Behavioral Economics 1

BEHAVIORAL ECONOMICS

By [Name]

Course

Professor’s name

Institution

Location of Institution

Date
 Behavioral Economics 2

Behavioral economics

SECTION 1

Question #1

The Ultimatum game is a trial-and-error behavioral economics exchange game. The

situation brings two people's financial interests into close proximity. The first player makes a

proposal to the second player regarding how to divide a sum of money. If the second player

declines to participate in this division, neither player receives anything. According to Krawczyk

(2018), there are variations on this premise in some versions of the Ultimatum game, where

multiple rounds are played, implying that it is rational to consider rejecting the offer. According

to Askari et al. (2019), this is an aspect of rational choice theory when considering individuals

pursuing personal interests. According to Grewal et al. (2015), as predicted by neoclassical

theory, the respondent should accept whatever the split is, regardless of how unfair the split is in

reality. The game's primary behavior can be identified explicitly. According to Castelli et al.

(2014), the critical aspects and behaviors are based on a person's awareness of social norms of

unfairness or an aversion to inequity.

Secondly, Alós-Ferrer and Farolfi (2019) noted that the Trust Game is the preferred

experiment for assessing trust in economic decisions. The experiment, according to the author, is

intended to demonstrate that trust is an economic primitive, or that it is as fundamental to

economic transactions as self-interest is. Alós-Ferrer and Farolfi (2019) identified the game as

the workhorse for assessing individual differences in trust and trustworthiness. Additionally,

there is the betrayal aversion component, which refers to the social aspect of risk in the Trust

Game. Additionally, the authors noted that betrayal aversion may be a significant factor in the

decision (not) to trust. Because this reflects a specific type of social risk
 Behavioral Economics 3

Generally, research with the ultimatum and trust games provide insight into what

individuals think to be fair results in instances involving the sharing of some benefit between

claimants. In these games, a proposer must give a portion of a good (often money) supplied by

the experimenter to an anonymous responder, who may accept or reject the offer. If the offer is

refused, neither party benefits. These games allow for varying degrees of strategic thought and

attention to fairness. Sensitivity to fairness might refer to two distinct concepts. On the one hand,

it might relate to a fundamental dislike of uneven results. On the other hand, it may relate to an

understanding of a societal standard of justice and its strategic implementation in all instances

when violation results in negative repercussions.

Question #2

Hyperbolic discounting refers to people's rising preference for a smaller-but-earlier

reward over a larger-but-later benefit when the delay occurs sooner rather than later in time.

When individuals are promised a greater incentive in return for waiting a certain length of time,

they become less impulsive as the rewards approach (El Haj et al., 2020). This is seen in the case

of Sarah. Roughly estimating her current consideration, the cost of going to the gym comprises

of monetary and psychological cost. The benefits of going to the gym are considered higher

which also considers going to the gym for a period of time. As such, just from a preview of

Sarah’s preference, despite having to plan to go to the gym, she will reconsider the period and

later on change her decision and finally won’t go given the time it will take to gain the benefits

of the gym.

Assuming based on her preference β=0.7∧δ =0.9

Also considering that the immediate costs = 8 and further

The delayed benefits of attending the gym = 20

 Behavioral Economics 4

For the case of Sarah, she will consider to exercise when the benefit exceeds the costs. This can

be considered based on the calculation below;

-8 + 0.7[20] = 6

0+0.7[-8 + 20] = 8.4

As noted from the quasi-hyperbolic discounting based mainly on procrastination and

dynamic inconsistency calculation, despite having a plan to go to the gym prior days, when the

time comes to go to the gym, Sarah will not attend the gym given that preferences are

dynamically inconsistent. According to Adil and Rajadhyaksha (2021), dynamic inconsistency

refers to a circumstance in which a decision-preferences maker's vary throughout time in such a

manner that they become inconsistent at another point in time.

Beshears et al. (2016) outlined ways for boosting the possibility that this person would

take the preventive health action based on the beta-delta model, including lowering the upfront

expenses or providing her a commitment device. This can be noted on a case where monthly

membership is reconsidered. This means there will be an increase in her commitment given her

subscription reduced the upfront costs.

Question #3

According to Mauersberger and Nagel's (2018) study, the "p-beauty contest" model is

comprised of a reference point dubbed level 0 and (limited) iterated best responses. Within the

sphere of behavioral interaction, this rule may also resemble a generative principle. For

inadequate rationale, it is assumed that all (naive) participants in a Beauty Contest game pick

randomly, with an average of 50 in the range [0, 100]. A level-1 player expects this and selects

the optimal answer; a level-2 player predicts and selects a level-1 player's selection. A level-k
 Behavioral Economics 5

player behaves in the same way as a level-k 1 player. Thus, a player who thinks that all players

will eventually arrive to the same conclusion and iterates indefinitely would approach

equilibrium zero. Given that equilibrium play is often not a winning strategy, a player who opts

for it is likely to suffer from the curse of knowing of the mathematical solution, being unaware of

a winning approach while dealing with boundedly rational individuals.

Despite this complexity, level-k models are quite effective at predicting subjects'

behavior in situations similar to the traditional beauty contest, such as when the coordination

incentive is high and the information is symmetric. According to Zhang (2020), level-k theories

undermine the Nash equilibrium rational-expectations logic by presuming that individuals see

others as less knowledgeable than themselves. The best replies then decide behavior via

induction based on the degree of reasoning of the participants, beginning with a "anchor" that

sets the behavior at level 0.

The average of the two signals acts as a focus point for individuals' initial beliefs, which

account for a significant portion of selected beliefs. According to Camerer (2011), as the

coordination drive diminishes, the conduct of other players becomes less significant, lowering

the incentives for people to anticipate it.

A game of strategic complements, loosely defined, is one in which one person must

match the actions of others, and hence might be referred to as a coordination game. In contrast, a

game of strategic substitutions is one in which one person must operate in the opposite direction

of others; hence, the game is also known as an anticoordination game.

Question #4

SECTION 2
 Behavioral Economics 6

Question 1

Question #2

Question #3

SECTION 3
 Behavioral Economics 7

References

Adil, M.H. and Rajadhyaksha, N., 2021. Evolution of monetary policy approaches: A case study

of Indian economy. Journal of Public Affairs, 21(1), p.e2113.

Alós-Ferrer, C. and Farolfi, F., 2019. Trust games and beyond. Frontiers in neuroscience, p.887.

Askari, G., Gordji, M.E. and Park, C., 2019. The behavioral model and game theory. Palgrave

Communications, 5(1), pp.1-8.

Beshears, J., Milkman, K.L. and Schwartzstein, J., 2016. Beyond beta-delta: The emerging

economics of personal plans. American Economic Review, 106(5), pp.430-34.

Castelli, I., Massaro, D., Bicchieri, C., Chavez, A. and Marchetti, A., 2014. Fairness norms and

theory of mind in an ultimatum game: judgments, offers, and decisions in school-aged

children. PloS one, 9(8), p.e105024.

El Haj, M., Boutoleau-Bretonnière, C., Moustafa, A. and Allain, P., 2020. The discounted future:

Relationship between temporal discounting and future thinking in Alzheimer’s

disease. Applied Neuropsychology: Adult, pp.1-7.

Grewal, N.S., Sparks, J.A., Reiter, J. and Moses, E., 2015. Behavioral Economics. Encyclopedia

of Mental Health, p.143.

Krawczyk, D.C., 2018. Social cognition: reasoning with others. Reasoning: The neuroscience of

how we think, pp.283-311.