imply asymmetric changes in individual welfare. The markets for entrepreneurship, ownership and control that liberate creativity and boundedly rational decision-making, therefore, also lead inevitably to conflict among various social groups. Democratic mechanisms for correlating public and private interest that enlist the voluntary participation of agents who are sometimes made worse off in the continuing process of social transformation and which restore access to markets for those who lose is therefore an essential part of a modern economic system. The dialectical interaction among market al1ocations, non-market buffering and stabilizing institutions and democratic process is thus fundamental. Reforms that are based on this interaction achieve voluntary self-transformations. Those that do not, ultimately fall victim to involuntary forces.
In: Gsottbauer , E & van den Bergh , J C J M 2011 , ' Environmental Policy Theory Given Bounded Rationality and Other-regarding Preferences ' , Environmental and Resource Economics , vol. 49 , no. 2 , pp. 263-304 . https://doi.org/10.1007/s10640-010-9433-y
Using a natural voting experiment in Switzerland that encompasses a 160-year period (1848 - 2009), we investigate whether a higher level of complexity leads to increased reliance on expert knowledge. We find that when more referenda are held on the same day, constituents are more likely to refer to parliamentary recommendations in making their decisions. This finding holds true even when we narrow our focus to referenda with a relatively lower voter turnout on days on which more than one referendum was held. We also show that when constituents face a higher level of complexity, they listen to parliament rather than interest groups.
Using a natural voting experiment in Switzerland that encompasses a 160-year period (1848-2009), we investigate whether a higher level of complexity leads to increased reliance on expert knowledge. We find that when more referenda are held on the same day, constituents are more likely to refer to parliamentary recommendations in making their decisions. This finding holds true even when we narrow our focus to referenda with a relatively lower voter turnout on days on which more than one referendum was held. We also show that when constituents face a higher level of complexity, they listen to parliament rather than interest groups.
Using a natural voting experiment in Switzerland that encompasses a 160-year period (1848-2009), we investigate whether a higher level of complexity leads to increased reliance on expert knowledge. We find that when more referenda are held on the same day, constituents are more likely to refer to parliamentary recommendations in making their decisions. This finding holds true even when we narrow our focus to referenda with a relatively lower voter turnout on days on which more than one referendum was held. We also show that when constituents face a higher level of complexity, they listen to parliament rather than interest groups.
The purpose of this thesis is to illustrate how the role of knowledge may be the missing link in economics and to argue that the assumption of unbounded rationality, which underpinned neoclassical economics, should be replaced by bounded rationality and that bounded rationality should be redefined as people are rational, but are constrained by asymmetric and imperfect knowledge. This decomposition of bounded rationality makes it possible for us to operationalize bounded rationality, which was founded by Herbert Simon in the 1950s, but has not been widely adopted in economics because the concept was considered too difficult to formalize. The inclusion of asymmetric and imperfect knowledge considerations in microeconomics provides new insights into the existence and boundaries of firms, the role and nature of institutions, financial market inefficiency and political choices. The inclusion of asymmetric knowledge considerations in macroeconomics can help explain the unequal distribution of wealth between individuals, firms and nations. A lack of knowledge, and the difficulties in overcoming a lack of knowledge, can help to explain aspects of economic fluctuations, prices rigidities, monetary non-neutrality and unemployment. Most importantly, when the role of knowledge is considered, it provides better explanations to various anomalies in economics, helps reconciles differences between various theories and may opens up the possibility of unifying various schools of economic thought.
The mathematical analogies between economics and classical mechanics can be extended from constrained optimization to constrained dynamics by formalizing economic (constraint) forces and economic power in analogy to physical (constraint) forces in Lagrangian mechanics. In a differential-algebraic equation framework, households, firms, banks, and the government employ forces to change economic variables according to their desire and their power to assert their interest. These ex-ante forces are completed by constraint forces from unanticipated system constraints to yield the ex-post dynamics. The out-of-equilibrium model combines Keynesian concepts such as the balance sheet approach and slow adaptation of prices and quantities with bounded rationality (gradient climbing) discussed in behavioral economics and agent-based models. Depending on the power relations and adaptation speeds, the model converges to a neoclassical equilibrium or not. The framework integrates different schools of thought and overcomes some restrictions inherent to optimization approaches, such as the problem of aggregating individual behavior into macroeconomic relations and the assumption of markets operating in or close to equilibrium.
When individuals choose from whatever alternatives available to them the one that maximizes their utility then it is always desirable that the government provide them with as many alternatives as possible. Individuals, however, do not always choose what is best for them and their mistakes may be exacerbated by the availability of options. We analyze self-selection models, when individuals know more about themselves than it is possible for governments to know, and show that it may be socially optimal to limit and sometimes to eliminate individual choice. As an example, we apply Luce's (1959) model of random choice to a work-retirement decision model and show that the optimal provision of choice is positively related to the degree of heterogeneity in the population and that even with very small degrees of non-rationality it may be optimal not to provide individuals any choice.
Political rationality as a theory is important in its own right. Government leaders must calculate political costs such as the resources needed to generate support for a policy, the implications of a policy decision for re-election, and the possibility of provoking hostility for decisions not well received. Bounded rationality approach has yielded an enhanced understanding of how government organizations may produce unexpected or even unpredicted policy or program results. With public organizations not operating under full rationality conditions, administrators aspiring toward rationality may nonetheless find their goals undermined by a variety of forces, such as informational uncertainties and non-rational elements of organisational decision-making.
In questo lavoro viene analizzata la possibilità che le fluttuazioni economiche possano essere descritte attraverso l'interazione di agenti a razionalità limitata. Accanto a questa ipotesi, si assume anche che gli agenti sono eterogenei. Questi due elementi si inseriscono all'interno del contesto economico che è visto come un sistema complesso in evoluzione popolato da agenti che interagiscono tra loro impiegando differenti strategie decisionali. Questa tesi si sviluppa su tre modelli di riferimento, sviluppati in capitoli separati. Nel primo si studia un mercato immobiliare utilizzando un modello di equilibrio parziale in cui l'ipotesi di aspettative razionali è sostituita da un meccanismo di interazione fra cartisti e fondamentalisti, che è in grado di generare endogenamente lo sviluppo di fasi di boom e bust. Nel secondo viene mostrato come la selezione evolutiva tra diverse strategie di previsione possa spiegare il coordinamento fra comportamenti individuali. Nel terzo si considera un semplice modello macroeconomico costituito da domanda aggregata, offerta aggregata e una regola di politica monetaria per analizzare aspetti quali l'effetto stabilizzante delle diverse politiche monetarie in un sistema popolato da agenti eterogenei. ; We investigate the possibility that economic fluctuations can be explained through the interaction of boundedly rational agents, that is, agents are not assumed to be rational. In deviating from rationality and modeling agents as boundedly rational, it is often assumed that agents are heterogeneous. Bounded rationality and learning in a complex environment naturally fit with heterogeneous expectations, with the economy viewed as complex evolving system composed of many different interacting agents, using different decision strategies. This thesis is built around three main economic frameworks, which are developed in separate chapters. In chapter 2 we study the housing market using a partial equilibrium model in which the rational expectations hypothesis is relaxed in favor of chartist-fundamentalist mechanism to allow for the endogenous development of bubbles. In chapter 3 we present evidence that evolutionary selection among different forecasting heterogeneous heuristics can explain coordination on individual behavior. In chapter 4 we consider a simple model made up by the standard aggregate demand function, the New Keynesian Phillips curve and a Taylor rule to deal with different issues, such as the stabilizing effect of different monetary policies in a system populated by heterogeneous agents.
As mentioned in the introduction, the objective of this work has been to get a more realistic understanding of economic decision making processes by adopting an interdisciplinary approach which takes into consideration at the same time economic and psychological issues. The research in particular has been focused on the psychological concept of categorization, which in the standard economic theory has received until now no attention, and on its implications for decision making. The three experimental studies conducted in this work provide empirical evidence that individuals don not behave according to the perfect rationality and maximization assumptions which underly the SEUT, but rather as bounded rational satisfiers who try to simplify the decision problems they face through the process of categorization. The results of the first experimental study, on bilateral integrative negotiation, show that most of the people categorize a continuum of outcomes in two categories (satisfying/not satisfying), and treat all the options within each category as equivalent. This process of categorization leads the negotiators to make suboptimal agreements and to what I call the ?Zone of Agreement Bias? (ZAB). The experimental study on committees? decision making with logrolling provides evidence of how the categorization of outcomes in satisfying/not satisfying can affect the process of coalition formation in multi-issue decisions. In the first experiment, involving 3-issues and 3-parties decisions under majority rule, the categorization of outcomes leads most of the individuals to form suboptimal coalitions and make Pareto-dominated agreements. The second experiment, aimed at comparing the suboptimizing effect of categorization under majority and unanimity rule, shows that the unanimity rule can lead to a much higher rate of optimal agreements than the majority rule. The third experiment, involving 4-issues and 4-parties decisions provides evidence that the results of experiments 1 and 2 hold even when the level of complexity of the decision problem increases.
