interdependent preferences and reciprocityeconweb.ucsd.edu/~jsobel/papers/iprdraft.pdf · sobel:...

Journal of Economic LiteratureVol XLIII (June 2005) pp 392ndash436

Interdependent Preferences and Reciprocity

JOEL SOBELlowast

392

lowast Sobel University of California San Diego I present-ed a version of this paper at the First World Congress ofthe Game Theory Society and to my colleagues at theCenter for Advanced Study in the Behavioral Sciences Ithank Eli Berman Antonio Cabrales Miguel Costa-Gomes Vincent Crawford David M Kreps HerbertGintis Mark Machina Efe Ok Luiacutes Pinto MatthewRabin Paul Romer Klaus Schmidt Uzi Segal JoelWatson and Kang-Oh Yi for discussions references andcomments I am especially grateful to two referees whosupplied detailed intelligent and constructive commentson an earlier version of the manuscript and to JohnMcMillan for his advice and encouragement I worked onthis project while a Fellow at the Center for AdvancedStudy in the Behavioral Sciences I thank my classmates atthe Center for conversations and encouragement and theCenter for financial and clerical support NSF funding isalso gratefully acknowledged

1 Introduction

Much of economic analysis stems from thejoint assumptions of rationality and indi-

vidual greed Common sense and experimen-tal and field evidence point to the limits of thisapproach Not everything of interest to econ-omists can be well understood using thesetools This paper reviews evidence that narrowconceptions of greed and rationality performbadly The evidence is consistent with the viewthat economic incentives influence decisionmaking Hence there is a role for optimizingmodels that relax the assumption of individualgreed I discuss different ways in which onecan expand the notion of preferences

I pay particular attention to how reciproc-ity influences decision making Reciprocityrefers to a tendency to respond to perceivedkindness with kindness and perceived mean-ness with meanness and to expect thisbehavior from others I introduce models ofintrinsic reciprocity in section 34Intrinsic reciprocity is a property of prefer-ences The theory permits individual prefer-ences to depend on the consumption ofothers Moreover the rate at which a personvalues the consumption of others dependson the past and anticipated actions of othersAn individual whose preferences reflectintrinsic reciprocity will be willing to sacri-fice his own material consumption toincrease the material consumption of othersin response to kind behavior while at thesame time be willing to sacrifice materialconsumption to decrease someone elsersquosmaterial consumption in response to unkindbehavior

It is more traditional to view reciprocity asthe result of optimizing actions of selfishagents Responding to kindness with kind-ness in order to sustain a profitable long-term relationship or to obtain a (profitable)reputation for being a reliable associate areexamples of instrumental reciprocityEconomics typically describes instrumentalreciprocity using models of reputation and

ju05_Article 2 61005 140 PM Page 392

Sobel Interdependent Preferences and Reciprocity 393

repeated interaction This approach is quitepowerful as essentially all exchanges in natu-ral settings can be viewed as part of somelong-term interaction Consequently onecould argue that the models of section 34are unnecessary This essay presents thecounterargument that models of intrinsicreciprocity can provide clearer and moreintuitive explanations of interesting econom-ic phenomena An openness to the possibili-ty of intrinsic reciprocity leads to a new anduseful perspective on important problems

The next section contains a stylized exam-ple that illustrates the limitations of standardmodels I use the example to provide aninformal introduction to alternative theoret-ical approaches and motivate the paperSection 3 introduces these models formallySection 4 describes some economic settingsin which the modeling approaches of section3 may be particularly useful Section 5reviews literature on the evolution of prefer-ences Section 6 responds to stylized argu-ments against the approach and section 7 isa conclusion

2 An Informal Guide to the Concepts

We regularly read accounts of dissatisfiedor recently fired employees destroying prop-erty sabotaging computer files or evenldquogoing postalrdquo and killing people at theirworkplace The sense of outrage at an appar-ent injustice is real Many people are willingto take destructive actions as part of the out-rage This kind of destructive behavior isunlikely to be in the material interest of afired employee it takes time it is not com-pensated and it carries the risk of criminalpenalties How should we think about itFor concreteness imagine that Paul was ahigh-ranking executive who had worked fora company for more than ten years He losthis job when business turned bad On his lastday on the job Paul destroyed vital companydocuments and continued to sabotage com-puter files until he was caught six monthslater In this section I will use Paulrsquos story to

introduce and motivate the ideas I review inthe manuscript

21 Descriptions

There are several ways to react to Paulrsquosdestructive activity One response is to treat itas an emotional response not subject to eco-nomic analysis We should not give up so eas-ily Paul may be crazy but his former bossMarsha probably is not Unless Paulrsquos actionsare completely unrelated to the environmentMarsha will want to understand how toreduce the chance of adverse behaviorMarsha may need to hire lawyers or psychi-atric consultants (instead of economists) to tellher how to deal with Paul or reduce the risk ofcostly outbursts by employees but she shouldevaluate her options using economic models

I will concentrate on descriptions that areconsistent with the hypotheses of optimiza-tion and equilibrium Once we allow thatPaul maximizes something more that his ownmonetary reward there are many stories likethis available This section introduces somepotential descriptions informally Section 3provides a more systematic treatment

211 Static Income Maximization

Hypothesis The narrowest version ofeconomic theory assumes that Paul seeks tomaximize his utility and that his utilitydepends on the quantities of the privatematerial goods he consumes In staticincome maximization Paul balances theimmediate cost and benefits of actionsrather than the long-term implications ofthese decisions In simple settings thishypothesis reduces to the assumption thatPaul maximizes his monetary income

Analysis Paul would carry out hisdestructive action only if he imagined that itwould lead to direct material gain It is hardto rationalize Paulrsquos behavior under theseassumptions His actions may advance hisimmediate material interests if Marsha giveshim back his job or if he receives a paymentto stop sabotaging the company but a moreelaborate description seems necessary


394 Journal of Economic Literature Vol XLIII (June 2005)

212 Interdependent Preferences

Hypothesis Paul maximizes a utilityfunction that depends on Marsharsquos consump-tion of material goods in addition to his own

Analysis If Paulrsquos utility is decreasing inthe material wealth of Marsha then Paul willbe willing to sacrifice his own material wellbeing to punish Marsha These preferencesexplain why Paul would wish to harmMarsha but do not explain why he waitsuntil after he is fired to do so There are twopossibilities In the midst of an ongoingemployment relationship Paul does notharm Marsha because he fears that Marshawill fire him which would be a sufficientlygreat punishment to deter him from hurtingMarsha

Alternatively the marginal rate of substi-tution between Paul and Marsharsquos materialincome in Paulrsquos preferences may change asa result of Paulrsquos termination The impover-ished Paul is willing to sacrifice to makeMarsha worse off This explanation onlyworks if Paulrsquos income after being fired islower than after a voluntary separation (oth-erwise any separation would trigger Paulrsquosdisruptive behavior)

For the example it makes sense to assumethat Paulrsquos utility is decreasing in Martharsquosincome The interdependent preferenceapproach permits Paul to be willing to sacri-fice material welfare to decrease the incomeof others

213 Preferences over GeneralConsumption Goods

Hypothesis Paul maximizes a utilityfunction that is a function of ldquoconsumptiongoodsrdquo that are derived from marketed goodsthrough a personal production process

Analysis This approach generates severalpossible stories One possibility is that Paulrsquosbehavior demonstrates that he has a mar-ketable characteristicmdashthat is he is not thetype of person who can be pushed around heis not afraid to stand up for injustice or he iscapable of identifying weaknesses in a firmrsquos

security By hurting Marsha Paul gainsbecause he positions himself to get anotherjob (which he may be less likely to lose) or sella book about his experiences Under thesecircumstances Paul may have preferencesdefined over both his monetary wealth andhis ldquosense of honorrdquo If the preferences areincreasing in both arguments then he will bewilling to make material sacrifices in order toincrease in honor If Paul only cares abouthonor because it enables him to increase hismonetary payoff then this explanationreduces to income maximization

Another possibility is that Paul takes pleas-ure directly from the act of sabotage That ishis preferences contain an additional argu-ment (ldquosabotagerdquo) Paul will not maximizehis material payoff but he is selfish and goaloriented This explanation does not explainwhy Paul turns to sabotage only after he wasfired Perhaps the advantage of maintainingthe employment relationship deterred hisurge to destroy files until he was fired butthis explanation suggests that the sabotagelevels would be the same whether theemployee was fired or separated voluntarily

214 Intrinsic Reciprocity

Hypothesis Paulrsquos utility depends on thematerial wealth of Marsha Moreover Paulrsquosperception of Marsharsquos behavior determinesthe direction of Paulrsquos preferences The mar-ginal utility of Paul with respect to anincrease in Marsharsquos income increases whenMarsha is kind to Paul and decreases whenMarsha is unkind

Analysis Paul believes that Marsha actedunfairly when she fired him Consequentlyhis preferences changed and he becomes(more) willing to sacrifice his own income toreturn the insult he received

215 Commitment

Hypothesis Paul seeks to maximize autility function that depends only on hismaterial consumption He can commit him-self to taking future actions that are in hisbest interest when he makes his plans but



1 Alternatively Marsha might institute tighter securityor announce that she will seek severe punishments fordestructive activities

may not be in his best interest when heenacts his plans

Analysis If fired workers retaliateMarsha might be reluctant to fire people orshe may offer attractive separation packagesThese actions benefit workers so if workerscould commit to destructive actions afterbeing fired then it might be in their interestto do so1 Marsha fired Paul because sheconcluded that he would do more damage asan employee than not but there is no expla-nation for why Paul carried out his threatafter he was fired Standard equilibriumconcepts rule out this kind of commitmentFor this reason I do not treat commitmentas a description consistent with equilibriumand optimization I discuss evolutionaryarguments for why individuals may maintaincommitment ability in section 5

216 Repeated Games

Hypothesis Paul seeks to maximize hismaterial consumption but he views the rela-tionship as ongoing More precisely he isengaged in a repeated game with Marshaand he seeks to maximize a discounted sumof single-period payoffs

Analysis Actions have implications forfuture payoffs in repeated games so equilib-rium behavior does not require short-termmaximization It is natural to assume thatPaulrsquos destructive action imposes a short-term cost on Paul but an even greater coston Marsha punishing her for firing himEquilibrium strategies in repeated gamesoften specify that one player punish anotherplayer following a deviation from equilibri-um behavior In the simplest cases potentialpunishments deter the behavior that wouldtrigger them So one would never see pun-ishments When Marsha is uncertain aboutPaulrsquos willingness or ability to sabotage itmight be in her best interest to take actionsthat lead to Paulrsquos destructive behavior

This hypothesis works like the commit-ment hypothesis in this example and it hasthe same problem Paul lacks incentives tocarry out his threat after he loses his jobFor the repeated-game hypothesis to applyPaul must expect to receive benefits after hepunishes Marsha that he would not receiveotherwise These benefits may comebecause Paul receives rewards from thirdparties (friends or future employers) afterhe punishes Marsha

22 Sorting out the Explanations

In this section I have presented severalexplanatory models in an informal context Ata conceptual level it is sometimes difficult todifferentiate the models I make an attemptto do so in the next section where I discussthe explanations more precisely in an explicitgame-theoretic context Nevertheless thedistinction is often linguistic The differentapproaches sometimes just use different terminology to describe the same thing

At an empirical level the differentdescriptions identify different reasons forPaulrsquos behavior Fully specified models willlead to different ways to organize the workenvironment in response to the threat of dis-satisfied workers On the other hand given aparticular observation it is usually possibleto construct a ldquojust-sordquo story from the per-spective of onersquos favorite class of descriptionsthat is consistent with the observation Mytaxonomy does not generate a fully specifiedtestable model in each category but rather afamily of models with the same underlyingmechanism Rejecting a model is easyrejecting an approach is nearly impossible

Natural formulations of the differenthypotheses do have different implications insome situations however in part becausethey have different conceptions of what thebenefit of Paulrsquos actions are Factors thatmay distinguish the descriptions are howlong Paul has worked for Marsha and thenature of their relationship how widelyknown his destructive actions become howmuch discretion Marsha has in her decision



and how old Paul is when he is fired I closethe section with a few examples

In the repeated-game explanation Paulpunishes Marsha to influence his futurereturns If his future returns decrease withage and the cost of sabotage does notchange then the older Paul is the less likelyhe is to sabotage Marsha It is not necessaryin the repeated-game story for Paulrsquos behav-ior to depend on the amount of severancepay he received or the number of otheremployees laid off Simple stories based onintrinsic reciprocity would not predict Paulrsquosbehavior to depend on his age Stories basedon interdependent preferences would pre-dict that the wealth of Marsha and otheremployees would influence Paulrsquos behavior

On the other hand considerations basedon reciprocity are largely retrospective Paulwould be less inclined to punish Marsha if hethought that she had no choice but to firehim or if steps were taken to inform him andreward him for service prior to separationOne would expect destructive behavior todecrease with the amount of goodwill Marshahas accumulated during their relationshipThe consequences of Paulrsquos behavior after heis fired are less important under the hypoth-esis of reciprocity than in the repeated-gamestory or general consumption good story

The simplest explanation of Paulrsquos behav-ior based on reciprocity involves only therelationship between Paul and Marsha Pauldestroys data to hurt Marsha He may wantit known that something bad has happenedto the company because this revelation mayhurt Marsha but he gains nothing fromadvertising his own connection to the crimeFor at least some of the explanations basedon generalized consumption goods orrepeated games it is important Paulrsquos associ-ation with the sabotage becomes public

The interdependent-preference hypothe-sis predicts less punishment if it is clear thatMarsha is suffering material losses when shefires Paul It would be to Marsharsquos advantageto coordinate firings with reductions in payof employees under these circumstances

2 The discussion of evolutionary models in section 5permits a less arbitrary identification of selfishness withfitness maximization

The different implications of the hypothe-ses imply that more precise versions of thestories can be supported or rejected by dataThe different hypotheses also suggest differ-ent ways for Marsha to modify the environ-ment to improve outcomes If Marshathought that the repeated-game or general-ized consumption good hypotheses were thebest explanations of Paulrsquos destructive behav-ior she would try to reduce sabotage bymanipulating Paulrsquos incentives after he leavesthe firm If Marsha thought that Paul wasmotivated by intrinsic reciprocity then shewould focus on changing behavior during theemployment

3 Models

Whenever a theory appears to you as the onlypossible one take this as a sign that you haveneither understood the theory nor the problemwhich it was intended to solve

Karl Popper

Several different models have been devel-oped to describe and organize the evidenceof nonselfish behavior No model provides acomplete description of the observationalfindings A sensible approach will take ideasfrom different models This section parallelssection 2 It introduces formal models forthe different descriptions of Paul andMarsharsquos conflict and the theoretical ques-tions raised by the use of these models Imaintain the assumption that individualshave well defined preferences and theybehave to maximize their preferences sub-ject to resource constraints For this reasonthere is a clear sense in which all of thebehavior I discuss is selfish I will use theterm selfish preferences in a more limitedway to mean preferences that do not direct-ly depend on the consumption of others2

Preferences are altruistic if they are increasingin the material consumption of others



3 Reciprocity has many definitions so it is not surprisingthat adjectives modifying reciprocity take on differentmeanings depending on the author AnthropologistsMarshall Sahlins (1968 page 82) and Elman R Service(Service 1966 pages 14 and 15) generously credit eachother for definitions of generalized balanced and negativereciprocity While economists do not use the terms general-ized and balanced reciprocity they use negative reciprocityto describe the tendency to punish people who treat youbadly On the other hand for Sahlins and Service negativereciprocity describes many standard economic ldquotransactionsopened and conducted towards net utilitarian advantagersquorsquo(Sahlins 1968 page 83) To avoid unnecessary interdiscipli-nary confusion I propose the terms destructive and con-structive reciprocity as alternatives to negative and positivereciprocity This is not the only possible source of confusionRichard D Alexander (1987) uses the term direct reciproc-ity to describe bilateral exchanges of favors the personreceiving a benefit compensates the person who generatedthe benefit and indirect reciprocity when the return favorcomes from a third party Robert L Trivers (1971) uses gen-eralized reciprocity in the sense that Alexander uses indirectreciprocity Herbert Gintis (2000) uses weak reciprocity todescribe reciprocal interactions that are instrumental andstrong reciprocity in the way that I use intrinsic reciprocity

The narrowest formulation of rationalitydemands that an economic agent maximize autility function that depends only on his cur-rent consumption of material goods Thisformulation is easily refuted but it is anunnecessarily restrictive view of rationalityGeneral models of rational behavior permita wider range of arguments to enter utilityfunctions Somewhat arbitrarily I classifythe models according to the way they extendpreferences Section 32 looks at models inwhich an individual cares about people otherthan himself Section 33 discusses models inwhich preferences depend on more thingsthan marketed goods

Paulrsquos behavior toward Marsha illustratesan apparent willingness to risk material wellbeing in order to damage someone else Spiteoutrage moralistic aggression and the desirefor revenge are behaviors that are as familiarto social scientists as they are inconvenient tothe economistsrsquo narrow notion of self interestBut while people will go out of their way toharm enemies they will make sacrifices tohelp their friends I will call repaying unkind-ness with unkindness destructive reciproci-ty and repaying kindness with kindnessconstructive reciprocity3 Individuals with

4 Ernst Fehr and Simon Gaumlchter (2000) and Fehr andKlaus M Schmidt (2003) also review of the material inthis section

5 It is a Nash equilibrium for the proposer to offer s gt 0and for the responder to accept any offer greater than orequal to s This equilibrium fails to be subgame perfectbecause it relies on the responderrsquos threat to reject positiveoffers less than s

an intrinsic preference for reciprocity willhave different preferences over allocationsdepending on the context Unkind behaviorof their neighbors induces destructive reci-procity while kindness induces constructivereciprocity Section 34 examines models inwhich the process that creates outcomesinfluences preferences These models are formal representations of intrinsic reciprocity

Section 35 briefly discusses how commit-ment power influences predictions Section36 discusses how the theory of repeatedinteractions may lead selfish individuals tobehave as if they cared about the welfare ofothers This provides a foundation for theoriesof instrumental reciprocity4

Throughout this section I illustrate mod-els using the ultimatum game The ultima-tum game provides a powerful challenge tothe hypothesis that income maximizationand equilibrium describe economic interac-tions In the ultimatum game two playersbargain over the distribution of a surplus offixed size 1 The first player (proposer) canchoose any distribution of the surplus s isin [01] The second player (responder) theneither accepts or rejects the proposal If theresponder accepts the proposal s then theproposerrsquos monetary payoff is 1 minus s and theresponderrsquos monetary payoff is s Otherwiseboth receive nothing

Game theory assuming that players seekto maximize their monetary payoff makestwo predictions First in Nash Equilibriumall positive offers must be accepted Secondin subgame-perfect Nash Equilibrium theproposer must offer s = 0 (or if the set offeasible proposals is discrete either s = 0 orthe minimum positive proposal)5

The ultimatum game is a beautiful subjectfor experimental study It is simple The



6 See Werner Guumlth Rolf Schmittberger and BerndSchwarze (1982) for early experiments and Guumlth (1995b)and Alvin E Roth (1995) for reviews

combination of payoff maximization andrationality leads to sharp predictionsExperimental subjects repeatedly violate thetheoretical predictions6 The violations aresystematic low (s lt 2) proposals are rareproposals are rejected proposals rarely givethe second player more than half of the sur-plus (so that s gt 5 is rarely observed) andequal or nearly equal splits (4 lt s le 5) arecommon occurring more than half the timein typical experiments In addition rejectionsfrom the responder decrease as s increasesThis finding is consistent with althoughmuch weaker than the stark theoretical pre-diction since subjects are more likely tochoose actions that maximize their materialpayoffs the larger the (material) benefit asso-ciated with doing so These results continueto hold under a range of conditions

Before describing the models I introducebasic notation Limit attention to a strategicenvironment with I agents The strategy setof agent i is si Any strategy profile s = (s1hellipsI) (where si isin Si for all i = 1hellipI)determines an outcome O(s) Conventionalgame theory adds to this formulation theassumption that agents have well definedpreferences over outcomes Assume thatagent irsquos preferences can be represented bya utility function ui() defined over out-comes Without additional assumptions self-ish behavior is not defined The abstractdefinition of outcome does not identify aconsumption bundle for each agent

31 Income Maximization

In this setting O(s) = (x1hellipxI) where xi

is an allocation to player i and ui(O(s)) is anincreasing function of xi and independent ofxj for j ne i That is the outcome consists ofprivate goods allocated to each player andeach player cares only about his or her ownconsumption In many applications the pri-vate goods are one-dimensional monetary

payoffs For simplicity xi will refer to amonetary payoff in this section This modelis simple and leads to clear predictions Thepredictions are systematically wrong inmany interesting situations It is this modelcombined with the assumption that playersuse (subgame perfect) equilibrium strate-gies that leads to the prediction that thefirst player demands essentially everythingin the ultimatum game


This subsection describes models thatassume individuals seek to maximize well-defined preferences and that base predic-tions on equilibrium behavior but permitpreferences to depend on the consumptionof others

As in the case of income maximization letO(s) = (x1hellipxI) denote the outcome wherexi is the material allocation of player i Withinterdependent preferences agents careabout the distribution of material goods andnot simply their own allocation That isui(O(s)) may now depend nontrivially on xjfor j ne i

Several authors have proposed specificfunctional forms for interdependent prefer-ences For these authors material allocationsare one dimensionalmdashconformable to mone-tary payoffs in an experiment To reviewthese models consider the utility function

(1)

The simplest form of interdependentpreferences consistent with (1) arises whenij is constant A positive ij reflectsaltruism (in the sense that an agent is willingto decrease his own consumption in order toincrease the consumption of another agent)a negative ij reflects spite

Gary Charness and Matthew Rabin (2002)and Fehr and Schmidt (1999) offer specifi-cations that are special cases of (1) Thesepapers impose the further restriction thatij is independent of i and j and dependson only the sign of xi minus xj

u x x x x xi ij i

ij i j j( ) = + sum minus( )ne

λ



Charness and Rabin (2002) opt for anaverage of functional forms that place posi-tive weight on the selfish monetary payoffthe monetary payoff received by the leastwell off agent and the total payoff Withthis specification ij gt 0 but is greaterwhen xi gt xj That is individual i alwaysplaces positive weight on the consumptionof others and places more weight on theconsumption of individuals poorer than heis than on richer individuals

For the inequity aversion approach sug-gested by Fehr and Schmidt ij is positiveif xi gt xj and negative if xi lt xj Under thisspecification an agent cares about his ownmonetary payoff and in addition would liketo reduce the inequality in payoffs betweenthe two players Gary E Bolton and AxelOckenfelsrsquos (2000) ERC (for ldquoEquityReciprocity and Competitionrdquo) model has asimilar motivation but proposes a utilityfunction that is not in form (1) InsteadBolton and Ockenfels assume agent irsquos pref-erences are an increasing (possibly nonlin-ear) function of xi and agent irsquos relative

income

The simplest model of interdependentpreferences provides the flexibility todescribe some observed violations of incomemaximization in the ultimatum game Forexample if the responder is spiteful so thatij = minus is constant and negative then whenshe is offered the share s she will reject it if s minus (1 minus s) lt 0 If both players have isin (01)then the unique equilibrium of the ultima-tum game would be for the first player to

offer the second player the share

which is positive but less than one halfThis resolution is unsatisfactory Intuition

suggests that at least some of the behavior inthe ultimatum game comes from generosityand not fear of rejection One would notexpect a spiteful individual to make charita-ble contributions or give a positive share to

γγ1 +

x

xi

jN

jsum

=1

7 Models of interdependent preferences predict allpositive offers are accepted when ij is nonnegativeHence Charness and Rabin (2002) also combine theirfunctional form with preferences that depend on contextin order to explain some of the observed responderbehavior in ultimatum games

his opponent in a dictator-game version ofthe ultimatum game (in which the secondplayer is required to accept any feasible pro-posal) Allowing the sign of to changedepending on the income distribution isconsistent with this behavior7

David K Levine (1998) assumes that theextent to which agents care about anotherplayerrsquos material utility is a weighted averageof a pure altruism parameter and the altru-ism parameter of the other player Levineassumes that people differ in the degree towhich they care about others and that peo-ple care more about the material payoffs ofnice people Formally he assumes that imaximizes

Here i is the altruism parameter of play-er i and i is the weight player i places on jrsquospreferences If i = 0 then the weight playeri places on jrsquos material payoff is independentof jrsquos degree of altruism otherwise theweight is an increasing function of jrsquos altru-ism parameter This specification is a specialcase of (1) In contrast to inequity aversionthe weight placed on the material payoff ofanother player depends on the identity ofthat player In Levinersquos model an individualwants to be kind to a kind person Levineuses this model to describe experimentalresults In order to do so he assumes thatplayers are uncertain about their opponentrsquospreferences and solves for the equilibriumof incomplete information games Agentswant to identify altruistic (high ) people sothat they can be nice to them Players drawinferences from the strategies of other peo-ple This permits a form of reciprocity toarise in equilibrium If agents with highers choose nicer strategies then players

x xij i

i i j

ij+ sum

+

+ne

α β αβ1



8 Jacob K Goeree and Charles A Holt (2000) attemptto test for this effect in the laboratory They vary the lump-sum payment received by subjects in a perfect-informationbargaining game Results from the experiment are consis-tent with the hypothesis that subjects take into accountthese payments which are irrelevant to standard models ofthe bargaining process

place higher weights on the material pay-offs of people who play nice strategiesbecause playing nice strategies signals thatyou really are nice

Models of interdependent preferencesraise theoretical issues about how to deter-mine the arguments of the utility functionImagine an agent who is motivated by thedesire to maximize a utility function thatreflects inequity aversion Exactly whose util-ity enters into this function and how shouldthis utility be measured An experimentalsubject could try to maximize her monetarypayoff in the laboratory and then redistributeher earnings to deserving people later Thisbehavior would be appropriate if the concernfor inequity was ldquobroadly bracketedrdquo (DanielRead George Loewenstein and Rabin 1999and Richard H Thaler 1999) in that con-cerns outside of the laboratory entered intothe decision making in the laboratory If thesecond player in the ultimatum gamelearned the proposer was relatively poorwould she be willing to accept small offers8

If experimental subjects had to earn the rightto play a role in a game in which the equilib-rium prediction (assuming narrowly self-interested behavior) gave unequal payoffswould the effect of inequity aversion bereduced Would it matter whether attractivepositions were allocated by scoring high on atest of general intelligence or by a pseudo-random device like being born on an oddday of the year Do winners of lotteriesattempt to find out the names of the losers inorder to reduce inequality (or increase thewealth of the agent who did poorly on thisparticular transaction)

Concerns that always arise in experimen-tal settings are especially salient hereShould the experimenterrsquos payoff enter into

9 On the contrary one could also argue that subjectsmay have more incentive to curb their selfish instincts inthe laboratory than in other settings if convincing fellowexperimental subjects and experimenters that they are notselfish is the best way to gain future riches

the subjectrsquos utility function Subjects havesome idea that the experimenter is budgetconstrained (or at least the money from theexperiment comes from somewhere) So allallocations are just transfers Since the totalmonetary payments are constant utilitari-an objectives are not relevant Also thesubjects must be aware that they makemore than one decision during an experi-mental session Even if subjects do notbring their lifetime decision problem intothe lab they may impose notions of fair-ness or social preferences across the entireexperimental session rather than just onedecision at a time

An optimizing agent whose utility functionplaces positive weight on the wealth of oth-ers could allocate income outside the labcarefully so that one could not infer the truenature of preferences from lab behaviorThis agent would optimize his interdepend-ent preferences before entering the labora-tory so at the margin he would beindifferent between allocating his laboratorywinnings to increase his personal income orto decrease inequality If one accepts thepossibility that laboratory behavior takes intoaccount decisions made outside of the labo-ratory then this argument suggests thatexperiments overestimate the amount of(narrowly) selfish behavior since selfish peo-ple must be selfish in all situations and oth-ers may appear selfish in the laboratory inorder to pursue their nonselfish interestsoutside the laboratory more effectively9

There are tacit assumptions in the mod-els of interdependent preferences Themodeler makes the assumptions when spec-ifying the identities of the players in thegame and their initial wealth levels Inapplications subjects are assumed to careonly about the welfare of other active par-ticipants in the game and to make relative



income comparisons based only on thematerial payoffs of the game It is typical(and necessary) to identify a ldquosmall worldrdquoin which to apply decision-theoretic argu-ments (particularly in models involvingchoice under uncertainty) The problemseems especially critical when using inter-dependent preferences however In decid-ing how to interpret these models one mustunderstand why the subject cares about theutility of other subjects but not the utility ofthe experimenter In deciding how to applythese models to a contracting problem onemust decide whether preferences aredefined over coworkers or just the parties tothe contract In deciding how to apply thesemodels to the labor market one mustdecide whether workers care about inequityacross labor and management across allworkers or only across workers in similarjobs One must also decide whether toinvoke an interdependent utility function todetermine decisions separately or whetheragents make decisions that reduce inequityover longer intervals

33 Preferences over General ConsumptionGoods

The ldquoChicago Schoolrdquo pursues the goal ofusing the optimizing models of self-interest-ed agents constrained by a market environ-mentmdasha limited endowment existingprices and economic institutionsmdashtoexplain a broad range of economic phenom-ena The approach is advocated powerfullyin the work of George J Stigler and Gary SBecker (for example Stigler and Becker1977) The theory explicitly exploits the pos-sibility that self interest has a broad defini-tion Preferences are not defined overmarketed goods but general commoditiesthat individuals transform into consumptiongoods Models in this tradition therefore donot require that experimental subjects basetheir decisions solely on their own monetarypayoffs

Stigler and Beckerrsquos posit that the decision-maker (household) has a utility function

(2) U(Z1hellipZm)

where for i = 1hellipm

(3) Zi = ƒi(X1ihellipXnit1ihellipt1iS1hellipSlYi)

Zi are the generalized consumption goodsƒi is the production function for commod-ity i Xji is the quantity of the jth marketgood tki in the time input of individual kSk

is the human capital of the kth person andYi represents all other inputs Given wagesand prices for the market goods a house-hold selects Xji and tki to maximize (2) sub-ject to (3) In any application the definitionof market goods will not be controversialThe quantities Xji and tki will be observableIn the general specification of the theoryhowever the levels of human capital thefunctional form of the production functionsand indeed the nature of generalized con-sumption goods can be freely selected bythe modeler

While the approach of Stigler and Beckeris firmly grounded in ideas familiar to econ-omistsmdashbudget constraints and individualmaximizationmdashit also reflects a commonview among cultural anthropologists Sahlins(1968 page 9) who provides a useful taxon-omy of reciprocity observes that ldquoin anuncommon number of tribal transactionsmaterial utility is played down to the extentthat the main advantages appear to be socialthe gain coming in good relations rather thangood thingsrdquo Sahlins recognizes the need tolook beyond immediate material gain tounderstand the workings of simpleeconomies While Stigler and Becker do notexplicitly substitute ldquogood relationsrdquo forldquogood thingsrdquo their formulation broadensthe notion of consumption good and con-cedes that economic exchange may be moti-vated by more than short-term material gaineven in developed market economies

When stripped to its mathematical corethe StiglerndashBecker model posits that decision-makers have preferences over their choicevariables and that these preferences dependon something that is determined in part by



10 In the StiglerndashBecker formulation the householdutility function does not depend on the household butheterogeneity may enter through the human capital variables

11 I use this formulation rather than simply Ui(s) inorder to connect this model to explicitly strategic modelsthat I introduce in section 34

choices and in part by other factors that areleft unconstrained in the basic formulation10

Everything can be written

(4) ui(O(s)(s))

where s = (s1hellipsI) is strategy profile (indi-vidual i chooses si) describes personalcharacteristics and is a parameter11 Inmaking the transformation si represents thechoice variables of the household (quantitiesof market goods and labor) denotes theadditional parameters (human capital andldquoother inputsrdquo) O(s) denotes those general-ized consumption goods whose productiondoes not depend on and (s) all othergeneralized consumption goods

The description of the utility function in(2) appears to rule out externalities since anagentrsquos utility is a function only of his owngeneralized consumption goods Thereduced-form (4) allows utility to depend onthe entire outcome so it permits interde-pendent utilities Characteristics of otherindividuals in the economy enter throughthe production function it includes as argu-ments the human capital of all agentsFurther since the general model makes norestrictions on the relationship betweenchoices of other agents and their level ofhuman capital on one hand and the defini-tion of generalized consumption goods onthe other nothing prevents agent irsquos opti-mization problem from having an arbitrarydependence on agent krsquos market decisions

What distinguishes this formulation fromthe models of income maximization andinterdependent preferences is that optimiz-ing decisions can be based on more than thedistribution of material goods There are twoaspects to this difference First the model ofgeneralized consumption goods does not

require that the outcome is a vector ofobservable private allocations Models withgeneralized consumption goods permit someof the goods to be standard private goodsbut are flexible enough to include publicgoods The arguments could also includequantities that cannot be measured directlylike a warm glow from giving The seconddifference is that in models of generalizedconsumption goods preferences over out-comes may vary with parameters In terms ofthe representation in (4) an individualrsquospreferences over outcomes O can dependon the parameter which is difficult toobserve let alone control

The reduced-form description of theStiglerndashBecker model also connects it to anapproach that at least on the surfaceappears quite different

George A Akerlof and Rachel E Kranton(2000)rsquos formulation of identity posits thatthe decisionmaker has a utility function

(5) Ui(aiaiIi(aiaiciεiP))

where ai is the action of individual i Ii isthe individualrsquos identity ci is the individualrsquosassigned social categories εi is individual irsquoscharacteristics and P are prescriptions thatldquoindicate the behavior appropriate for peo-ple in different social categories in differentsituationsrdquo (Akerlof and Kranton 2000 page719) Given ci εi P and ai individual kselects ai to maximize Ui In this theoryaction choices are observable

Akerlof and Krantonrsquos model alsoreduces to (4) by denoting the action vari-able a by s letting contain the variablesassociated with social and individual char-acteristics and prescriptions and definingα(s) = Ii(aiaiciεiP) The models ofAkerlofndashKranton and StiglerndashBecker arethus mathematically identical It is curiousthat these formally equivalent approachesare associated with schools of thought thatoften are viewed as opposites

The theories are identical because they areconsistent with precisely the same set of



12 The fixed component of status derives from geneticendowmentmdashinherited wealth titles race and gendermdashin addition to other attributes obtained in the pastDecisions made in the current period cannot influence thefixed component of status

observations Any observation consistentwith the first must be consistent with the sec-ond and conversely The theories have differ-ent social scientific implications because theylead one to look for different ways to describeobservations For example the Chicagoschool may assume that generous behavior isa consumption good that directly enters theutility function (possibly because the appear-ance of kindness that will be useful in thefuture) Akerlof and Kranton might posit thatan individualrsquos identity required behavingaccording to accepted norms of fairness (andtherefore the proposer loses utility if heoffers unequal divisions or the responderloses utility if she accepts unequal divisions)

Gertrud M Fremling and Richard APosner (1999) provide a more elaborateexample of this approach They sketch amodel in which an individualrsquos utilitydepends on status and nonconspicuous con-sumption In this formulation nonconspicu-ous spending is the category that summarizesexpenditures on standard consumptionitems Inserting a status argument in the util-ity function provides a reduced-form meantto capture the instrumental value of increas-ing status Agents have the same underlyingpreferences but differ in their given endow-ment of status12 Individuals allocate theirincome over nonconspicuous consumptionitems and expenditures that influence theirvariable component of status Becauseagents will forgo consumption to increasetheir status this formulation is sufficient tobe consistent with many apparent departuresfrom self interest Fremling and Posner sug-gest that dictators will not take the entiresurplus in order to signal that they are altru-istic Being known as a generous personenhances your status which will put you in abetter position to advance your material self

13 This effect should arise in the dictator game as wellso the difference in proposer behavior in the two gamesmust depend on some expectation that low offers will berejected in the ultimatum game

14 Alexanderrsquos (1987) discussion of the evolution ofmorality contains discussions consistent with the view ofFremling and Posner In his discussion of (apparently)altruistic giving on pages 159 and 160 Alexander raisesselfish motivations for generous behavior He is aware ofthe broadness of the theory and writes (page 160) ldquoIfsuch conditions seem to render the propositions virtual-ly untestable that is simply a problem that we must solveif we are to deal in a better way with the unparalleleddifficulty of understanding ourselvesrdquo

interest in the future The decision to sacri-fice nonconspicuous consumption forincreased status is a standard economictradeoff Proposers will not make low offersin the ultimatum game for the same reasonand also to avoid challenging the secondplayerrsquos status13 Responders reject lowoffers in the ultimatum game in order to sig-nal that small amounts of money are notimportant to them Voluntary contributionsto public goods arise if status is enhanced bycontributing to charitable projects

Fremling and Posner presumably wish tomaintain the Chicago tradition and basetheir explanations of differences in givenstatus rather than preferences They arguethat heterogeneous behavior arises becausedifferent agents have different endowmentsof status but their formulation provides noway to measure endowments of statusFurther this position is a bit strainedresponse to heterogeneity of laboratorybehavior since experimenters make greatefforts to suppress information about givenstatus

Fremling and Posnerrsquos model is not fullyspecified They do not provide a completeoperational definition of status The statusargument that enters their utility function isnot observable Hence there is no way inwhich it can be controlled in the laborato-ry14 They do not provide an explanation ofwhy status should enter the utility functionnor do they place substantial restrictions onthe form that it enters Yet their motivation



15 Andrew Postlewaite (1998) provides an overview ofone approach This article also argues that there are advan-tages for explicitly incorporating the reasons why status (orother intangible arguments) should matter into formalmodels rather than relying on reduced-forms

16 This interpretation suggests that differences inincome across experimental subjects would be both rele-vant for experimental results and difficult to control

is powerful and consistent with casual intu-ition There have been successful attemptsto incorporate status concerns in prefer-ences which means that one can derivepreferences like the ones proposed byFremling and Posner from a more detailedmodel15 Still the lack of guidance about howstatus influences preferences is disconcert-ing Fremling and Posner describe situationsin which conspicuous spending increasesstatus and others in which conspicuous thrift(for example buying a modest car or wear-ing unpretentious clothes) enhances statuswhich makes me suspect that ex post adjust-ments in their status variable will make theirmodel consistent with any observation

While Fremling and Posner describetheir model as a signaling model it is notcompletely clear what is being signaledImplicitly status is important because it isan observable way for third parties to learnsomething important about an individual Inthe formal model the only characteristicthat may be hidden is an individualrsquosincome If status does signal income (as itdoes in many of the informal stories) thenpresumably it is not status that enters theutility function but income (as perceived bythird parties)16 The function that trans-forms investment in status into perceivedincome would be determined as an equilib-rium of a signaling game and need not haveeven the weak properties that Fremling andPosner posit


Game theory assumes that in strategic sit-uations players act to maximize a preferencerelation over outcomes As a result theprocess by which the outcome is reacheddoes not matter I argued that models of

17 Some of the experiments reported in Charness andRabin (2002) have a similar flavor

identity and generalized commodities per-mit preferences over outcomes to depend onthe context in which the outcome wasreached Formally this means only that appears in the utility function This subsec-tion describes a framework in which thepreferences that players optimize in a gamedepend on the game itself

Context matters in a strategic situation ifpreferences over outcomes depend on thegame being played The idea is best intro-duced by an example Consider two versionsof the ultimatum game In the first versionthe proposer can make only two offers an80ndash20 split and a 20ndash80 split In the secondversion the proposer can make three offers80ndash20 50ndash50 and 20ndash80 In both of thesegames there exists an opportunity for theresponder to choose between 80ndash20 divisionand a 0ndash0 division If the responderrsquos prefer-ences depend only on the distribution ofmaterial payoffs available when she makesher decision then her decision after she hasbeen offered 20 cannot depend on whetherplayer one could have proposed an equalsplit Intuition suggests that the additionalstrategy might matter with the respondermore likely to reject the ldquounfairrdquo 80ndash20 splitwhen player one could have offered anequal division than when only unequal splitsare available The experimental results ofArmin Falk Fehr and Urs Fischbacher(2003) confirm this intuition17

Assuming equilibrium behavior there aretwo reasons why adding strategies mightinfluence the responderrsquos choice in the ulti-matum game The first possibility is thatadding strategies changes the equilibriumselection This could only happen if the sub-games in which responder decides whetherto accept or reject a proposal have multipleequilibria For appropriately defined prefer-ences over outcomes the responder may beindifferent between accepting or rejectingtwenty units out of one hundred but it is an



18 If the responderrsquos preferences over outcomes left herindifferent between 0ndash0 and 80ndash20 then for all popularparametrizations of (1) she would have a strict preferencebetween 0ndash0 and 79ndash21 Consequently a model thatexplained the experimental results on the basis of equilib-rium selection predicts that small perturbations in the setof feasible offers would dramatically change experimentaloutcomes

implausible way to explain experimentalbehavior18

The second possibility is that preferencesdepend on more than final payoffs In theultimatum game if player 2rsquos preferencesdepend only on final outcomes and she has astrict preference between accepting the80ndash20 split and turning it down then shemust make the same choice on the equilibri-um path whatever the other strategies maybe available to player 1 Hence I concentrateon the possibility that preferences over out-comes at a decision point depend on morethan just final payoffs Player 2rsquos rejection ofthe 80ndash20 offer when the equal split isunavailable is an example of destructive rec-iprocity In situations where beliefs aboutthe actions of others are irrelevant (forexample when the second player decideswhether to accept or reject an offer in theultimatum game) any descriptive modelmust permit allow preferences to depend onmore than the distribution of income

Rabin (1993) was the first to propose aspecific model of equilibrium behavior ingames where players take into account con-text to determine their behavior His formu-lation uses the theory of psychological gamesintroduced by John Geanakoplos DavidPearce and Ennio Stacchetti (1989)Psychological games permit playersrsquo beliefsto enter into their preferences In Rabinrsquosmodel the weight placed on an opponentrsquosmaterial payoffs depends on the interpreta-tion of that playerrsquos intentions He evaluatedintentions by using beliefs (and beliefs aboutbeliefs) over strategy choices Rabin pro-posed that agent i pick his strategy si in agame to maximize a function of the form

(6) ui(sislowast) = vi(O(s)) + Gi (slowast)vj(O(s))

19 Rabin (1993) assumes that the outcomes are distri-butions of money x and that vi(middot) depends only on xiCharness and Rabin (2002) relax the second assumption

In this expression G is the game slowast = (slowast

islowastj) s = (sislowast

j) vi denotes player irsquosutility function over outcomes and O(s) isthe outcome obtained if the players play s 19

Rabin interprets si as the strategy choice ofplayer i slowast

j as player irsquos beliefs about player jrsquosstrategy choice and slowast

i as what player ibelieves that player j believes about playerirsquos strategy choice In equilibrium beliefsare accurate so that j actually plays slowast

j and si = slowast

i Gi is a function of the beliefs of

player i It is this feature that makes thegame a psychological game

The utility function ui expresses irsquos prefer-ences over his own strategies (si) conditionedon expected behavior (slowast) A player seeks tomaximize a weighted average of his materialutility with that of his opponent The weightG(slowast) depends on the game being played inaddition to the strategy profile The naturalinterpretation of G(slowast) is as a measure of theextent to which player i cares about player jrsquosmaterial welfare The conventional formula-tion (G

i equiv 0) is a special case of this repre-sentation When G

i is not constant as istypically the case in Rabinrsquos model player irsquospreferences over strategies depend on morethan his preferences over outcomes thestrategic context matters Rabin presents aspecific functional form for the coefficientG

i in (6) The form of the coefficient isless important than its content G

i is posi-tive if i thinks that jrsquos behavior is nice andnegative if he thinks that the behavior isnasty In this way (6) provides a model ofintrinsic reciprocity Kind (unkind) treat-ment raises (lowers) the weight placed onopponentrsquos material payoff is preferencesmaking an agent more willing to sacrifice hisown material payoff to increase (decrease)that of his opponent

The optimization problem (4) faced byindividual agents in the generalized con-sumption model appears to include the



problem (6) as a special case There is a sub-tle difference in the way that one closes themodels to compute equilibria however Inthe strategic models agent i takes context asgiven and chooses si to maximize (6) holdingslowast fixed In equilibrium one must have s = slowastModels based on the generalized consump-tion good idea often require a consistencycondition (the condition may describe theevolution of human capital or the magnitudeof a status argument) but in general thedecisionmaker controls si as it enters bothdirectly and indirectly in (4) There is a tech-nical implication of the difference Assumingthat preferences over outcomes are linear inprobabilities the standard assumption exis-tence of equilibrium follows from standardarguments in the game-theoretic modelsExistence would not be guaranteed in theAkerlofndashKranton or StiglerndashBecker settingswithout assumptions that lead to quasicon-cavity of the reduced-form preferences in(4) The following example illustrates part ofthe problem

Example 1 Consider the game

The matrix describes the material payoffsfor a standard battle-of-the-sexes gameAssume that payoffs can be written in theform (6) with vi as given in the payoff matrixand G

i (FightFight) = Gi (OperaOpera) = 8

and Gi (FlightOpera) = G

i (OperaFight) = minus 8for i = Row and Column These weights havea natural interpretation a player who antici-pates coordination places positive weight on his or her opponentrsquos material payoffwhile one who anticipates a failure to coor-dinate blames the other player and placesnegative weight on that personrsquos payoffsAssume that the players expect the outcomeslowast = (FightOpera) Then each player willplace a negative weight on the other playerrsquospayoff and will prefer playing as expectedthan deviating That is (FightOpera) is an

equilibrium outcome When (FightOpera)is the expected outcome the man believesthat the women is planning to go to theopera even though she believes he is goingto the fight In this situation he thinks thatshe is being nasty and is willing to give upthe material value of coordination in orderto lower her payoff

Alternatively one can view the payoffsas the result of Akerlof and Krantonrsquosidentity theory Assume that preferenceshave the same representation as beforeThat is they can be written in the formui(s) = vi(s) + G

i (s)vj(s) where i ne j Gi is the

same as before and the material payoffs(v1(s)v2(s)) are given in the payoff matrixCoordination permits the man to feel incharge (if the outcome is (FightFight)) orthoughtful (if the outcome is (OperaOpera))failure to coordinate leads to negative because the man does not want to be viewedas selfish (if the outcome is (FightOpera)) orconfused (if the outcome is (OperaFight))Now the outcome (FightOpera) is not anequilibrium because given that the columnplayer is going to the opera the manrsquos bestresponse is to go there as well Doing so rais-es his material payoff and also changes hisidentity ( increases from ndash8 to 8)

The difference between the two formula-tions is that when considering a deviation aplayer can change his ldquoidentityrdquo but cannotchange his view of his opponentrsquos intentionsIn the example Rabinrsquos model had a largerequilibrium set than Akerlof and Krantonrsquosbut in general there is no relationshipbetween the two sets

The models of context-dependent prefer-ences include the interdependent prefer-ence approach The underlying preferencesvi(middot) in (6) are defined over outcomes If anoutcome specifies a material payoff to bothplayers it is permissible for vi to depend onplayer jrsquos material payoff Charness andRabin (2002) propose a functional form thatassumes that the vi are interdependent pref-erences that place positive weight on jrsquosmonetary payoff (with the weight changing

Fight

Opera

Fight

21

00

Opera

00

12



to reflect concern for the player with the lowest monetary payoff) Falk andFischbacher (2005) also attempt to separateconcerns for equity and concerns for inten-tions Their model contains a ldquopure out-come concern parameterrdquo This numbermeasures the degree to which a playerrsquospreferences in the game depend only on theoutcome and not on the context in which itwas obtained At one extreme a playercares only about the outcome In this caseFalk and Fischbacherrsquos (2005) model hasthe flavor of the models of Bolton andOckenfels (2000) and Fehr and Schmidt(1999)

Since the approach outlined in this sub-section generalizes the interdependent pref-erence approach without restrictions it hasbroader descriptive powers To the extentthat preferences over outcomes depend onthe game reciprocity models provide insightinto the observations

There is substantial experimental evi-dence that the distributional approach is notsufficient to explain and organize experi-mental findings which suggests that it wouldbe worthwhile investigating models of intrin-sic reciprocity

Ken Binmore John McCarthy GiovanniPonti Larry Samuelson and Avner Shaked(2002) compare one- and two-stage alterna-tive-offer bargaining games in an effort totest whether experimental subjects obeybackward induction for these games Thepaper observes that subgame-perfect equi-librium strategies played by agents withinterdependent preferences satisfy back-ward induction They discover systematicdepartures from backward induction whichis evidence against the hypothesis of equilib-rium behavior with interdependent prefer-ences Context-dependent models permitpreferences over outcomes to depend uponhow one reached the outcome Hence theexperimental results of Binmore McCarthyPonti Samuelson and Shaked do not con-tradict these models The fact that thesemodels are consistent with experimental

20 Uzi Segal and Joel Sobel (2004) show that dominancearguments have power to rule out some predictions ingames governed by preferences represented by (6) butthese restrictions are weak

results is a tribute to their flexibility ratherthan actual support for the formulation 20

Miguel Costa-Gomes and Klaus GZauner (2001) analyze data from ultimatumgame experiments and estimate utility func-tions of the form vi + λvj under the assump-tion that agents play an equilibrium to agame with perturbed preferences Theirmethod contains an indirect test of the pureinterdependent preference approach In allterminal nodes in which the second playerrejects the proposal monetary payoffs arethe same (zero for each player) If the coef-ficient λ does not depend on actions thenthe estimated variance in the error termshould be the same after all rejections Thisis not the case providing some evidence thatpreferences depend not just on the outcomebut on how the outcome was reached

There are other ways to demonstrate thatpreferences depend on more than the finaldistribution of wealth Yoella Bereby-Meyerand Muriel Niederle (2005) compare out-comes of three-player games The first play-er proposes a division of a fixed quantitybetween himself and the second player Thesecond player either accepts or rejects thisproposal The third player is nonstrategic Ifthe second player accepts then the first andsecond players get paid according to the pro-posal (and the third player receives nothing)If the second player rejects then (dependingon the treatment) either the first or the thirdplayer receives a payment while the othertwo players receive nothing Bereby-Meyerand Niederle find that the second playerrsquosbehavior depends both on the quantity ofthe payment given following a rejection andwho receives this payment The second play-er is more willing to reject a small offer whenshe knows that doing so will not lead to ahigh payoff for the proposer (either becausethe rejection payment is low or because thethird player receives the payment) To



explain this behavior with some form ofinterdependent preferences the secondplayer would not only need to have prefer-ences that depended non trivially on themonetary payoffs of others but she wouldneed to weigh an opponentrsquos monetary pay-off differently depending on his role in thegame Models that permit preferences overstrategies to depend on strategy choices pro-vide a convenient way to capture the intu-ition that the second player might be willingto sacrifice her material payoff in order topunish player one when the first playermakes a small offer Naturally the ability topunish (and therefore the second playerrsquosaction) depends on whether the first or thirdplayer receives a payment after a rejection

James C Cox (2004) compares the out-comes of three related games designed toseparate predictions from different modelsdesigned to identify the source of nonselfishbehavior in experimental trust games In thebasic experiment (Treatment A) subjects aredivided into two groups Those in the firstgroup receive $10 and decide how much tocontribute to a member of the second groupThe member of the second group receivesthree times the contribution Finally mem-bers of the second group can return any partof the transfer he or she received (All trans-fers are anonymous) In Treatment B mem-bers of the first group decide on transfers asin the Treatment A while members of thesecond group do not have a move In theTreatment C members of the first group donot move Instead experimenters make thesame contributions that were made in theTreatment A (and subtract the appropriateamounts from members of the first group)Members of the second group receive trans-fers as in the Treatment A are told how thetransfers are generated (and how they influ-ence the endowment of first movers) andthen decide how much to return The con-trast between the results of Treatments Aand C present the evidence most relevant tothe power of the interdependent prefer-ences to describe outcomes If the second

mover cares only about the distribution ofpayoffs then contributions should be thesame in these two treatments They are notThe second mover tended to return moremoney in Treatment A The differencebetween the amount returned is largest afterlarge transfers suggesting that in part thesecond mover acted to reward intentionallygenerous behavior

In contrast to the models that focus oncontext adding strategies to a game does notinfluence a playerrsquos preferences over the out-comes in the original game in Levinersquos (1998)set up When players are uncertain abouttheir opponentsrsquo preferences however play-ers may try to use their actions to signal theirpreferences The inferences one playerdraws about his opponentrsquos payoffs dependon the strategies available Consequentlyobserved preferences over outcomes dependon the strategic context in Levinersquos model(because changing the set of available strate-gies can change the signaling content ofstrategy choice)

Expanding the set of arguments in theutility function as in the models of sections32 and 33 is consistent with standard deci-sion theoretic methods The new argumentsin utility functions are externalities and fullycaptured by expanding the definition ofcommodity The models in this subsectionare not traditional One attempt to returnthe models to the standard framework is toredefine the notion of an outcome If theway in which one arrives at an outcomeinfluences preferences then the outcomeshould include that information Formallyan outcome would need to include a descrip-tion of the entire game and an anticipatedstrategy profile Specifically the 80ndash20 offerin the ultimatum game leads to an outcomethat not only specifies that player onereceives 80 and player two receives 20 butalso the existence of other possibilities avail-able to the first player This transformation islogically possible but hardly useful Notefurther that the representation (6) specifiespreferences over player irsquos own strategies



conditional on a strategy profile s it is not autility function defined over outcomes Afterredefining the outcomes one would need toextend the preferences to this new space

There are several problematic aspects ofmodels based on context-dependent prefer-ences The most basic problem is the speci-fication of Charness and Rabin (2002)Martin Dufwenberg and Georg Kirchsteiger(2004) Falk and Fishbacher (2005) andRabin (1993) present explicit functionalforms for all motivated by plausible intu-itive arguments and appeals to selectedexperimental evidence but no one hasdescribed observable behavioral assump-tions on that best describe behaviorWithout a model of this parameter Segaland Sobel (2004) demonstrate that the theo-ry that makes few definitive predictionsabout behavior

Another problem is identification It shouldbe possible to separate preferences repre-sented by vi and ui in (6) through revealedpreference analysis Observation of decisionsmade in a nonstrategic setting determine viObservations of decisions made in a strategicsetting determine ui Adding incompleteinformation about preferences complicatesthis exercise however On the other handmany different combinations of material pay-offs vi and weight will lead to the samebehavior in strategic settings Looking only atchoice behavior in games it will not be possi-ble to separate preferences for reciprocityfrom preferences over outcomes

The third problem deals with the inter-pretation of mixed strategies The behav-ioral interpretation of deliberaterandomization is somewhat strained becauseit requires a player to select a precise weighton each pure strategy in spite of being indif-ferent over at least two pure strategiesHence it is often attractive to interpretmixed-strategy equilibria as equilibria inbeliefs The important idea is that in somesituations an agent must be uncertain aboutthe pure-strategy choice of his opponent inequilibrium but that uncertainty may be the

result of incomplete information regardingthe opponentrsquos characteristics rather thandue to conscious randomization on the partof the opponent In standard game theorythe characterization of equilibrium does notdepend on the interpretation of mixedstrategies In games where a playerrsquos prefer-ences depend on the intentions of his oppo-nent the interpretation matters A simpleexample taken from Segal and Sobel (2004)makes the point clearly


Column is a plumber and Row is a home-owner with a leaky faucet The plumber cancome in the AM or in the PM while thehomeowner can arrange to be at home in theAM in the PM or ALL day The plumberearns 10 if she coordinates with the home-owner but nothing otherwise The home-owner receives a payoff of 10 if he can meetthe plumber and only cancel half of hisappointments he receives 7 if he stays homeall day he receives 0 is he fails to coordinatewith the plumber If playersrsquo preferencesover strategies agreed with their preferencesover outcomes then the game has threeequilibrium outcomes (AMAM) (PMPM)and a continuum of equilibria in which thehomeowner stays home all day and theplumber places probability of at least 3 oneach pure strategy

Now assume that the homeowner haspreferences over strategies that lead him toput a positive weight on the plumberrsquos payoffin response to nice behavior (apparent coor-dination) and a negative weight in responseto nasty behavior (Assume that the plumbercares only about her own payoffs) Clearlythe two pure-strategy equilibria from thegame with standard preferences will contin-ue to be equilibria But if randomization by

AM

PM

ALL

AM

1010

00

710

PM

00

1010

710



the plumber is purposeful then the home-owner may well think that a plumber whorandomizes equally between AM and PM isnasty because this behavior minimizes theprobability of coordination With a suffi-ciently negative weight on the plumber pay-offs the homeowner may prefer to playeither AM or PM rather than to stay at homeall day Consequently there may be an equi-librium in which both the homeowner andthe plumber randomize equally betweenAM and PM while ( ) isno longer an equilibrium

The above analysis depends on the inter-pretation of mixed strategies In many appli-cations it is appropriate to treat thehomeowner as if he is matched against apopulation of plumbers some with a ten-dency to come in the morning others with atendency to come in the afternoon If thehomeowner does not attribute his uncertain-ty to a deliberate strategy of the plumberthen it is reasonable to assume that he doesnot place a negative weight on the plumberrsquospayoff In this case however there will be anequilibrium in beliefs in which the home-owner always stays at home (and he believeswith probability greater than 3 that theplumber will come at any time)

Many of the motivations for the impor-tance of context and intentions are intrinsi-cally dynamic but dynamic considerationsdo not play a role in the basic formulationDufwenberg and Kirchsteiger (2004) andFalk and Fischbacher (2005) study exten-sive-form games They argue that the strate-gic-form approach of Rabin does not lead togood predictions in extensive-form gameslike sequential prisonerrsquos dilemma gamesSince it is possible to represent any exten-sive-form game in strategic form the modelapplies to extensive-form games for standardreasons Even for standard game theorythere is dispute about whether this transfor-mation loses information This issue is morecomplicated when intentions matter

In standard examples the notion of recipro-cal preferences tends to increase the number

ALL AM PM 12

12+

21 Segal and Sobel (2004b) formalize the intuition thatallowing playersrsquo preferences to depend on context generallyenlarges the set of equilibria

22 This formulation leaves open how the other I minus 1players arrive at best responses and what to do when thebest response correspondence is not single valued

of equilibria Multiple equilibrium problemsare possible but less pervasive for the para-metric models of extended preferences usedin the literature Coordination problems arisewhen preferences are interdependent Playerscan get stuck in nasty equilibria in which theyexpect nasty behavior from their opponentsand get it or in nice equilibria in which posi-tive expectations are fulfilled21 While theexistence of multiple equilibria may be usefulin applications the possibility broadens the setof possible predictions from the theory so thatequilibrium analysis places few restrictions onobservable behavior

35 Commitment

Allowing commitment changes the equi-librium concept rather than the specificationof preferences A player with commitmentpower selects his strategy to maximize afunction of the form

(7) ui(siBRi(si))

where BRi(si) is the strategy profile of bestresponses for all other agents taking irsquos strat-egy as given22 Commitment models are con-sistent with more general specifications ofpreferences In the ultimatum game if a self-ish responder had full commitment powerthen she would announce that she wouldonly accept s = 1 and the proposer could dono better than to offer her the entire surplusExperimental results in the ultimatum gameare broadly consistent with the hypothesisthat the responder has partial commitmentpower but merely assuming commitmentability is not sufficient to handle a broaderrange of empirical regularities

The solution slowasti of problem (7) typically will

not be a best response to the strategy choices ofthe other players That is commitment behav-ior is not consistent with Nash Equilibrium I



23 That is if equilibrium strategies specify the actions slowast

in a given period then there is no reason to expect that slowasti

solve maxsiui(sislowasti)

find it more useful to assume that all feasiblecommitment abilities are described in thespecification of the strategic environment

36 Repeated Games

The theory of repeated games provides aconventional framework in which to explainapparently unselfish behavior In an infinite-ly repeated game agents play a given staticgame observe its outcome and then playthe game again and again without endPayoffs for the repeated game are discount-ed sums of the individual static-game pay-offs Strategies are rules that specify how toplay in each repetition as a function of pastbehavior Repeated games typically havelarge sets of equilibria The folk theorem ofrepeated games states roughly that any fea-sible individually rational payoff for thestage game can be obtained as a subgame-perfect equilibrium payoff for the associatedinfinitely repeated game

To compare repeated games to the earlierapproaches consider a reduced-form descrip-tion in which player i selects a stage-gameaction si to maximize

(8) (1 minus )ui(sisi) + Vi((s))

where ui(s) is player irsquos stage-game payofffunction isin (01) is a discount factor describes the history of play and Vi() givesthe continuation (average) value given histo-ry In this formulation the continuationvalue function is endogenous Thanks to thefolk theorem however there are few restric-tions on Vi So although it is not possible tostate that models of repeated interaction areformally identical to those based on generalconsumption goods it is clear that if Vi cantake an arbitrary individually rational andfeasible payoffs and is close to one there isno reason that an equilibrium action choicefor player i will be a myopic best response tothe actions of his opponents23

24 The anthropologists (for example Sahlins 1968 andService 1966) studying exchange clearly recognize thismotivation

In a repeated interaction an agent exclu-sively interested in his material consumptioncould rationally forgo short-term utility inorder to obtain future benefits If an appar-ently unselfish action is part of a repeatedinteraction between patient agents then thefolk theorem of repeated games can explainthe observation as a part of equilibriumbehavior between selfish agents The logic ofthe folk theorem is the logic of instrumentalreciprocity24 Individuals forgo their short-term selfish gains because being nice (ormore precisely and more generally playingtheir equilibrium strategy) will lead to nicetreatment in the future Punishing nastybehavior serves to discourage nasty behaviorbut punishment only occurs because playersfear that a failure to punish will lower theirfuture payoffs This argument requires thatthe actions an agent takes today influenceshis future payoffs and that the influence issufficiently great to counter short-termincentives

Embedding an interaction into a repeat-ed-game setting is a powerful and acceptedway to describe behavior that when viewedwith a static perspective appears to beinconsistent with selfish behavior Like theapproach of generalizing consumptionrepeated game theory forces the observer toask ldquoWhat does that player stand to gainrdquo ina way that often leads to useful insights

The approach has limits I discuss some ofthem now

Because laboratory experiments carefullycontrol for repeated-game effects theseresults need a different explanation

In order for conventional repeated-gamearguments to apply the future must beimportant Agents must be patient andthere must be opportunities to reward andpunish todayrsquos behavior When these condi-tions fail theory predicts a return to myopicselfish behavior Relationships do end and



25 Classic treatments are Dilip Abreu (1988) and DrewFudenberg and Eric Maskin (1986)

while it is easy to find evidence of myopicself interest at the end of relationships it isalso easy to cite examples of employees whodo not shirk as retirement approaches andfamilies that stand by dying relativesFitting this behavior into an individualisticrepeated-game framework is possible butawkward

Repetition increases the range of equilibri-um behavior because it creates the possibili-ty of punishment Punishment may be costlyfor the punisher as well as the punished Ifso the question arises Why should anyonepunish The theoretical answer is Peoplepunish because otherwise they will be pun-ished themselves Of course the argumentmust be repeated to ensure that people arewilling to punish the punishers of the pun-ishers and so on Theory provides elegant jus-tification for this answer25 The theory is lessdirect and perhaps less convincing than theanswer supplied by models of intrinsic reci-procity Punishment arises because peopleget utility directly from lowering the welfareof people who have hurt them

Repeated-game theory incorporatesstrategic context not by changing prefer-ences but by changing the way people playIn order to obtain equilibria distinct fromrepetitions of equilibria of the underlyingstatic game the history of play must influ-ence future play History does not influencepreferences but it does influence expecta-tions about behavior The principle of sub-game consistency would require play in asubgame to be independent of where thesubgame arises in a larger game One mustabandon subgame consistency to in order topredict repeated-game behavior distinctfrom repetitions of static equilibria

Conditioning on history is so descriptivethat there is little resistance to abandoningsubgame consistency There is some supportfor adopting a weaker principal Some histo-ries may trigger punishments that are bad

26 Abreu Pearce and Stachetti (1993) and JosephFarrell and Maskin (1989) are two approaches

for all players For example the ldquogrim trig-ger strategyrdquo specifies that players neveragain cooperate following a noncooperativeaction in the prisonerrsquos dilemma The princi-pal of renegotiation proofness identifies a setof possible (renegotiation-proof) equilibri-um payoffs with the property that no payoffsin the set are Pareto-dominated by otherpayoffs in the set The logic behind this def-inition is that if players are able to ldquorenegoti-aterdquo at the beginning of each period on theequilibrium that they will play then they willnever agree to play an equilibrium that isPareto inferior to another equilibriumRenegotiation proofness says in effect thathistory can influence future play but no his-tory can induce players to select inefficientcontinuation The idea is controversial (theweaker position that players will not play anequilibrium whose payoffs are Pareto domi-nated by another equilibriumrsquos payoffs isalready controversial for one-shot games) Itis not straightforward to define renegotiationproofness in infinitely repeated games andthe restrictions imposed by renegotiationproofness do not lead to more descriptivepredictions26

Finally repeated game theory providespredictions consistent with many observa-tions and also gives strong intuitions aboutqualitative features that increase the possibil-ity of cooperation But repeated games havetoo many equilibria and the selection processis often tailored to particular examples Thetheory as it is typically used does not produceinteresting refutable hypotheses

4 Using the Models

This section describes several economicsettings in which narrow notions of self-interested behavior provide limited insightThese examples provide further evidence insupport of developing models that assumeextended preferences and illustrates the way



27 Andreoni (2001) is a survey

in which the different approaches of section3 provide alternative predictions

41 Charity

It is difficult to rationalize charitablecontributions as optimizing behavior froman individual who cares only about materialwealth Nevertheless people do makecharitable contributions

Contributions appear to be sensitive tothe economic environments in ways that areconsistent with conventional theory27 Forexample changes in tax laws that reduce themarginal cost of giving increase the amountof giving Social psychologists have discov-ered factors that influence contributionsthat are less obvious consequences of stan-dard economic assumptions For exampleRobert C Cialdini and Melanie R Trostrsquos(1998) review essay suggests that contribu-tions increase in response to small gifts fromthe charity There is also evidence that con-tributions are an increasing function of thecontributions of others These predictionsare less obvious consequences of standardeconomic assumptions

The models of section 3 suggest differentreasons why people give to charity Thesemodels make different predictions aboutwhat influences charitable giving and in prin-ciple can be distinguished This section dis-cusses some theoretical models of charitablegiving and relevant experimental evidence

Altruism modeled as one agent placingvalue on the material welfare of others pre-dicts positive contributions that decline withthe contributions of third parties This is thecrowding-out effect The crowding-outeffect should be strengthened if agents havedistributional preferences If agents aremotivated to give because they wish to raisethe income of the poor then the more thatthe poor receive from others the lower thevalue of direct transfers The distinguishingfeature of this kind of explanation is thatpeople care about the distribution of 28 If j gains income from third parties the marginal

value of a contribution by i to j should not increase The lit-erature assumes that contributions will actually decreasethis prediction would not hold for linear preferences

income but they do not care about thenature of transfers that determines incomedistribution28

James Andreonirsquos (1990) warm-glow theo-ry of charitable giving fits within the tradi-tion of preferences over generalconsumption goods Andreoni assumes thatagents obtain utility by contributing to oth-ers Agent irsquos utility depends on agent irsquosmaterial consumption and how much hecontributes to other agents Preferencesdepend on not just the distribution of mate-rial goods but on how one arrives at the dis-tribution of material goods Andreonirsquosmodel is qualitatively different from model-ing altruism by simply assuming prefer-ences place positive weight on otherpeoplersquos consumption as in the models ofinterdependent preferences In distribu-tional models i cares about irsquos income butnot the source of the income If jrsquos incomeincreases then (under the standard assump-tion of diminishing marginal utility) i wouldbe less willing to give money to j InAndreonirsquos model i derives utility from con-tributing In the purest formulation irsquos con-tribution would be independent of irsquosincome in contrast to the prediction ofmodels based on altruism

Robert Sugden (1984) provides a model ofcharitable giving based on intrinsic construc-tive reciprocity Sugden assumes that agentsfeel an obligation to contribute With this(nonstandard) assumption Sugden is able toanalyze his model using conventional meth-ods The most interesting result is thatbecause obligations are assumed to beincreasing functions of the contributions ofothers there will be a positive relationshipbetween onersquos contribution and the (expected)contribution of others

Hence one obtains a different predic-tion about the relationship between the



29 Andreoni (1995) and Thomas R Palfrey and JefferyE Prisbrey (1997) study experiments designed to distin-guish giving due to altruism warm-glow effects and mis-takes Both papers find evidence of warm-glow givingPalfrey and Prisbreyrsquos design convincingly demonstratesthat apparently altruistic behavior is due to mistakes

30 See Oliver Hart (1995) for an overview of the problemand its implication

contributions of others and onersquos own con-tributions depending upon the underlyingtheory Altruism and more general distribu-tional approaches predict that an individualcontributes less when others contributemore Warm-glow models predict that anindividualrsquos contribution does not dependon the contribution of others Sugdenrsquosmodel of giving based on reciprocity pre-dicts that an individualrsquos contributionincreases with the contributions of othersEmpirical evidence from Cialdini and Trost(1998) and Rachel T A Crosonrsquos (1999)experiments therefore provide evidenceagainst the simplest models of altruism orthe warm-glow hypothesis29

42 Incentives and Effort

The hypotheses of greed and equilibriumform the basis of powerful theories of con-tracting which in turn make predictionsabout how firms should design internal com-pensation schemes and trade with suppliersThese predictions do not hold in simpleexperiments designed to reflect natural set-ting and do not appear to hold in many nat-ural settings Consequently there is a role forthe kinds of models described in section 3

421 The Hold-Up Problem

The hold-up problem has become animportant toy model of bargaining betweenworkers and firms30 It has been used as thefoundation for theories of the internal organ-ization of the firm Yet there is substantialreason to be skeptical of the predictions ofthe model

In the simplest hold-up model the firstagent makes a costly investment The invest-ment increases the value of an object to thesecond agent (but not the objectrsquos value to

31 These predictions are sensitive to modeling assump-tions Tore Ellingsen and Jack Robles (2002) point out thatadaptive dynamics do not avoid efficient outcomes FarukGuumll (2001) suggests that the standard results are sensitiveto the information structure and assumptions about thebargaining process

the first agent) The second agent makes atake-it-or-leave it offer to the first agentAssuming that agents maximize their mone-tary payoff the subgame-perfect equilibri-um predicts that there will be no investmentThe second agent will purchase the item atthe first agentrsquos reservation price Typicallypositive investment is efficient31 The litera-ture focuses on institutional arrangementsthat reduce or eliminate the inefficiency

The standard analysis points out that ifagents can commit to a complete contractthe first agent can be given proper incen-tives to invest The literature on incompletecontracts argues that complete contracts areinfeasible if agents have asymmetric infor-mation or unenforceable if agents are free torenegotiate and third parties lack informa-tion needed to enforce the contracts The lit-erature then argues that ownership patternsand internal organization of firms arise tosolve or lessen hold-up problems Assumingthat the predictions of the hold-up modelwith selfish agents are valid the standardapproach provides a coherent framework inwhich to study the nature of firm boundarieswhen complete contracting is not feasible

There have been many attempts to studyproperties of simple hold-up games in exper-imental environments The game underlyingthe hold-up problem has the same structureas the gift-exchange game introduced in arti-cles by Fehr Kirchsteiger and Arno Riedl(1993) and Fehr Erich Kirchler AndreasWeichbold and Gaumlchter (1998) In the firststage the firm offers the wage w to theworker In the second stage the worker caneither reject the offer (leading to zero mon-etary payoff to each player) or accept theoffer If the worker accepts the offer hemust then choose a level of effort e There isa monetary cost associated with effort but it



32 When the monetary payoff to the firm is (v minus w)e thefirmrsquos choice of wage is not determined in equilibrium

increases the profits available to the firmFor example monetary payoffs conditionalon an accepted offer could be (v minus w)e forthe firm and w minus c(e) for the worker wherev is a redemption value set by the experi-menter and c is the workerrsquos cost of effortIf the worker maximizes his material payoffthen he would choose e = 0 since the firmcannot condition wages on output32

Experimental subjects violate standard theo-ry In the laboratory wage offers are typical-ly positive and effort supplied is anincreasing function of the wage

Charness and Ernan Haruvy (2002)attempt to identify the cause of the increas-ing relationship between wages and effortThey compare the workerrsquos behavior whenwages are set by the firm as in the originalgift-exchange model or by an externalprocess In the treatments where wages aredetermined through an external processthey were drawn from a bingo cage or set bythe experimenter In Charness and Haruvyrsquos(2002) study effort increases with wageswhen the firm sets wages but is relatively flatotherwise This provides evidence that mod-els based on interdependent preferences arenot sufficient to describe the workerndashfirmrelationship Preferences depend on theprocess by which workers receive theirwagesmdashnot on the wages themselves

These experiments suggest a reconsidera-tion of simple contracting environments Fehrand Schmidt (2000) present an experimentalstudy of a simple contracting environmentThe agentrsquos effort net of wages determines theprincipalrsquos monetary payoff The agent earnsher wages net of effort costs Fehr andSchmidt permit the principal to offer two dif-ferent kinds of contract An explicit contractspecifies a wage a target effort level and afine The agent receives her wage and if hereffort is less than the target then she pays thefine with positive probability An implicit con-tract specifies a wage a target effort and a

33 Antonio Cabrales and Charness (2000) obtain similarresults

bonus The agent receives her wage Afterobserving the agentrsquos effort choice the princi-pal decides whether to pay the bonus Fehrand Schmidt assume that the principal mustpay an additional (small) cost to propose anexplicit contract Assuming that players maxi-mize their monetary payoffs in nontrivialspecifications subgame-perfect equilibriumpredicts that the principal will offer an explic-it contract If the principal offers an implicitcontract the agent will expect to receive nobonus independent of her effort choice andwill therefore not agree to work An explicitcontract typically can induce positive effortlevels Fehr and Schmidtrsquos principals opted foran explicit contract in fewer than 15 percentof the trials with the frequency declining overtime Principals made more money when theyoffered implicit contracts which induced pos-itive effort levels and positive bonuses Fehrand Gaumlchter (2002) compare the performanceof explicit to implicit contracts in a similarenvironment where the choice of contract is atreatment rather than a choice variable of theprincipal They find that the implicit contractsperform better than explicit contracts in anespecially strong sense agents cooperate lessat a given level of compensation if they face acontract that fines them for shirking33

The results of the contracting experimentsare consistent with observational studiesGeorge Homans (1953 and 1954) observed agroup of workers who systematically exceededminimum work standards without apparenteconomic incentive for doing so Truman FBewley (1999) conducted extensive surveys ofmanagers His informants (managers) empha-size the importance of maintaining moraleReducing wages is costly to firms because itleads to lowered worker morale which in turnreduces workersrsquo productivity Bewley arguesthat high-powered incentives (wages andbonuses) are not an effective means of moti-vating workers Bewley (1999 page 407) findslittle support for the standard paradigm in his



34 Robert M Solow (1979) also argues that sociologicalfactors contribute to downward wage rigidity

interviews with managers He describes thehold-up model as ldquofancifulrdquo and states bluntlythat ldquothe hold-up problem hardly exists itis not a consideration in labor relationsrdquo Partof the explanation for the failure of the hold-up model is that productivity depends uponthe attitudes that workers have toward eachother and to the firm and that incentiveschemes are selected with this in mind

Employers opt for contracts that create therisk of hold up but that workers do not takefull advantage of this opportunity Inefficiencyarises but not to the extent that theory pre-dicts Furthermore it does not pay to makecontracts as complete as possible At the mar-gin there appears to be an important trade offbetween contractual incompleteness andapparently unselfish behavior

Theories of internal organization of firmscould benefit from an emphasis on inten-tions rather than on contracts and informa-tion Akerlof (1982) is a good example of thepotential of this approach Akerlof usesHomanrsquos (1953 and 1954) studies of clericalworkers in the early 1950s to motivate amodel of labor markets that shares many fea-tures with the identity model that he laterdeveloped with Akerlof and Kranton (2000)In the model the firm offers a fair wage thewage generates good feeling among theworkers who in turn work more than theminimum required by the firm Workersrsquoutility may be increasing in effort in thismodel due to a desire to conform to a normof behavior The firmrsquos decision to pay a fairwage is a profit maximizing response to thestrategic environment34

422 Intrinsic versus Extrinsic Rewards

Economic theory emphasizes the impor-tance of incentives Providing rewards con-tingent upon effort or positive performancedirectly encourages positive effort Whilethere is substantial evidence consistent withthis point of view there is also an argument

35 Edward L Deci and Richard M Ryan (1985) surveythe literature in social psychology

that explicit rewards may have the adverseconsequence of crowding out the agentrsquosintrinsic motivation for performing the task35

The social psychology literature containsexperiments that demonstrate the possibilitythat people provided with extrinsic rewardswill devote less effort to a task than peoplenot provided with explicit incentives A rep-resentative study (Mark R Lepper DavidGreene and Richard E Nisbett 1973) meas-ured how the willingness of children to par-ticipate in a drawing activity depended onwhether the activity had been rewarded inthe past Children given extrinsic rewards forthe drawing activity were less likely thanother children to participate in the activityafter the reward had been withdrawn Socialpsychologists interpret this result as a signthat the existence of an explicit rewardinhibits the subjectrsquos ability to get intrinsicenjoyment from the activity The experimen-tal evidence on contracting is preliminary evi-dence that similar results arise in economicenvironments

Two approaches from economics providea framework for intrinsic rewards based oninformational asymmetries The work ofBengt Holmstroumlm and Paul Milgrom (1991)on multidimensional agency problems sug-gests that high-powered incentive schemesmay encourage agents to devote effort intoactivities that lead to immediate or observ-able outputs In this model agents respondto extrinsic rewards by allocating effortinefficiently

Roland Beacutenabou and Jean Tirole (2003)assume that the principal has information rel-evant to the agent Any incentive contractoffered by the principal has the potential toconvey this information to the agent Forexample if the principal has superior infor-mation about the difficulty of the job then acontract that promises a high-reward contin-gent on success of a project might convey themessage to the agent that the job is distasteful



Beacutenabou and Tirole present models in whichthe incentive offered by the principal may sig-nal to the agent that the task is an onerousone In their basic model increasing compen-sation increases the probability that an agentwill supply effort but also signals to the agentthat the job is distasteful or that effort isunlikely to lead to success

Uri Gneezy and Aldo Rustichini (2000aand 2000b) present evidence for explicitincentives having counterintuitive influencesin laboratory and natural experimentsGneezy and Rustichini (2000a) show that theimposition of an explicit penalty for failing topick up a child on time at a day-care centerleads to a decrease in the number of peoplewho pick up their child on time Gneezy andRustichini (2000a) describe experimentsthat show the level of performance in a taskis not monotonic in monetary rewardsGneezy and Rustichini suggest that a mech-anism similar to the one described byBeacutenabou and Tirole is at work The incentivescheme conveys information to the agentwhich leads to a counter-intuitive responseIn the day-care setting of Gneezy andRustichini (2000b) for example imposing amodest fine for late pick ups could lower theagentrsquos subjective probability that an evenmore severe penalty would be imposed

These models of negative aspects ofextrinsic rewards focus on information asym-metries In Holmstroumlm and Milgrom (1991)rewarding observable performance mayinduce suboptimal allocation of effort InBeacutenabou and Tirole (2003) explicit incen-tives provide information that may lead to arational agent to update his opinion aboutthe attractiveness of a task

The psychology literature suggests thatcrowding out does not depend on the abilityof incentive schemes to convey informationabout the task but instead argues that incen-tive schemes change preferences in system-atic ways Bewley (1999) and David MKreps (1997) support this point of viewSpecifically Bewley discusses three ways by which managers motivate workers

Direct exchange is standard monetary (extrin-sic) incentives Indefinite exchange describesimplicit but material payoffs Internalizationis a change in preferences brought about bythe work environment If firms treat workersnicely then the workers start to care aboutthe objectives of the firm Employees becomepart of the team and work to advance thefirmrsquos interests Bewley suggests that firms donot lower wages because doing so woulddestroy the basis for voluntary cooperationIntrinsic reciprocity focuses attention on therole that incentive schemes play in preferenceformation Models based on intrinsic reci-procity permit a firmrsquos behavior to induce itsworkers to obtain satisfaction from directlycontributing to the firmrsquos profitability

43 Markets and Selfishness

Do markets cause selfish behavior Somehave argued that they do Samuel Bowles(1998 page 89) observes that the more theldquosituation approximates a competitive (andcomplete contracts) market with manyanonymous buyers and sellers the lessother-regarding behavior will be observedrdquoIn his comparative study of the developmentof markets in Indonesian villages CliffordGeertz (1963 page 34) writes that ldquothe gen-eral reputation of the bazaar-type trader forlsquounscrupulousnessrsquo lsquolack of ethicsrsquo etc aris-es mainly fromrdquo asymmetry of roles in retailmarkets Balance is more difficult to main-tain in asymmetric transactions so coopera-tion based on reciprocity is more difficult tosustain The reciprocity that facilitates coop-eration in symmetric transactions does notthrive in market settings36

36 On the other hand the experiments that JosephHenrich and his associates (2001) performed in differentsocieties led these authors to conjecture that cooperationin simple experimental games is positively related to thedegree of market integration They argue that experimen-tal subjects apply strategies that succeed outside the labo-ratory to novel experimental games Subjects moreexposed to situations where there are substantial gainsfrom cooperation or where application of fairness normsare important for success will be more likely to exhibitcooperative behavior in the laboratory



37 This treatment is a variation on the best-shot game ofGlenn W Harrison and Jack Hirshleifer (1989)

Results of experiments designed to modelcompetitive situations are consistent withpredictions of self interest Vesna Prasnikarand Roth (1992) studied a variation of theultimatum game with many proposers Theproposers simultaneously make an offer Ifthe responder accepts the offer pi from pro-poser i then proposer i earns $10 minus pi theresponder earns p and the other proposersearn 0 If the responder rejects all offersthen all players earn nothing Hence thedesign adds competition between pro-posers Subgame-perfect equilibrium pre-dicts that the responder will receive (nearly)all of the surplus Experiments confirm thisprediction

Andreoni Paul M Brown and LiseVesterlund (2002) identify a related experi-mental environment in which standard pre-dictions are confirmed and compare theresult to similar games in which experimen-tal results are not consistent with narrowversions of self interest They consider atwo-player game in which the monetary pay-off of player i is T minus ci + iG(ƒ(c1c2)) whereT is an initial endowment ci is player irsquos con-tribution i gt 0 is a measure of a playerrsquosmarginal utility of the consumption goodƒ aggregates the contributions and G isan increasing concave transformation of thetotal contribution Andreoni Brown andVesterlund (2002) assume that 1 gt 2 anddistinguish three games In the first ƒ(c1c2) = c1 + c2 and players move simultane-ously The second treatment uses the sameƒ but is a sequential game player onemoves first and then player two knowing thefirst playerrsquos contribution moves secondThe third treatment is like the secondexcept that ƒ(c1c2) = max(c1c2)

37 In the firsttreatment the Nash equilibrium predictsthat the second player will contribute noth-ing while in the second and third treat-ments the first player contributes nothing in

38 The predictions for the second and third treatmentsrequire that 1 is not too much greater than 2

39 Since the second player responds differently whenplayer one fails to make a contribution in the second andthird treatment theories that rely on preferences thatdepend only on the distribution of monetary payoffs willnot make predictions consistent with the experiments

a subgame-perfect Nash equilibrium38

Andreoni Brown and Vesterlund (2002)find that players make positive and roughlyequal contributions in treatment one con-tributions are positive for player one andslightly greater for player two in treatmenttwo while in the third treatment experi-mental behavior roughly conforms to thesubgame-perfect Nash equilibrium theory(with the first player making no contribu-tions) In the third treatment the secondplayer is much less likely to punish a freerider (by responding to a zero contributionwith a zero contribution) than in the game inwhich contributions are additive

From the perspective of intrinsic reci-procity the third treatment is qualitativelydifferent from the first two Since the sec-ond player receives a higher marginal utili-ty from the public good she can see that inthe third treatment any ldquosensiblerdquo contribu-tion made by the first player will be wast-edmdashthe second player will want tocontribute even more making the value ofthe first contribution zero Hence the mag-nitude of player onersquos contribution shouldnot influence player tworsquos preferences overfinal outcomes It is reasonable to expectplayer tworsquos material preferences to deter-mine her behavior In the first and secondtreatment player onersquos strategy can influ-ence player tworsquos material payoff39 It is nothard to specify preferences in the form (6)that are consistent with experimentalresults Agents act as if they were selfish inthe third treatment because the form of thegame prevents player from exhibiting thekind of nice or nasty behavior that mighttrigger deviations from selfishness

The evidence that markets behave as stan-dard theory predicts in experimental settings



motivates research to identify weakerassumptions under which the predictions ofthese models continue to hold Beckerrsquos(1962) observation that budget-constrainedindividuals with randomly generateddemands lead to downward sloping demandcurves and Dhananjay K Gode and ShyamSunderrsquos (1993) work on auction perform-ance with ldquozero-intelligencerdquo agents areexamples

Bolton and Ockenfels (2000) and Fehr andSchmidt (1999) show how the ldquocompetitiverdquoprediction of the game studied by Prasnikarand Roth (1992) continues to hold under theassumption that some individuals in the pop-ulation have utility functions that depend onthe distribution of monetary payoffs Theseresults follow because in the market it onlytakes two selfish bidders to drive the price upto the competitive level Assuming that someof the proposers or the responder caresabout the distribution of payoffs does notchange the equilibrium outcome

The broad observations of Bowles andGeertz and the specific experimental find-ings are also consistent with models ofintrinsic reciprocity In these modelsunselfish behavior arises in response to thebehavior of others An agent may be gener-ous to another in order to avoid a spitefulresponse or in order to provoke an altruisticresponse The power of spiteful behavior isweak in market environments If a consumerrefuses to buy an object because its price isldquotoo highrdquo a firm will just sell to another cus-tomer (and in equilibrium there will beanother customer willing to pay the price)In some situations the cost of generosity ishigh In a competitive equilibrium a firmthat drops its price risks the possibility offacing large excess demand Meeting thedemand might drive average cost aboveprice Hence in certain market environ-ments it may be impossible to distinguishbetween the decisions of agents who aremaximizing their narrow self interest fromunselfish agents who make the same deci-sions Added to the anonymous nature of

40 The interaction can go both ways Toshio Yamagishi(1988) and Yamagishi Karen S Cook and Motoki Watabe(1998) demonstrate how well developed sanctions proce-dures enhance trust in Japanese society Fehr Gaumlchterand Kirchsteiger (1997) and Kevin A McCabe Stephen JRassenti and Vernon L Smith (1998) present additionalexperimental evidence that providing more opportunitiesto punish increases cooperation in situations where self-ishness and subgame perfection predict that they wouldhave no influence on behavior It is possible that effective-ness of punishment options differs systematically acrosscultures

market interactions (that make it difficult toidentify the kind and the unkind) the out-line of a model of how markets might influ-ence behavior begins to appear Segal andSobel (2004a) provide such a model Thispaper makes two contributions First itshows that it in market environments moregeneral than the ones studied in experi-ments equilibrium outcomes are competi-tive even when agents are willing to punishnasty behavior and reward nice behaviorThe result follows because in a marketagents can only influence the payoffs of oth-ers by changing the equilibrium price andthere are limited opportunities to do thisWhen there is no opportunity to help or hurtothers narrow self interest determinesbehavior Second it demonstrates for thekind of separable functional forms used inthe study of interdependent preferences andreciprocity ((1) and (6)) price-taking behav-ior cannot be distinguished from selfishbehavior Hence agents will appear selfishwhenever the price-taking assumptionmakes sense (for example in largeeconomies)

The existence of markets may not changepreferences but it may remove incentivesfor reciprocal behavior Indeed the theorysuggests the possibility of substitutionbetween well organized economic institu-tions and the observance of other-regardingbehavior40 As Partha Dasgupta (2000)notes there is nothing mysterious in manyacts of reciprocity and ldquothere is no reasonto invoke the idea that there is greaterinnate generosity and fellow-feeling among



41 Krantonrsquos (1996) theoretical work demonstrates thestability of both market based and reciprocal systems ofexchange In her model market-based exchange is moreefficient than bilateral reciprocal trading arrangementsNevertheless a system of reciprocal exchange may be self-sustaining When more agents opt for reciprocal exchangemarkets thin It becomes optimal for agents to engage inpersonal exchange

poor people in poor communities thanexists among members of modern urbansocietiesrdquo

Assuming that the predictions of standardmodels hold in more general settings itwould be worthwhile investigating the extentto which the properties of these outcomescontinue to hold One can show the existenceof competitive equilibrium in an environ-ment where agents have exotic preferencesfor example but it is a separate questionwhether the unselfish behavior leads to goodoutcomes The fundamental theorems ofwelfare economics provide conditions underwhich selfish behavior leads to efficiencyThere is no general result suggesting thatoutcomes in games played by agents with thekinds of extended preferences described inthis paper will be efficientmdasheither withrespect to underlying material preferencesor with respect to preferences that take intoaccount attitudes toward the behavior andintentions of others41

44 Repeated Interaction

Game theory relies on two methods toexplain cooperative behavior in repeatedinteractions The folk theorem of repeatedgames provides a rich theory that is consis-tent with all manner of behavior in repeatedinteractions If future gains are large enoughrelative to the gains from cheating todaythen (assuming a mild technical assumptionholds) any individually rational feasible pay-off can be supported as an equilibrium pay-off The literature on reputations worksdifferently Players initially are uncertainabout the motives of their opponentCooperation arises if players can infer frompast behavior that their opponent is likely tobe trustworthy

In the folk theorem players must be for-ward looking In each period there is typi-cally short-term benefit from cheatingPlayers refrain from cheating in order to gainfuture benefits In reputation stories playersuse experience to determine whether theybelieve their opponent is reliable

In the purest form these stories differ intheir predictions about breaches of coopera-tion In the simplest repeated-game storiesthere are no deviations (When there is adeviation a punishment ensues) In the rep-utation stories a reputation develops onlybecause of learning Learning takes placeonly because cheating arises with positiveprobability One expects to see breakdowns insome relationships (when the interests of theplayers are not matched) Models of intrinsicreciprocity provide a third way to describecooperation in repeated interactions After asequence of good outcomes playersrsquo interestsbecome more closely linked A history of pos-itive interaction with someone leads you tocare about that personrsquos welfare

Allowing playersrsquo preferences to exhibitintrinsic reciprocity typically enlarges theequilibrium set in one-shot gamesTherefore it is perhaps surprising thatrepeated games played by agents with intrin-sic preference to reciprocate may have equi-librium sets that are smaller than whenplayers have conventional preferences overoutcomes Take a simple example Let slowast bea strategy profile that maximizes the sum of(material) payoffs in the stage gameSuppose that by playing slowast

1 repeatedly player1 leads player 2 to play to maximize the sumof material payoffs This could happen forthe appropriate specification of preferencesIt follows that if player 1 is sufficientlypatient he can guarantee an average payoffequal to the outcome of slowast Hence undercertain conditions average repeated gamepayoffs must be efficient (in the set of mate-rial payoffs) if individuals have intrinsic pref-erences towards reciprocity On the otherhand if individuals have conventional pref-erences efficient payoffs are only guaranteed



42 Rajiv Sethi and E Somanathan (2003) also review thisliterature The January 2004 issue of Journal of EconomicBehavior and Organization contains a review essay byHenrich (2004) on evolutionary models of prosocial prefer-ences and a number of commentaries

43 Elliott Sober and David Sloan Wilson (1998) presenta careful discussion of these issues

to be elements of a large set of equilibriumpayoffs The result requires strong assump-tions and it suggests that agents will cooper-ate in the final periods of long repeatedinteraction a prediction that is not consis-tent with all available evidence It does pro-vide an alternative to conventional modelingof repeated interaction

5 Origins

It is natural to ask where preferencescome from The question takes on agreater importance when one argues thatincorporating extended preferences maylead to more useful models A betterunderstanding of the origins of preferencesmay add structure to modeling efforts byplacing restrictions on the type of utilityfunctions that people can have and the cir-cumstances under which utility functionscan change This section provides anoverview of attempts to model the evolu-tion of interdependent preferences andreciprocity42

In economic contexts utility maximizingbehavior can be confused with selfish behav-ior If one is intrinsically motivated by thedesire to help others then one can questionwhether making a material sacrifice to aidothers is truly altruistic43 The evolutionaryperspective might make it possible to distin-guish clearly between selfish behavior andmore general preferences There is no dis-pute that at the lowest level of selection fit-ness is the appropriate measure of successUnselfish genes do not exist The notion ofself interest leads to confusion even in bio-logical models when one thinks about evolu-tion of individual organisms (instead ofindividual genes) A trait that appears to be 44 See Lee A Dugatkin (1997) for extensive examples

Frans B M De Waal (1996) describes more elaborateforms of reciprocity that arise in higher primates PeterKropotkin (1902) presents many examples of apparentlynonselfish behavior in animals Matt Ridley (1996) how-ever argues that elaborate forms of reciprocity are unique-ly human Robert Boyd and Peter J Richerson (1988)briefly survey additional evidence supporting the positionthat cooperation in large group settings is a characteristicof human behavior

altruistic at the level of an organism willarise as the result of conflicting ldquoself inter-estsrdquo of different genes Traits that fail tomaximize the fitness of the organism arecommon At this level of abstraction theo-retical explanations of prosocial behavior areeasy to generate but difficult to evaluate Inbiology reduced-form models sometimesabstract from gene-level conflicts and modelevolution at the level of the individual Ineconomics I am aware of no model thattreats selection at a level lower than the indi-vidual I therefore limit attention to selec-tion for individual traits and describeconditions under which it is in the best long-term interest of an individual to maximizesomething other than his short-term materi-al payoff The interaction between individu-als and groups will play an important role inthis discussion

51 Reciprocal Altruism

Trivers (1971) introduced the idea ofreciprocal altruism His theory parallelsstandard repeated games arguments thatjustify forgoing short-term gains for long-term benefits in repeated relationships Thistype of behavior arises in nonprimates44

There is a large literature on the evolution-ary foundations of cooperative behavior inrepeated games This literature provides afoundation for the appearance of behaviorthat is inconsistent with short-term rational-ity Reciprocal altruism is instrumental reci-procity Actors may repay kindness withkindness but only because they anticipatefuture benefits in return

Arguments that generate cooperativebehavior in evolutionary settings using recip-



45 Frank models this as a fixed characteristic of theagent but alternatively one could assume that differentgroups have different preferences

rocal altruism depend on the same kind ofassumptions that are necessary for the folk-theorem in repeated games The future mustbe important there must be an ability andincentives to punish opportunistic behaviorand it must be possible to identify deviatorsFrom the game-theoretic perspective aweakness of the repeated-game arguments ismultiplicity of equilibria Indeterminacyarises in the evolutionary literature becausestrategically stable strategies often fail toexist in repeated games

52 Green Beards

Richard Dawkins (1982) describes a gener-al mechanism that creates the possibility ofcooperative behavior Imagine a populationthat will play a prisonerrsquos dilemma game inpairs A subset of the population has an observ-able feature (a ldquogreen beardrdquo) that is perfectlycorrelated with discriminatory cooperativebehavior people with green beards cooperatewith other green beards but with no one elseIndividuals with green beards can thrivebecause they gain the benefits of cooperativepairings without running the risk of gettingcheated Robert H Frank (1988) exploits aversion of this argument He introduced amodel in which people decide whether to playa prisonerrsquos dilemma game with an opponentor opt out The population contains one groupof agent that always cooperates and anotherthat always defects45 Group members give offdifferent signals Frank shows that if the sig-nals are sufficiently informative players canuse them to determine whether they wish toplay with their opponent A significant degreeof cooperation can be supported in equilibri-um provided that the signal that cooperatorsemit is sufficiently informative The green-beard argument provides a powerful reasonnicely modeled by Arthur J Robson (1990) tobelieve that inefficient outcomes may fail to beevolutionarily stable

46 Guumlth (1995a) Guumlth and Yaari (1992) Joel MGuttman (2000) and Alex Possajennikov (2000) all provideresults with the same general flavor with an emphasis onsocial preferences broadly consistent with those introducedto describe experimental outcomes

47 Thomas Schelling (1960) gives vivid early illustrationsof the approach in the context of bargaining

A well-understood limitation of thisapproach is that an individual who couldgrow a green beard without cooperatingwould have an advantage This individualwould be able to reap the gains of generousbehavior when he meets others with greenbeards without paying the cost

The same mechanism forms the basis for ageneral approach to the problem of selectionof preferences in a strategic setting The basicframework begins with a game The payoffs ofthe game are assumed to be the playersrsquomaterial payoffs (or in a strict evolutionaryframework reproductive fitness) Players mayalter their utility functions within a paramet-ric class For example a player may replacehis material payoff with a weighted average ofhis material payoff and the material payoff ofhis opponent Altering payoffs creates a newgame Assuming equilibrium play in the newgame generates a predicted equilibrium out-come which in turn generates material pay-offs for the players The evolutionary dynamicoperates on the material payoffs Players canchoose to play games using different strate-gies than fitness-maximizing strategiesFurther the presence of non-fitness maximiz-ers in the population may influence thebehavior of others Assuming that the fractionof agents in the population with particularpreferences grows in proportion to relativefitness the literature asks whether there aresituations in which non-fitness maximizersremain a positive fraction of the population

There are many games in which a playergains by acting as if he is not motivated byhis material payoffs provided that his oppo-nentsrsquo know his preferences Guumlth andMenahem E Yaari (1992)46 initiated thestudy of this process under the assumptionthat strategy choice is observable47



48 The result requires more assumptions in nndashplayergames Koccedilkesen Ok and Sethi (2000b) prove a relatedresult for games with strategic substitutes

49 Koccedilkesen Ok and Sethi (2000a) contains a relatedresult

These approaches study specific gamesthey are open to the criticism that the suc-cessful preferences are finely tailored tothe strategic setting Levent Koccedilkesen EfeA Ok and Sethi (2000b) provide a versionof these results that applies more broadlyThey identify a more general class ofgames in which agents who choose a utilityfunction that is increasing both in theirmonetary payoff and their relative mone-tary payoff (the ratio of monetary payoff tothe average monetary payoff) receive high-er monetary payoffs in equilibrium thanplayers who maximize monetary payoffsThe critical assumption in Koccedilkesen Okand Sethi (2000b) (and also in a relatedexample of Possajennikov 2000) is anassumption of supermodularity (or strate-gic complementarity) To get an intuitionfor the result imagine a symmetric two-player game in which one player cares onlyabout monetary payoffs and the secondcares about relative payoffs as wellKoccedilkesen Ok and Sethi (2000b) observethat for these games there is no equilibri-um in which the second player has a lowermonetary payoff than the first player(because by mimicking the first player thesecond player increases both absolute andrelative payoff)48 Using similar tech-niques Sethi and Somanathan (2001) showthat preferences similar to those intro-duced by Levine (1998) can survive in ageneral family of games49 As many publicgoods games exhibit strategic substitutesthese results may help organize someexperimental results

The approach does not provide specificguidance about the nature of the interde-pendent preferences that survive evolu-tionary pressures The analysis identifiescircumstances in which commitment abilityis valuable The papers give conditions

50 Although in Ok and Vega-Redondo (2001) playerscan infer it under some matching conditions

under which certain types of nonselfishpreferences can persist in a populationdominated by selfish individuals Theanalysis does not provide a systematic theo-ry of the distribution of preferences thatwould survive without a priori restrictionson preferences Due to the complexity ofthe analysis the papers study the advan-tages of a particular intuitive sort of non-selfish behavior rather than identify theend result of an evolutionary process Thisapproach is the appropriate first step in aresearch program designed to provide arationale for social preferences but sup-ports only the conclusion that evolutionarymodels do not demand all agents have fit-ness maximizing preferences Future workmay provide a more precise description ofstable preferences

A more basic problem is the centralassumption that preferences be observableIn all of the models described it is (at leastweakly) to an agentrsquos advantage to convincehis opponent that he has nonselfish prefer-ences while actually having fitness maximiz-ing preferences These agents gain thestrategic advantages of commitment to non-selfish behavior (changing the behavior oftheir opponents) but do not pay the cost(making decisions that fail to maximize fit-ness) In this way the models suffer fromprecisely the same criticism as the green-beard models One would expect evolution-ary pressures to favor the kind of duplicitousbehavior found in standard models Agentswould arise who look like nonselfish agentsbut whose true preferences are traditionalThese strategies are not feasible in commit-ment models because of the assumptionthat there is complete information aboutpreferences

Ok and Fernando Vega-Redondo (2001)and Jeffry C Ely and Okan Yilankaya (2001)examine the evolution of preferences whenpreferences are not directly observable50



51 For example Trivers (1971 page 5) states that ldquothereis ample evidence to support the notion that humansrespond to altruistic acts according to their perception ofthe motives of the altruist They tend to respond morealtruistically when they perceive the other as acting ldquogen-uinelyrdquo altruisticrdquo De Waal (1996 page 116) writes that ldquoaperson who lies without blushing who never showsremorse and who grabs every opportunity to bypass therules just does not strike us as the most appealing friend orcolleague The uniquely human capacity to turn red in theface suggests that at some point in time our ancestorsbegan to gain more from advertising trustworthiness thanfrom fostering opportunismrdquo Paul Ekman (2001) arguesthat there are characteristic facial expressions that providecredible signals of honest behavior

Consequently these papers provide a formalmodel that studies the critique of green-beard mechanism The central idea is thatmodifying preferences only increases fitnessto the extent that the preference change canmodify the behavior of other agents Whenpreferences are not observable there will beselective advantage to imitating the behaviorof self-interested agents The evolutionarilystable outcomes of the selection process mustagree with the equilibrium outcomes of theunderlying game played by selfish agentsThese models therefore warn that theassumption that preferences are observablein commitment models is critical It providesa framework confirming the intuition thatldquogreen-beardrdquo arguments rely on the assump-tion It naturally leads one to ask about theexistence of mechanisms by which agents cancredibly signal their true preferences

As explanations for the existence of cooper-ative behavior all of the green-beard modelsraise the same question What preventsdefectors from learning how to fake signalsEven if the answer is ldquonothingrdquo it is likely thatselection will favor members of the popula-tion who are capable of creating difficult toimitate signals or who are able to distinguishsincere from insincere signals Green-beardarguments have power if there is a hard-to-break link between signal and behavior Whilethese links cannot be deduced from generalprinciples biologists argue that humans havedeveloped the capacity to evaluate the inten-tions of others51 It seems likely people differ

52 Abraham Lincoln [or possibly P T Barnum] made(most of) this point more gracefully ldquoYou may fool all thepeople some of the time you can even fool some of thepeople all the time but you canrsquot fool all of the people allthe timerdquo

53 Alexander even conjectures that consciousness is theoutcome of the need to evaluate and interpret the motiva-tions of others

in their abilities to deceive others and to bedeceived52 These characteristics vary withindividual preferences and have implicationsfor the kinds of tasks people are suited toperform

The end results of these conflicting pres-sures is not clear Alexander (1987) andRidley (1993) argue that the pressures leadto increases in social mental and emotionalcomplexity53 What remains is a complicatedpicture of the preferences of individuals butone which includes the possibility of non-selfish behavior intrinsically included inpreferences

53 Kin and Group Selection

Arguments supporting altruistic behaviorin the sense that individuals reduce theirown reproductive fitness to benefit otherscan be based on inclusive fitness William DHamiltonrsquos (1964) notion of inclusive fitnessprovides an explanation for altruistic behav-ior in animals Hamilton shows that anaction that lowers the probability that anindividual survives could increase that indi-vidualrsquos total fitness (genetic contribution infuture generations) if it increases the proba-bility that relatives survive Hamiltonrsquos ideasprovide a way to understand a wide range ofanimal behavior While these ideas providestrong support for prosocial behavior whenindividuals interact in small groups withclosely related individuals these conditionssurely do not apply to laboratory experi-ments and are inadequate to explain theexistence of prosocial behavior in commonnatural settings

There are coherent theoretical modelsthat extend kin selection to groups of unre-lated individuals Sober and Wilson (1998)describe how group-selection models can



lend support to nonselfish behavior (see alsoTheodore C Bergstrom 2002 and Paul ASamuelson 1993) These models are naturalgeneralizations of arguments based on inclu-sive fitness Since Hamiltonrsquos work it hasbeen apparent that nonselfish behavior canhave selective advantage in closely relatedgroups One agent should be willing to sacri-fice individual fitness if by doing so there isa large enough increase in the fitness ofclosely related individuals In this way theindividualrsquos genes (although not necessarilythe individual) gain More generally one canimagine that nonselfish preferences in a sub-set of the group may make the average fit-ness of the group higher than that of anentirely selfish group Within the group self-ish members do better than nonselfish mem-bers This is the case for standardpublic-goods models If there is only onegroup these conditions lead to the extinc-tion of the nonselfish members Imagineinstead that there is another populationconsisting entirely of selfish individuals Theproportion of nonselfish agents in the entirepopulation may increase from one genera-tion to the next if the relative increase of thegroup containing nonselfish agents (at theexpense of the other group) compensates forthe relative decline of the nonselfish agentswithin their own group If groups remainstable over time this argument only post-pones the extinction of the nonselfish agentsas first the selfish group dies and then theselfish agents take over the remaining groupIf groups reform in each period then thereare conditions under which nonselfishbehavior can survive

An attractive model using group selectionarguments to explain the persistence of non-selfish preferences in an economic environ-ment is due to Florian Herold (2003) Heroldexamines a two-player game of perfect infor-mation in which the leader can decidewhether to give a gift to the follower Givingthe gift maximizes total surplus but is costlyto the leader The follower can do nothingreward or punish the first player Herold

looks at three situations two in which onlyone of the unselfish preference types is avail-able and one in which all three types of pref-erences may enter the population Rewardsand punishments lower the material payoff ofthe follower Herold investigates whetherplayers with nonselfish preferences can beevolutionarily stable in an environmentwhere the game is played in (anonymous)small groups fitness (material payoffs) deter-mines reproductive success and groups re-form after each generation Players know thedistribution of preferences in their group butdo not know the preferences of their partnerHerold observes as in Ok and Vega-Redondo(2001) and Ely and Yilankaya (2001) theleaders behave as if they maximize expectedfitness in any stable outcome Their behaviorcould involve giving gifts but only if doing sobrings rewards or avoids punishment Thereare stable outcomes in which a fraction of thefollowers has interdependent preferences

Consider the case where only rewards arepossible In a world in which every followeris selfish none of the leaders are generousConsequently followers with preferencesfor rewarding generous behavior can enterthe population without sacrificing fitnessMoreover if a positive fraction of the popu-lation of followers give rewards to generousleaders then there is a positive probabilitythat a large enough fraction of them will beconcentrated in a group to induce the lead-ers in this group to be generous All mem-bers of the cooperative group obtain higherpayoffs than the rest of the population andbecause there must be a high concentrationof followers who give rewards in this groupthe fraction of the entire population whogives rewards can grow

Next consider the case in which followersare either selfish or get utility from punish-ing It is also possible for followers who liketo punish to be represented in a stable pop-ulation but the argument differs in animportant respect It is costly for a followerwho punishes greedy behavior to enter apopulation in which all followers are selfish



54 Gintis (2000) presents a related model

(because in this population leaders will notbe generous and therefore the punisher willbe required to engage in costly punish-ment) Herold (2003) shows that in this set-ting a monomorphic equilibrium of selfishfollowers is stable but there is also amonomorphic equilibrium with only follow-ers who punish Selfish followers cannotgain a foot hold in the punishment equilib-rium because if there were enough selfishfollowers to create a group in which leadersare greedy then the followers in thisgroupmdashwith a disproportionate share ofselfish followersmdashwould do badly relative tothe population and therefore be less com-mon in the next generation Finally whenHerold permits all three types of prefer-ences a stable outcome in which all follow-ers punish exists and under someconditions the equilibrium in which bothsome followers do nothing and some rewardexists54

A straightforward analysis of the GeorgePrice (1970) equation provides an under-standing of the mathematical conditionsneeded for a group selection argument tosupport the spread of prosocial behaviorHenrich (2004) and Sober and Wilson(1998) discuss these conditions carefully Arestrictive condition is that the variationwithin groups is significantly smaller thanthe variation between groups If there is a lotof variation within a group then individualswho are not fitness maximizing within thegroup are at a large disadvantage relative toother group members If different groupsare similar then one group is unable to dosignificantly better than another If there isfree mixing between groups then the vari-ance between groups falls

There is general agreement among biolo-gists that group selection depends on adegree of genetic variation across groupsthat is not consistent with migration pat-terns Relatively small amounts of intermar-riage are sufficient to destroy between group

55 Sober and Wilson (1998) argue that group selectionis an important explanation for the evolution of prosocialbehavior in humans Barbara Smutsrsquos (1999) insightfulreview of Sober and Wilsonrsquos book accepts the logicalvalidity of group-selection arguments but argues thatattempts to identify altruism in organisms should not losesight of the fact that selection leads to fitness maximizationat the level of the gene

variation necessary for biological groupselection arguments Alexander (1987 page37 and pages 168ndash70) is representative ofthe consensus55

While human groups are genetically simi-lar they are culturally diverse These differ-ences make the transmission of prosocialbehavior through cultural channels moreprobable than purely genetic transmissionChristopher Boehm (1993 and 1997) pres-ents and defends a mechanism that supportsthe rise of altruistic behavior Boehm arguesthat human forager societies have character-istic social organization that facilitates groupselection for prosocial behavior Boehm(1993) cites evidence that foragers and othersmall-scale societies create egalitarian cul-tures in which all households have compara-ble social and economic status Thisstructure comes about through the ability tosanction both the shirkers who attempt toshare in the grouprsquos resources without con-tributing and bullies who attempt to monop-olize the resources A consequence of theegalitarian structure is a reduction of thebehavioral variation within groups Boehmthen points out that there is variation acrossgroups in the way that they respond to emer-gency conditions (for example famine)

Boehm (1997) argues that these featuresof small-scale societies (in addition to theability and willingness of groups to sanctiondeviations) strongly support the develop-ment of behaviors that favor group survivalBecause variation within a group is low anddeviations from group behavior are sanc-tioned there is within group pressure toretain traits that are good for the groupBecause different groups behave differentlysuccessful groups grow Hence the structureimposed by human culture facilitates the



56 Boyd and Richerson (1985) argue that cultural groupselection can lead to the development and retention ofprosocial behavior They describe the importance of imita-tion as a mechanism that reduces intragroup variationwhile maintaining intergroup variation

57 In a speculative essay Francisco J Varela (1999) sug-gests that effective people rely on ldquocrazy wisdomrdquo He sug-gests that ethical behavior requires a mixture of rationalcalculation and spontaneity and that cognitive limitationsincrease the likelihood of ethical behavior

58 Social and cognitive psychologists conducted theexperiments The experimental designs violate the accept-ed practices of experimental economics the task was poor-ly specified subjects had no financial incentive forproviding accurate answers and controls on the contextwere incomplete

development of traits that are beneficial togroup survival56

In summary genetic group selection argu-ments are not likely to be an important rea-son for the development of altruisticbehaviors but that the ability of groups todesign cultural practices or institutions thatreduce intragroup variation and maintainintergroup variation does provide a power-ful consistent and empirically justifiableexplanation of the development of prosocialbehavior

54 Evolutionary Evidence of DecisionBiases

I have described evolutionary modelsbased on strategic interaction Evolutionarypsychology suggests a variety of mechanismsconsistent with natural selection to describesocial behavior Some of this work providesreasons for action rules that violate standardmaterial-utility maximizing behavior in favorof actions consistent with social norms57 Inthis section I discuss one example that theroutines are context specific Leda Cosmidesand John Tooby (1992) review experimentalevidence on Wasonrsquos problem58 In its origi-nal form the Peter C Wason (1966) selec-tion task subjects examine four cards Onthe visible side of the cards they see

(E) (4) (K) (7)

Subjects know that each card has a letter onone side and a number on the other

59 Subjects should check the (E) and (7) cards to verifythe statement Most people examine either the (E) cardonly or the (E) card and the (4) card

60 Patricia W Cheng and Keith J Holyoak (1985) andPaul Davies James H Fetzer and Tom R Foster (1995)offer critiques and alternative interpretations Even if oneaccepts Cosmides and Toobyrsquos interpretation of their datatheir hypothesis only states that humans are equipped toidentify certain types of cheating behavior Standard mod-els in economics typically assume that agents have thisability Cosmides and Toobyrsquos experiments do not explainwhy agents would lower their material payoffs to respondto cheaters

Subjects are asked to turn over preciselythose cards that need to be turned over todetermine the truth of the statement

If a card has a vowel on one side then ithas an even number on the other side

Subjects make systematic errors in analyz-ing conditional statements when given theproblem in an abstract form59 The errorrate goes down when the problem is refor-mulated so that the task asks whether some-one has violated a social norm In arepresentative reformulation the visiblefaces of the four cards are

(Beer) (24) (Coke) (17)

Subjects know that each card has a beverageon one side and an age on the otherSubjects are asked to turn over preciselythose cards that need to be turned over todetermine whether there are any violationsof a law forbidding people under 21 fromdrinking alcoholic beverages

Cosmides and Tooby (1992) interpretthese experiments as evidence that humancognitive processes have evolved to identifyviolations of conditional statements whenthese statements can be interpreted ascheating on a social contract They go on tospeculate that people have mental algo-rithms that lead them to punish cheatersCosmides and Toobyrsquos experimental resultsare stimulating but alternative explanationsof the experimental findings that have norelationship to reciprocity or interdependentpreferences are available60



55 Learning

Game-theoretic models of the evolutionof preferences take a simple view of theevolutionary process Reality is more com-plicated This subsection speculates on sev-eral directions that may lead to alternativeexplanations for nonselfish behavior

Animals (including humans) operate in avariety of different strategic environmentsCognitive constraints make it impossible foranyone to optimize in every natural environ-ment These limitations create at least threereasons why people would fail to exhibitself-interested preferences

The first and most obvious observation isthat individuals will not be fully selfishbecause they are unable to perform theneeded calculations There is no doubt thatcognitive limitations prevent people fromsolving complex optimization problems butin general the critique applies equally wellfor all objective functions Cognitive limita-tions are a good argument for some modelsof bounded rationality but without a theoryof complexity provide no systematic evi-dence that people optimize interdependentpreferences or incorporate intentions ofothers in optimizing behavior

Another idea is that people have a limitedability to distinguish one situation fromanother Instead they use experience andeasy-to-process signals to sort the problemsthat they face into a small number of cate-gories For each category they apply a pref-erence relationship (or behavioral rule ofthumb) that is well suited to representativemembers of the category According to sucha view an agent may have several prefer-ence relationships Nonselfish preferenceswould be likely to appear in some environ-ments (for example those resemblingrepeated interaction with close associates)than in others

Finally preferences appear to be espe-cially fluid during the earlier years of lifeand especially susceptible to the influenceof others Most children find themselves

61 Herbert A Simon (1990 and 1993) argues that peo-ple should be receptive to social influences because thebenefits from access to cultural wisdom are greater thanthe costs associated with following societyrsquos suggestions tohelp others

62 Alexander (1987 page 103) writes that a basis formoral systems is the strong incentive for individuals toinfluence others to be ldquobeneficentrdquo to others Parents maybe particularly effective teachers

surrounded by supportive cooperativeinformants The hypothesis that they areplaying in cooperative strategic environ-ments with cooperative players gets rein-forced The existence of a supportiveenvironment is plainly essential The childwill die without food The recognition of thenature of the environment is also essentialfor the development of certain skills notablylanguage The ability of humans to learnnatural language presumably requires oper-ating under hypotheses that inputs are reli-able What mommy calls a ball really is aball At least it is something that everyonecalls a ball The ability to acquire languagemay be more important than the ability toavoid being duped in economic exchangeslater in life and (perhaps) biological hard-ware may bias individuals to follow coopera-tive strategies even when they are not fitnessmaximizing61

Parents and schools attempt to teach chil-dren to be nonselfish Parentsrsquo dominantposition may enable them to induce theirchildren to internalize preferences that ben-efit the parents Since conflicts of interestexist between parents and children it willnot be in the best interest of parents to haveselfish children In particular parents standto gain from having children who are willingto repay kindness with kindness62 To theextent that changes in their preferencesoperate against their self interest childrenshould be expected to resist the changesSince children have so much to gain fromtrusting their parents and since the trust isfrequently well placed efforts to internalizepreferences may be effective neverthelessExperimental evidence that preferences areage dependent (for example the William



63 Expelled agents may have difficulty gaining entranceto other groups

Harbaugh Kate Krause and Steven Liday(2003) study of the ultimatum game) areconsistent with the possibility that prefer-ences are fluid at some stages in life and thatpeople learn to adopt prosocial preferences

56 Summary

This section reviewed literature aimed atproviding evolutionary foundations for non-selfish preferences The results are mixed Ifone takes the position that pressures thatlead to selection of genetic material deter-mines an individualrsquos preferences then thereis no reason why different selection pres-sures faced by different genes in a singleindividuals will direct the individual to max-imize fitness The literature in economicsdoes assume that selection operates at thelevel of the individual In this setting theclearest theoretical setting for the survival ofnonselfish preferences is an environment inwhich preferences are observable or moregenerally it is costly for selfish agents toappear otherwise This condition sets thestage for an evolutionary ldquoarms racerdquo inwhich there is coevolution of both abilities tomisrepresent preferences and to detect mis-representation At the other extreme whenthere is incomplete information aboutstrategies there is theoretical support forthe view that equilibrium behavior will coin-cide with fitness maximizing equilibriumbehavior for all agents

I draw three conclusions from the workdescribed First the analysis is consistentwith the idea that predictions based on theassumption of maximizing material self-interest need not be accurate in small-groupsettings In small groups agents are morelikely to know each other Preferences aremore likely to be observable (either directlyor through a signal that is linked to prefer-ences) Sanctions based on expulsion arefeasible63 These sanctions can reduce thefitness of selfish agents

64 A serious evolutionary study that permits hetero-geneity of preferences must confront the issue ofwhether spatially isolated people facing different condi-tions might evolve differently People from differentareas may have genetic predispositions toward differentpreferences For example hunters face qualitatively dif-ferent strategic situations than gathers Hunters (oflarge game) must cooperate in order to gather food suc-cessfully Gatherers can usually collect food withoutcooperation One could imagine that if the style of foodgathering was the essential arena for the evolution ofpreferences then there would be different levels of fit-ness maximizers within a population of hunters than in apopulation of gatherers On the other hand to theextent that these differences ever existed mixing ofpopulations would diminish them Jared Diamond(1997) argues convincingly that it is unnecessary toinvoke genetic differences to explain broad patterns ofworld history

65 The proposition does shake the foundation of themethodology put forth in Stigler and Becker (1977)who argue that economists should seek to explainbehavior under that assumption that ldquotastes neitherchange capriciously nor differ importantly betweenpeoplerdquo

Second in all of the models there isscope for fitness maximizers The crudeinterpretation of this observation is thatself-interested behavior narrowly definedwill always be with us To the extent thatother preferences appear in the populationthey are balanced by traditional economicpreferences64

That different people have different pref-erences is hardly controversial but it raisesan important question65 Under what condi-tions on the strategic environment (or eco-nomic institution) do standard predictionsremain valid when only a fraction of theagents maximize material payoffsExperimental results in auctions and best-shot bargaining suggest that standard pre-dictions continue to hold in competitiveenvironments This insight awaits a com-plete characterization

Third the evolutionary approach does notimpose structure on preferences The cau-tious conclusion from current research isonly that there is no strong argument for rul-ing out all behavior that does not maximizematerial payoffs



66 I found the Dalai Lamarsquos quotation in the reviewessay on Sober and Wilson (1998) by primatologist BarbaraSmuts (1999) She argues that many types of apparentlyunselfish behaviors are viable at the level of an organism

67 My list overlaps the list in section 3 of John Conlisk(1996) which provides a parallel defense of bounded-rationality modeling

68 See Edward Lazear (2000) for a compelling review ofthe successes of the Chicago school

6 Closing Arguments

If you would like to be selfish you should do itin a very intelligent way The stupid way to beselfish ishellipthe way we always have worked seek-ing happiness for ourselves alonehellipThe intelli-gent way to be selfish is to work for the welfareof others

The Dalai Lama

Economics which frequently relies on thejoint hypotheses of intelligence and selfinterest should be open to models in whichagents are selfish in intelligent ways66 Thispaper reviews reasons why more narrowlyconceived models may be insufficientdescribes a variety of alternatives and sug-gests possible applications This section con-tains response to arguments against theapproaches discussed in the paper67

There are at least three problems with thislist First it treats ldquostandard theoryrdquo as a sin-gle object rather than many differentapproaches Second I could not find clearstatements of criticisms in the literature Imay have ignored or weakened the strongestcriticisms Third I did not give the criticismsprecise mathematical formulations Thismakes the boundaries of the argumentunclear and makes it impossible for any ofthe arguments or any of the counterargu-ments to be decisive Some of the criticismslend themselves to formal analysis

61 If It Is Not Broken Do Not Fix It

Argument Standard theory works Thereis no need to change it

Response Conventional theory does workwell in many situations68 The paper reviews

evidence that it fails to account for manyinteresting findings without being stretchedand strained Enlarging the toolkit to includemore general models could expand the rangeof useful economic analysis

Adopting a broader perspective also per-mits us to view apparent successes of stan-dard theory as evidence that assumptions aretoo strong When laboratory models confirmpredictions of conventional models forexample in market settings we can look forless restrictive assumptions that make thesame predictions

62 Complexity

Argument Allowing extended or context-dependent preferences leads to models thatimpose unrealistic demands on agentsrsquo abili-ties to reason and modelersrsquo abilities to char-acterize equilibria

Response Traditional rationality assump-tions do not impose any limits on the com-putational abilities of agents There is nojustification for imposing limits at an arbi-trary point that separates traditional modelsfrom the ones described in this paper

There are several examples notablyBolton and Ockenfels (2000) and Fehr andSchmidt (1999) of tractable models involv-ing interdependent preferences Arguablynone of the proposed models of reciprocityin games is as simple as these models butfurther work may change that To the extentthat the context-dependent models capturea genuine intuition about behavior and helpto organize observations and hypothesesthey are useful

63 Only the Selfish Survive

Argument A careful study of the originof preferences proves that only selfish agentssurvive

Response With sufficient freedom todefine ldquoselfishrdquo this statement is a tautologyWith a narrow conception of selfish behavior itis possible to provide formal models that sup-port the assertion but the models rely on strongassumptions There are plausible reasons to



believe that preferences for nonselfishbehavior and reciprocity have survival valueand have survived Until economics becomesa special case of molecular biology there willbe reason to examine reduced-form modelsthat permit nonselfish behavior

64 Generality

Argument The standard tools of eco-nomic analysis apply to a wide range of prob-lems no other approach has the same rangeOr in the words of Stigler and Becker (1977pages 76ndash77) ldquothis traditional approach ofthe economist offers guidance in tacklingthese problems and that no other approachof remotely comparable generality andpower is availablerdquo

Response Relaxing the assumptions ofthe traditional approach creates a theory ofmore generality and more power

65 Discipline

Argument Economics needs the disci-pline provided by the assumption of self-interested behavior to generate behavioralhypotheses and predictions based on wellunderstood general principles

Response What Conlisk (1996 page685) wrote in defense of bounded rationalitymodeling is appropriate here ldquoDisciplinecomes from good scientific practice notembrace of a particular approach Anyapproach can lead to an undisciplinedproliferation of hypotheses to cover allfactsrdquo Even within conventional economictheory individual greed can mean manythings We are comfortable abandoning riskneutrality to study gambling and insurancebehavior We are comfortable abandoningmyopic optimization to study dynamic inter-actions We are comfortable insertingunmarketed goods into utility functions tomodel externalities In the wrong handsthese modifications reflect a lack of disci-pline Properly used they reflect a willing-ness to extend and revise the principles ofequilibrium and optimization in order toexplain behavior

69 For a careful statement of the results see GerardDebreu (1974) Rolf R Mantel (1974) and HugoSonnenschein (1973) Werner Hildenbrandrsquos (1994)approach provides some limitations on aggregate behavior

66 Definite Outcomes

Argument Standard models provideclear predictions Expanding the domain ofpreferences makes it impossible to obtaindefinite answers to economic questions

Response Traditional economic method-ology owes its power to its generality and itsflexibility In markets and strategic settingsindeterminacy is the rule If preferencesneed only satisfy standard neoclassicalassumptions then there are essentially norestrictions on aggregate excess demandfunctions and therefore no restrictions onmarket-clearing prices69 In game-theoreticenvironments even when preferences arespecified multiple equilibrium problemsarise There is no generally accepted way toselect among multiple equilibria especiallyin repeated-game environments where thefolk theorem places no serious restrictionson what can be observed Clear predictionscome only as a result of imposing strongassumptions on preferences or action sets

Not only is there indeterminacy once amodel has been specified there is no limitto the number of different models one canpropose that have a plausible connection toan economic problem Coming up with amodel to explain observations is not difficultex post the challenge is to come up with auseful model that applies to more than onesituation

67 Parsimony

Argument Models of extended prefer-ences introduce too many free variables Thetheory explains everything therefore itexplains nothing

Response It is important to distinguishthe set of all predictions that come from a the-ory from the set of predictions obtained froma particular specification within the theory



Any of the approaches described in section 3provide an imaginative modeler sufficientscope to summarize empirical regularitiesFor example the folk theorem of repeatedgames guarantees that practically any out-come can be supported as an equilibrium of arepeated interaction between patient playersWhile the theorem does have assumptions itis hard to imagine any outcome from adynamic interaction that could not bedescribed as an equilibrium of some repeatedgame We judge the value of a particularrepeated game model on its explanatorypower generality plausibility and eleganceBut these criteria are informal artistic cate-gories rather than logical ones A test of aclass of models is its ability to provide usefuldescriptions and predictions The new mod-els of interdependent preferences (Boltonand Ockenfels 2000 and Fehr and Schmidt1999) or reciprocity (Charness and Rabin2002 Dufwenberg and Kirchsteiger 2004Falk and Fishbacher 2005 and Rabin 1993)put forth specific parametric versions of theirmodels These models supply refutableimplications Parsimony demands that weobtain our descriptions from a relatively smallcollection of available parameterizations

7 Conclusion

The bully who boasts that he can beat hisfoes with one hand tied behind his back willprove his claim by picking his foes wiselyBut he will look awkward when he wins andlook foolish if he loses His boast is less a sig-nal of strength than an attempt to intimi-date Restricting theory to use only a subsetof available tools is not discipline It is ahandicap

The hypothesis that reciprocity is aninstrumental motivation for human behav-ior is overwhelming There are good reasonsto reciprocate in dynamic interactions ascooperation generates future cooperationand retaliation may serve to inhibit exploita-tion There is strong evidence that thedesire to reciprocate is an intrinsic aspect of

preferences There is strong social pressureto internalize a preference for reciprocityThere are plausible stories that describewhy these motivations persist While thebody of evidence cannot establish the truthof the hypothesis the evidence is sufficient-ly strong and the advantages sufficientlyclear to justify continued development ofthe modeling tools that I have discussed Aphilosophical refusal to consider extendedpreferences leads to awkward explanationsof some phenomena It limits the questionsthat can be asked and restricts the answersIt is a handicap

Extending the arguments of preferencesand permitting the preferences to changewith context in a systematic way enables the-orists to continue to use economic theory topredict and explain the impact of parameterchanges while expanding the scope of thetheory These models promise a language forthe study the effect of market institutionsand contracts on economic performance

To take the interdependent preferencetheory seriously work should proceed onthree fronts We need to develop founda-tional theory to identify general properties ofextended preferences We need to apply thetheory to specific problems and developrestrictions leading to tractable models thatefficiently summarize what we observe andgenerate interesting hypotheses We needexperimental work to investigate thesehypotheses and provide evidence aboutwhether preferences are stable acrossgames roles and individuals

REFERENCES

Abreu Dilip 1988 ldquoOn the Theory of InfinitelyRepeated Games with Discountingrdquo Econometrica56(2) 383ndash96

Abreu Dilip David Pearce and Ennio Stacchetti1993 ldquoRenegotiation and Symmetry in RepeatedGamesrdquo Journal of Economic Theory 60(2) 217ndash40

Akerlof George A 1982 ldquoLabor Contracts as PartialGift Exchangerdquo Quarterly Journal of Economics97(4) 543ndash69

Akerlof George A and Rachel E Kranton 2000ldquoEconomics and Identityrdquo Quarterly Journal ofEconomics 115 (3)715-53

Alexander Richard D 1987 The Biology of Moral



Systems New York Aldine de GruyterAndreoni James 1990 ldquoImpure Altruism and

Donations to Public Goods A Theory of Warm-GlowGivingrdquo Economic Journal 100(401) 464ndash77

Andreoni James 1995 ldquoCooperation in Public-GoodsExperiments Kindness or Confusionrdquo AmericanEconomic Review 85(4) 891ndash904

Andreoni James 2001 ldquoThe Economics ofPhilanthropyrdquo in The International Encyclopedia ofthe Social and Behavioral Sciences N J Smelser andP B Baltes eds Oxford Elsevier 11369ndash76

Andreoni James Paul M Brown and Lise Vesterlund2002 ldquoWhat Makes an Allocation Fair SomeExperimental Evidencerdquo Games and EconomicBehavior 40(1) 1ndash24

Becker Gary S 1962 ldquoIrrational Behavior andEconomic Theoryrdquo Journal of Political Economy70 1ndash13

Beacutenabou Roland and Jean Tirole 2003 ldquoIntrinsic andExtrinsic Motivationrdquo Review of Economic Studies70(3) 489ndash520

Bereby-Meyer Yoella and Muriel Niederle 2005ldquoFairness in Bargainingrdquo Journal of EconomicBehavior and Organization 56(2) 173ndash86

Bergstrom Theodore C 2002 ldquoEvolution of SocialBehavior Individual and Group Selectionrdquo Journalof Economic Perspectives 16(2) 67ndash88

Bewley Truman F 1999 Why Wages Donrsquot Fall Duringa Recession Cambridge Harvard University Press

Binmore Ken John McCarthy Giovanni Ponti LarrySamuelson and Avner Shaked 2002 ldquoA BackwardInduction Experimentrdquo Journal of EconomicTheory 104(1) 48ndash88

Boehm Christopher 1993 ldquoEgalitarian Behavior andReverse Dominance Hierarchyrdquo CurrentAnthropology 34(3) 227ndash40

Boehm Christopher 1997 ldquoImpact of the HumanEgalitarian Syndrome on Darwinian SelectionMechanicsrdquo The American Naturalist 150 S100ndash21

Bolton Gary E and Axel Ockenfels 2000 ldquoERC ATheory of Equity Reciprocity and CompetitionrdquoAmerican Economic Review 90(1) 166ndash93

Bowles Samuel 1998 ldquoEndogenous Preferences TheCultural Consequences of Markets and OtherEconomic Institutionsrdquo Journal of EconomicLiterature 36(1) 75ndash111

Boyd Robert and Peter J Richerson 1985 Cultureand the Evolutionary Process Chicago University ofChicago Press

Boyd Robert and Peter J Richerson 1988 ldquoTheEvolution of Reciprocity in Sizable Groupsrdquo Journalof Theoretical Biology 132(3) 337ndash56

Cabrales Antonio and Gary Charness ldquoOptimalContracts Adverse Selection and SocialPreferences An Experimentrdquo Universitat PompeuFabra Discussion Paper 478

Charness Gary and Ernan Haruvy 2002 ldquoAltruismEquity and Reciprocity in a Gift-ExchangeExperiment An Encompassing Approachrdquo Gamesand Economic Behavior 40(2) 203ndash31

Charness Gary and Matthew Rabin 2002ldquoUnderstanding Social Preferences with SimpleTestsrdquo Quarterly Journal of Economics 117(3)

817ndash69Cheng Patricia W and Keith J Holyoak 1985

ldquoPragmatic Reasoning Schemasrdquo CognitivePsychology 17(4) 391ndash416

Cialdini Robert C and Melanie R Trost 1998 ldquoSocialInfluence Social Norms Conformity andCompliancerdquo in The Handbook of Social PsychologyD T Gilbert S T Fiske and G Lindzey edsBoston McGraw-Hill 151ndash85

Conlisk John 1996 ldquoWhy Bounded RationalityrdquoJournal of Economic Literature 34(2) 669ndash700

Cosmides Leda and John Tooby 1992 ldquoCognitiveAdaptations for Social Exchangerdquo in The AdaptedMind Evolutionary Psychology and the Generationof Culture J H Barkow L Cosmides and J Toobyeds Oxford Oxford University Press 163ndash228

Costa-Gomes Miguel and Klaus G Zauner 2001ldquoUltimatum Bargaining Behavior in Israel JapanSlovenia and the United States A Social UtilityAnalysisrdquo Games and Economic Behavior 34(2)238ndash69

Cox James C 2004 ldquoHow to Identify Trust andReciprocityrdquo Games and Economic Behavior 46(2)260ndash81

Croson Rachel T A 1999 ldquoTheories of Altruism andReciprocity Evidence from Linear Public GoodsGamesrdquo University of Pennsylvania Discussion Paper

Dasgupta Partha 2000 ldquoEconomic Progress and theIdea of Social Capitalrdquo in Social Capital AMultifaceted Perspective P Dasgupta and ISerageldin eds Washington DC World Bank325ndash424

Davies Paul James H Fetzer and Tom R Foster1995 ldquoLogical Reasoning and Domain Specificity ACritique of the Social Exchange Theoryrdquo Biologyand Philosophy 10(1) 1ndash37

Dawkins Richard 1982 The Extended PhenotypeOxford Oxford University Press

De Waal Frans B M 1996 Good Natured TheOrigins of Right and Wrong in Humans and OtherAnimals Cambridge Harvard University Press

Debreu Gerard 1974 ldquoExcess Demand FunctionsrdquoJournal of Mathematical Economics 1(1) 15ndash21

Deci Edward L and Richard M Ryan 1985 IntrinsicMotivation and Self-Determination in HumanBehavior New York Plenum

Diamond Jared 1997 Guns Germs and Steel TheFates of Human Societies New York Norton

Dufwenberg Martin and Georg Kirchsteiger 2004 ldquoATheory of Sequential Reciprocityrdquo Games andEconomic Behavior 47(2) 268ndash98

Dugatkin Lee A 1997 Cooperation among AnimalsAn Evolutionary Perspective New York OxfordUniversity Press

Ekman Paul 2001 Telling Lies New York W WNorton

Ellingsen Tore and Jack Robles 2002 ldquoDoesEvolution Solve the Hold-Up Problemrdquo Games andEconomic Behavior 39(1) 28ndash53

Ely Jeffrey C and Okan Yilankaya 2001 ldquoNashEquilibrium and the Evolution of PreferencesrdquoJournal of Economic Theory 97(2) 255ndash72

Falk Armin Ernst Fehr and Urs Fischbacher 2003



ldquoOn the Nature of Fair Behaviorrdquo EconomicInquiry 41(1) 20ndash26

Falk Armin and Urs Fischbacher 2005 ldquoModelingFairness and Reciprocityrdquo in Moral Sentiments andMaterial Interests The Foundations of Cooperationin Economic Life H Gintis S Bowles R Boyd andE Fehr eds Cambridge MIT Press

Farrell Joseph and Eric Maskin 1989 ldquoRenegotiationin Repeated Gamesrdquo Games and EconomicBehavior 1(4) 327ndash60

Fehr Ernst and Simon Gaumlchter 2000 ldquoFairness andRetaliation The Economics of Reciprocityrdquo Journalof Economic Perspectives 14(3) 159ndash81

Fehr Ernst and Simon Gaumlchter 2002 ldquoDo IncentiveContracts Crowd Out Voluntary CooperationrdquoUniversity of Zurich Working Paper 34httpwwwiewunizhchwpiewwp034pdf

Fehr Ernst Simon Gaumlchter and Georg Kirchsteiger1997 ldquoReciprocity as a Contract EnforcementDevice Experimental Evidencerdquo Econometrica65(4) 833ndash60

Fehr Ernst Erich Kirchler Andreas Weichbold andSimon Gaumlchter 1998 ldquoWhen Social NormsOverpower Competition Gift Exchange inExperimental Labor Marketsrdquo Journal of LaborEconomics 16(2) 324ndash51

Fehr Ernst George Kirchsteiger and Arno Riedl1993 ldquoDoes Fairness Prevent Market Clearing AnExperimental Investigationrdquo Quarterly Journal ofEconomics 108(2) 437ndash59

Fehr Ernst and Klaus M Schmidt 1999 ldquoA Theory ofFairness Competition and Cooperationrdquo QuarterlyJournal of Economics 114(3) 817ndash68

Fehr Ernst and Klaus M Schmidt 2000 ldquoFairnessIncentives and Contractual Choicesrdquo EuropeanEconomic Review 44(4-6) 1057ndash68

Fehr Ernst and Klaus M Schmidt 2003 ldquoTheories ofFairness and ReciprocitymdashEvidence and EconomicApplicationsrdquo in Advances in Economics andEconometrics 8th World Congress M DewatripontL P Hansen and S J Turnovsky eds CambridgeCambridge University Press

Frank Robert H 1988 Passions within Reason NewYork Norton

Fremling Gertrud M and Richard A Posner 1999ldquoMarket Signaling of Personal CharacteristicsrdquoUniversity of Chicago Discussion Paper

Fudenberg Drew and Eric Maskin 1986 ldquoThe FolkTheorem in Repeated Games with Discounting orwith Incomplete Informationrdquo Econometrica 54(3)533ndash54

Geanakoplos John David Pearce and EnnioStacchetti 1989 ldquoPsychological Games andSequential Rationalityrdquo Games and EconomicBehavior 1(1) 60ndash79

Geertz Clifford 1963 Peddlers and Princes ChicagoUniversity of Chicago Press

Gintis Herbert 2000 ldquoStrong Reciprocity and HumanSocialityrdquo Journal of Theoretical Biology 206(2)169ndash79

Gneezy Uri and Aldo Rustichini 2000 ldquoA Fine is aPricerdquo Journal of Legal Studies 29(1) 1ndash17

Gneezy Uri and Aldo Rustichini 2000 ldquoPay Enough

or Donrsquot Pay at Allrdquo Quarterly Journal of Economics115(3) 791ndash810

Gode Dhananjay K and Shyam Sunder 1993ldquoAllocative Efficiency of Markets with Zero-Intelligence Traders Market as a Partial Substitutefor Individual Rationalityrdquo Journal of PoliticalEconomy 101(1) 119ndash37

Goeree Jacob K and Charles A Holt 2000ldquoAsymmetric Inequality Aversion and NoisyBehavior in Alternating-Offer Bargaining GamesrdquoEuropean Economic Review 44(4-6) 1079ndash89

Guumll Faruk 2001 ldquoUnobservable Investment and theHold-Up Problemrdquo Econometrica 69(2) 343ndash76

Guumlth Werner 1995a ldquoAn Evolutionary Approach toExplaining Cooperative Behavior by ReciprocalIncentivesrdquo International Journal of Game Theory24(4) 323ndash44

Guumlth Werner 1995b ldquoOn Ultimatum BargainingExperiments-A Personal Reviewrdquo Journal ofEconomic Behavior and Organization 27(3) 329ndash44

Guumlth Werner Rolf Schmittberger and BerndSchwarze 1982 ldquoAn Experimental Analysis ofUltimatum Bargainingrdquo Journal of EconomicBehavior and Organization 3(4) 367ndash88

Guumlth Werner and Menahem E Yaari 1992 ldquoAnEvolutionary Approach to Explaining CooperativeBehavior by Reciprocal Behavior in a SimpleStrategic Gamerdquo in Explaining Process and ChangeApproaches to Evolutionary Economics U Witt edAnn Arbor University of Michigan Press 23ndash34

Guttman Joel M 2000 ldquoOn the Evolutionary Stabilityof Preferences for Reciprocityrdquo European Journal ofPolitical Economy 16(1) 31ndash50

Hamilton William D 1964 ldquoThe Genetical Evolutionof Social Behaviorrdquo Journal of Theoretical Biology7(1) 1ndash17

Harbaugh William Kate Krause and Steven Liday2003 ldquoBargaining by Childrenrdquo University ofOregon Discussion paper

Harrison Glenn W and Jack Hirshleifer 1989 ldquoAnExperimental Evaluation of Weakest LinkBest ShotModels of Public Goodsrdquo Journal of PoliticalEconomy 97(1) 201ndash25

Hart Oliver 1995 Firms Contracts and FinancialStructure Oxford Clarendon Press

Henrich Joseph 2004 ldquoCultural Group SelectionCoevolutionary Processes and Large-ScaleCooperationrdquo Journal of Economic Behavior andOrganization 53(1) 3ndash35

Henrich Joseph Robert Boyd Sam Bowles HerbertGintis Ernst Fehr Richard McElreath and ColinCamerer 2001 ldquoIn Search of Homo EconomicusBehavioral Experiments in 15 Small-Scale SocietiesrdquoAmerican Economic Review 91(2) 73ndash78

Herold Florian ldquoCarrot or Stick Group Selection andthe Evolution of Reciprocal Preferencesrdquo Universityof Munich Discussion Paper

Hildenbrand Werner 1994 Market Demand Theoryand Empirical Evidence Princeton PrincetonUniversity Press

Holmstroumlm Bengt and Paul Milgrom 1991 ldquoMultitaskPrincipal-Agent Analyses Incentive Contracts AssetOwnership and Job Designrdquo Journal of Law



Economics and Organization 7 24ndash52Homans George 1953 ldquoStatus Among Clerical

Workersrdquo Human Organization 12 5ndash10Homans George 1954 ldquoThe Cash Postersrdquo American

Sociological Review 19 724ndash33Koccedilkesen Levent Efe A Ok and Rajiv Sethi 2000a

ldquoEvolution of Interdependent Preferences inAggregative Gamesrdquo Games and EconomicBehavior 31(2) 303ndash10

Koccedilkesen Levent Efe A Ok and Rajiv Sethi 2000bldquoThe Strategic Advantage of NegativelyInterdependent Preferencesrdquo Journal of EconomicTheory 92(2) 274ndash99

Kranton Rachel E 1996 ldquoReciprocal Exchange ASelf-Sustaining Systemrdquo American EconomicReview 86(4) 830ndash51

Kreps David M 1997 ldquoIntrinsic Motivation andExtrinsic Incentivesrdquo American Economic Review87(2) 359ndash64

Kropotkin Peter 1902 Mutual Aid A Factor ofEvolution London William Heinemann

Lazear Edward 2000 ldquoPerformance Pay andProductivityrdquo American Economic Review 90(5)1346ndash61

Lepper Mark R David Greene and Richard ENisbett 1973 ldquoUndermining Childrenrsquos IntrinsicInterest with Extrinsic Rewardrdquo Journal ofPersonality and Social Psychology 28 129ndash37

Levine David K 1998 ldquoModeling Altruism andSpitefulness in Experimentsrdquo Review of EconomicDynamics 1(3) 593ndash622

Mantel Rolf R 1974 ldquoOn the Characterization ofAggregate Excess Demandrdquo Journal of EconomicTheory 7(3) 348ndash53

McCabe Kevin A Stephen J Rassenti and Vernon LSmith 1998 ldquoReciprocity Trust and Payoff Privacyin Extensive Form Bargainingrdquo Games andEconomic Behavior 24(1-2) 10ndash24

Ok Efe A and Fernando Vega-Redondo 2001 ldquoOnthe Evolution of Individualistic Preferences AnIncomplete Information Scenariordquo Journal ofEconomic Theory 97(2) 231ndash54

Palfrey Thomas R and Jeffrey E Prisbrey 1997ldquoAnomalous Behavior in Public Goods ExperimentsHow Much and Whyrdquo American Economic Review87(5) 829ndash46

Possajennikov Alex 2000 ldquoOn the EvolutionaryStability of Altruistic and Spiteful PreferencesrdquoJournal of Economic Behavior and Organization42(1) 125ndash29

Postlewaite Andrew 1998 ldquoThe Social Basis ofInterdependent Preferencesrdquo European EconomicReview 42(3-5) 779ndash800

Prasnikar Vesna and Alvin E Roth 1992ldquoConsiderations of Fairness and StrategyExperimental Data from Sequential GamesrdquoQuarterly Journal of Economics 107(3) 865ndash88

Price George 1970 ldquoSelection and CovariancerdquoNature 227(5257) 520ndash21

Rabin Matthew 1993 ldquoIncorporating Fairness intoGame Theory and Economicsrdquo American EconomicReview 83(5) 1281ndash1302

Read Daniel George Loewenstein and Matthew

Rabin 1999 ldquoChoice Bracketingrdquo Journal of Riskand Uncertainty 19(1-3) 171ndash97

Ridley Matt 1993 The Red Queen Sex and theEvolution of Human Nature London Viking

Ridley Matt 1996 The Origins of Virtue New YorkPenguin

Robson Arthur J 1990 ldquoEfficiency in EvolutionaryGames Darwin Nash and the Secret HandshakerdquoJournal of Theoretical Biology 144(3) 379ndash96

Roth Alvin E 1995 ldquoBargaining Experimentsrdquo inHandbook of Experimental Economics J H Kageland A E Roth eds Princeton Princeton UniversityPress 253ndash348

Sahlins Marshall 1968 Tribesmen Englewood CliffsNJ Prentice-Hall

Samuelson Paul A 1993 ldquoAltruism as a ProblemInvolving Group versus Individual Selection inEconomics and Biologyrdquo American EconomicReview 83(2) 143ndash48

Schelling Thomas 1960 The Strategy of ConflictCambridge Harvard University Press

Segal Uzi and Joel Sobel 2004a ldquoMarkets MakePeople Look Selfishrdquo University of California SanDiego Discussion Paper

Segal Uzi and Joel Sobel 2004b ldquoTit for TatFoundations of Preferences for Reciprocity inStrategic Settingsrdquo University of California SanDiego Discussion Paper

Service Elman R 1966 The Hunters EnglewoodCliffs NJ Prentice-Hall

Sethi Rajiv and E Somanathan 2001 ldquoPreferenceEvolution and Reciprocityrdquo Journal of EconomicTheory 97(2) 273ndash97

Sethi Rajiv and E Somanathan 2003 ldquoUnderstandingReciprocityrdquo Journal of Economic Behavior andOrganization 50(1) 1ndash27

Simon Herbert A 1990 ldquoA Mechanism for SocialSelection and Successful Altruismrdquo Science250(4988) 1665ndash68

Simon Herbert A 1993 ldquoAltruism and EconomicsrdquoAmerican Economic Review 83(2) 156ndash61

Smuts Barbara 1999 ldquoMultilevel SelectionCooperation and Altruism Reflections on UntoOthersrdquo Human Nature 10(3) 311ndash27

Sober Elliott and David Sloan Wilson 1998 UntoOthers The Evolution and Psychology of UnselfishBehavior Cambridge Harvard University Press

Solow Robert M 1979 ldquoAnother Possible Source ofWage Stickinessrdquo Journal of Macroeconomics 1(1)79ndash82

Sonnenschein Hugo 1973 ldquoDo Walrasrsquo Identity andContinuity Characterize the Class of CommunityExcess Demand Functionsrdquo Journal of EconomicTheory 6(4) 345ndash54

Stigler George J and Gary S Becker 1977 ldquoDeGustibus Non Est Disputandumrdquo AmericanEconomic Review 67(2) 76ndash90

Sugden Robert 1984 ldquoReciprocity The Supply ofPublic Goods through Voluntary ContributionsrdquoEconomic Journal 94(376) 772ndash87

Thaler Richard H 1999 ldquoMental AccountingMattersrdquo Journal of Behavioral Decision Making12(3) 183ndash206



Trivers Robert L 1971 ldquoThe Evolution of ReciprocalAltruismrdquo Quarterly Review of Biology 46(1)35ndash58

Varela Francisco J 1999 Ethical Know-HowStanford Stanford University Press

Wason Peter C 1966 ldquoRealism and Rationality in theSelection Taskrdquo in Thinking and ReasoningPsychological Approaches J Evans ed London

Routledge and Kegan Paul 44ndash75Yamagishi Toshio 1988 ldquoThe Provision of a

Sanctioning System in the United States and JapanrdquoSocial Psychology Quarterly 51(3) 265ndash71

Yamagishi Toshio Karen S Cook and Motoki Watabe1998 ldquoUncertainty Trust and CommitmentFormation in the United States and JapanrdquoAmerican Journal of Sociology 104(1) 165ndash94



repeated interaction This approach is quitepowerful as essentially all exchanges in natu-ral settings can be viewed as part of somelong-term interaction Consequently onecould argue that the models of section 34are unnecessary This essay presents thecounterargument that models of intrinsicreciprocity can provide clearer and moreintuitive explanations of interesting econom-ic phenomena An openness to the possibili-ty of intrinsic reciprocity leads to a new anduseful perspective on important problems

The next section contains a stylized exam-ple that illustrates the limitations of standardmodels I use the example to provide aninformal introduction to alternative theoret-ical approaches and motivate the paperSection 3 introduces these models formallySection 4 describes some economic settingsin which the modeling approaches of section3 may be particularly useful Section 5reviews literature on the evolution of prefer-ences Section 6 responds to stylized argu-ments against the approach and section 7 isa conclusion

2 An Informal Guide to the Concepts

We regularly read accounts of dissatisfiedor recently fired employees destroying prop-erty sabotaging computer files or evenldquogoing postalrdquo and killing people at theirworkplace The sense of outrage at an appar-ent injustice is real Many people are willingto take destructive actions as part of the out-rage This kind of destructive behavior isunlikely to be in the material interest of afired employee it takes time it is not com-pensated and it carries the risk of criminalpenalties How should we think about itFor concreteness imagine that Paul was ahigh-ranking executive who had worked fora company for more than ten years He losthis job when business turned bad On his lastday on the job Paul destroyed vital companydocuments and continued to sabotage com-puter files until he was caught six monthslater In this section I will use Paulrsquos story to

introduce and motivate the ideas I review inthe manuscript

21 Descriptions

There are several ways to react to Paulrsquosdestructive activity One response is to treat itas an emotional response not subject to eco-nomic analysis We should not give up so eas-ily Paul may be crazy but his former bossMarsha probably is not Unless Paulrsquos actionsare completely unrelated to the environmentMarsha will want to understand how toreduce the chance of adverse behaviorMarsha may need to hire lawyers or psychi-atric consultants (instead of economists) to tellher how to deal with Paul or reduce the risk ofcostly outbursts by employees but she shouldevaluate her options using economic models

I will concentrate on descriptions that areconsistent with the hypotheses of optimiza-tion and equilibrium Once we allow thatPaul maximizes something more that his ownmonetary reward there are many stories likethis available This section introduces somepotential descriptions informally Section 3provides a more systematic treatment

211 Static Income Maximization

Hypothesis The narrowest version ofeconomic theory assumes that Paul seeks tomaximize his utility and that his utilitydepends on the quantities of the privatematerial goods he consumes In staticincome maximization Paul balances theimmediate cost and benefits of actionsrather than the long-term implications ofthese decisions In simple settings thishypothesis reduces to the assumption thatPaul maximizes his monetary income

Analysis Paul would carry out hisdestructive action only if he imagined that itwould lead to direct material gain It is hardto rationalize Paulrsquos behavior under theseassumptions His actions may advance hisimmediate material interests if Marsha giveshim back his job or if he receives a paymentto stop sabotaging the company but a moreelaborate description seems necessary
















215 Commitment







216 Repeated Games

















3 Models


Karl Popper




























(1)



u x x x x xi ij i


λ





income





γγ1 +

x

xi

jN

jsum

=1





x xij i

i i j

ij+ sum

+

+ne

α β αβ1


















(2) U(Z1hellipZm)













(4) ui(O(s)(s))















































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES




























































































































































215 Commitment


ju05_Article 2 61005 140 PM 94





216 Repeated Games

















3 Models


Karl Popper




























(1)



u x x x x xi ij i


λ





income





γγ1 +

x

xi

jN

jsum

=1





x xij i

i i j

ij+ sum

+

+ne

α β αβ1


















(2) U(Z1hellipZm)













(4) ui(O(s)(s))















































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES


















































































































































216 Repeated Games

















3 Models


Karl Popper




























(1)



u x x x x xi ij i


λ





income





γγ1 +

x

xi

jN

jsum

=1





x xij i

i i j

ij+ sum

+

+ne

α β αβ1












ju05_Article 2 61005 140 PM 00






(2) U(Z1hellipZm)













(4) ui(O(s)(s))















































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES






















































































































































3 Models


Karl Popper




























(1)



u x x x x xi ij i


λ





income





γγ1 +

x

xi

jN

jsum

=1





x xij i

i i j

ij+ sum

+

+ne

α β αβ1


















(2) U(Z1hellipZm)













(4) ui(O(s)(s))















































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES






































































































































































(1)



u x x x x xi ij i


λ





income





γγ1 +

x

xi

jN

jsum

=1





x xij i

i i j

ij+ sum

+

+ne

α β αβ1


















(2) U(Z1hellipZm)













(4) ui(O(s)(s))















































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES

















































































































































income





γγ1 +

x

xi

jN

jsum

=1





x xij i

i i j

ij+ sum

+

+ne

α β αβ1


















(2) U(Z1hellipZm)













(4) ui(O(s)(s))















































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES






























































































































































(2) U(Z1hellipZm)













(4) ui(O(s)(s))















































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES



















































































































































(4) ui(O(s)(s))















































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES

















































































































































































j and si = slowast























Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES



























































































































































Fight

Opera

Fight

21

00

Opera

00

12




























AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES








































































































































































AM

PM

ALL

AM

1010

00

710

PM

00

1010

710







ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES



















































































































































ALL AM PM 12

12+




35 Commitment


(7) ui(siBRi(si))










36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES



















































































































































36 Repeated Games





















4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES























































































































































4 Using the Models






41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES

















































































































































41 Charity





























































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES
































































































































































































































5 Origins













52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES

















































































































































52 Green Beards























































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES





























































































































































































(E) (4) (K) (7)







(Beer) (24) (Coke) (17)





55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES















































































































































55 Learning














56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES

















































































































































56 Summary













6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES


















































































































































6 Closing Arguments


The Dalai Lama








62 Complexity










64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES
















































































































































64 Generality



65 Discipline








67 Parsimony






7 Conclusion






REFERENCES
















































































































































7 Conclusion






REFERENCES




















































































































































































ju05_Article 2 61005 140 PM 4






















































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