rabin, matthew. psychology and economics.pdf

Journal of Economic LiteratureVol. XXXVI {March 1998), pp.

Psychology and Economics

MATTHEW RABINUniversity of Califomia at Berkeley

For corninf^nts on this es.vaif or disciissioii oil reifiter! lopirn, I llitiiik Ih'iirij Aiirnii. GeorgeAkerlof. Jninea Amheimi. Slnrn Blntl. Grinj Chnnw.ss. Edillf Dekel. I'eft'r Diinmtnd. joiiEhter. Erik Eij.slcr. Enist Filir. David 1 Levine. Gi-vrfU' Lonvnisleiu. Hoh MfJcCotiu, JamesMoiilgoiiiprij, V(ii-L(iiii Mtii. Tril O'DoiwsJnu'. Drazcn Prcler, lUjii Hrf^fit. Klilrir Shiifir. Ch-neSiiiolenskif. Joi-I Sohet, .'\jno.\ Tiersky. four iiiioiiijmoii.'i rrfi'n'fu. tiud f.sfu-i-iiilty Coliti Cnim-rer,Danny Knlmftiuiii. ami Rirhnrd Tlitili-r. Co-autliors on rfsearch relnled Iu ihc Inpir.'. of thisesiiiij inrlinlr Ptii iil Bouniaii. Dehornh Mincharl. Ted O'I)onog,hu<'. antl Jtwl Srlini^. ilr(}>fulre.si'drrh a.sshfaiiri- ivas protidi^d by Cadi BtiHmj. \Ukkl Blasbrrg. Clrill Bri'tinaii. I'mil iLllirk-.•ion. .A jnV Franco, .Marcus Hi'ii^, Bntre Ihu, jiii Woo }iiii^, iiiitl rfiju'rifilhj Sttvt'n Bltitl,Jimmy ('han, Erik Ei/slcr. and Clara W'mig. I tim cxircmrlij f^rawfiil li> thr \nlii>ntil Sdrnce,Hiissrll Sngr. Alfred P. Slotiit. and Mar.Arihur Foundalioiix for fmiinrial support ou ri'xi'arehrchili-d lo ihis I'ssny. A more vcrbosi- mul ciialUm-h<-ait/ ii-rsinii of this rssmj, roicn(i{; a feteailrlilional topics, is avfiiliihle as (hiiirrsily of California al Bcrkrh'y Dcjiariuwni of Econont-im Working PripiT \o. U7~25I

1. Introduction

BECAUSE PSYCHOLOGY systemati-cally explores huHian judgment, be-

havior, and well-being, it can teach usimportant facts about how humans differfrom the way they arc traditionally de-scribed by economists. In this essay Idiscuss a selection of psychological find-ings relevant to economics.

Economics has conventionally as-sumed that each individual has stableand coherent preferences, and that sherationally maximizes those preferences.Given a set of options and probabilisticbeliefs, a person is assumed to maxi-mize the expected value of a utilityfunction, Uix). Psychological researchsuggests various modifications to thisconception of human choice. Section 2provides examples of what psychologicalresearch can teach us about makingU{x) more realistic than under standardeconomic a.ssumptions. I begin by dis-cussing researcii which suggests that a

person's preferences are often deter-mined by changes in outcomes relativeto her reference level, and not uierelyby absolute levels of outcomes. In par-ticular, relative to their status quo (orother reference points), people dislikelosses significantly more than they likegains. I then discuss how people departfrom pure self-interest (as narrowly de-fined) to pursue "other-regarding" goalssuch as fairness, reciprocal altruism,and revenge.

By focusing on evidence consistentwith rational choice. Section 2 reviewsevidence that requires relatively smallmodifications of the familiar economicframework. Section 3 reviews researchon biases in judgment under nneer-tainty; because these biases lead peopleto make errors when attempting tomaximize U{x). [his researcii poses amore radical cliallenge to the econom-ics model. I discuss two biases in de-tail—how we infer too much from toolittle evidence and how we nusread evi-

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12 Journal of Economic Literature, Vol. XXXVI {March 1998)

deuce as contiriiiiTig previously held liy-potlieses—and briefly explain a fewmore. I also discuss some of the psycho-logical evidence on whether and whenexperience and learning lead people too\'erconie these biases.

The array of psychologieal findingsreviewed in Seetion 4 points to an evenmore radical critiqne of the economicsmodel: Even if we are willing to modifyour standard assumptions about U{x), orallow that people make systematic er-rors in judgment when attempting tomaximize t/(.v), it is sometimes mislead-ing to conceptualize people as attempt-ing to ma.Kimize a eoherent, stable, andaccurately perceived U{x). I begin byreviewing evidence that people havedifficulties evaluating their own prefer-ences—we don't always accurately pre-dict our owTi (iiture preferences, noreven accurately assess our experiencedwell-being from past choices. I then dis-cuss research on framing effects, pref-erence reversals, and related phenom-ena in which people prefer some option.V to y when the choice is elicited oneway, but prefer y to x when the choiceis elicited another way, I conclude Sec-tion 4 with a discussion of self-controlproblems and other phenomena thatarise because people have a short-runpropensity to pursue immediate gratifi-cation that is inconsistent with theirlong-run preforenees.

The cnstoiiuuy disclaiiuer of reviewessays—that they do not pretend to beexhaustive—applies even more lierethan usual: The topics covered are onlya small fraction of economically rele-vant psychology. Some omitted topics ofobvious economic relevance are non-expected utility; status, envy, and socialcomparisons: conformity and herd be-havior; self-serving biases and moti-vated cognition; the tendency of "ex-trinsic motivation" (e.g.. organizationalincentive schemes) to drive out ' intrin-

sie motivation" (e.g., the internal driveto excel at your vocation); and a mass ofresearch on learning from cognitive anddevelopmental psychology. '

Two other limitation,s of scope areconspicuous. First, I emphasize whatpsyehologists and experimental econo-mists have learned about people, ratherthan how they have learned it. Conse-quently, the focus of this essay is not atall on experimental methods per se.-Second, my primary emphasis is on re-viewing what psychology tells us aboutmodifying our general assumptionsabout individual behavior, rather thanon any of its specific economic applica-tions. For instance, while fairness andreference-le\el effects (reviewed inSeetion 2) and framing effects (re-viewed in Section 4) are likely to con-tribute to downward stickiness inwages. I leave the exploration of theseimplications to other forums.

Mainstream economics employs apowerful combination of methods:methodological individualism, mathe-matical formalization of assumptions,logical analysis of the consequences ofthose assumptions, and sophisticatedempirical field testing. I believe thesemethods are tremendously useful, and

' Another topic I have omittrd is "non-psycho-logit-al" models of bounded rationality. Re-.sparchers have fonimlated models of bounded ra-tionality (based on intuition, computer science, orartificial inteHigence) meant to capture cognitivelimits of economic actors, but whicIi do not invokeresearch on the specific patterns of errors that hu-man beings make. For an excellent review of therole of bounded rationalitv in economics, see JohnConlisk(1996}.

- Descriptions of experimental metliods em-ployed by psychologists can be fonnd in virtuallyany p.sychoiogy text. For an excellent set of re-views of the resnits of experimental economics,see John Kagel and Alvin Roth {1995). While mostof tiie fintlings I present in this essay come frompsychologists, I often draw on evidence from ex-perimental economics as well. My focus, however,is on experiments that explore the psychologicalnature of indi\idnals. not on research seeking toreplicate economic institutions in the laboratory.

Rabin: Psychology and Economics 13

an underlying premise of tins essay isthat we shotild strive to understand psy-chological findings in liglit of thesemethods.^ These methods raise prob-lems for doing full justice to behavioralreality: Because of the high premiumeconomies places on the logic and pre-cision of arguments and the qtiantifica-tion of evidence, attending to all facetsof human nature is neither loasible nordesirable. The realization that many de-tails of human behavior must be ig-nored, however, should not license in-stittitionalized complacency about thebehavioral validity of our assumptions;"traetability" and "parsimony" should beguiding principles in our efforts tomake our researcii more realistic, notpretexts for avoiding this task. As it nowstands, some important psychologicalfindings seem tractable and parsimoni-ous enough that we should begin theprocess of integrating them into eco-nomics. Incorporating other findingswill take longer. But even in thosecases, economists ought to becomeaware of the siiortcomings of otir mod-els, regret these shortcomings, and keepour eyes open for ways to remedy them.While I conclude in Section .5 hy brieflydiscussing the general endeavor ofincorporating psychological findingsinto econotriics, I have omit ted fromthis essay many of the classical meta-argttnLonts about whether it is "possi-ble" tliEit behavioral research identiiiesimportant departures froui economists"habitual assttmptions abottt human be-havior. Of course it is possible, and infact it is true. In this essiiy, I review

•'Indeed, I liavc organized the essay to rrflcctthis premise, .At times, difriculties in organizationbelie deeper difficulties of how to fit this researciiinto the economics framework. For instaiKe, wliileSection 2 discusses approaches to modeling lossaversion fully witliiii tiie ratioual-clioice frame-work, material in Section 4 suggests loss aversionisn t alway.s best conceived of as compatible withutility maximization.

what research shows some of those de-partures are.

2. Preferences

Tins section discusses how psyclio-logica! findings suggest we modify theutility functions economists employ.

A. Reference Levels, Adaptation,and Losses

Overwhelming evidence shows thathumans are often more sensitive to howtheir current sitttation differs fromsome reference level than to the abso-lute characteristics of the situation(Hany Helson 1964). For instance, thesame temperature that feels cold wbenwe are adapted to hot temperaturesmay appear hot when we are adapted tocold temperatures. Understanding thatpeople are often more sensitive tochanges tlian to absolute levels suggeststhat we ought incorporate into utilityanalysis such factors as habitual levelsof consumption. Instead of utility attime t dependiug solely on present con-sumption, Cl. it may also depend on a"reference level," o, determined by fac-tors like past consumption or expecta-tions of future consumption. Hence, in-stead of a utility function of the fonnut{ri;ci)- utility should be written in amore general form, Ut{rt\ci), Wliile someeconomists liave over the years incorpo-rated reference dependence into theireconomic analysis, it is fair to say thatthe ways and degrees to which refer-ence points influence behavior have notfully been appreciated by econotnists.'Researchers have identified a per\asivefeature of reference dependence: In awide variety of domains, people are sig-nificantly tnore averse to losses than

' There have been some earlier examples ofeconomists [on.sidering refereni,-!' dependence{James Duesenberry 1949; Richard Easterlin 1974;and Harl Ryder and Ceoffre\ Heal 1973}.

14 Journal of Economic Literature, Vol. XXX\^I (March 1998)

they are attracted to same-sized gaitis(Kahneman, Jack Knetsch, and Thaler1990). One realm where such /m.5 aver-sion plays otit is in preferences overwealth levels. Tversky and Kahneman(1991) stiggest that in the domain ofmoney (and in others where the sizes oflosses and gains can be measured),people val tie modest losses rotighlytwice as mnch as eqnal-sized gains.That the displeasure from a monetaryloss is greater than the pleasure from asame-sized gain is also implied by aconcave utility function, which econo-mists typicaliy use as the explanationfor risk aversion. But loss aversion savsthat the valtie function abruptly changessh)pe at the reference level, so that peo-ple dislike even small-scale risk. For in-stance, most people prefer their statusquo to a 50/50 bet of losing $10 or gain-ing $11. The standard coneave-utility-ftmction explanation for risk aversion issimply not a plansible explanation ofsuch risk attitudes. Rajnish Mehra andEdward Prescott (1985) and Larry Ep-stein and Stanley Zin (1990) have, forinstance, observed that the expected-utility framework catmot simultaneouslyexplain both the small-scale and large-scale risk attitudes implied by macrodata, and Rabin (1997) provides a "cali-bration theorem" that indeed showsthat no concave utility function can si-multaneously explain plausible small-scale and iarge-scale risk attitudes, Areference-based kink in the utility func-tion is required to explain such risk atti-tudes within the expected-utility frame-work.

Loss aversion is related to the strik-ing endowment effect identified byThaler (1980): Once a person comes topossess a good, she immediately values

zi Segal and A\ia Spiviik (1990). and otlifrs.however, develop a model of .such first-order riskaversion outside the expected-utility framework.

it more than before she possessed it.Kahneman, Knetsch. and Thaler (1990)nicely illustrate this phenomenon. Theyrandomly gave mugs worth about $5each to one group of students. Minimalselling prices were elicited from thosegiven the mugs (with an incentive-eom-patible procedure that ensured honestreports). Minimal "prices"—sums ofmoney sueh that they would choose thatsum rather than the mug—were elicitedfrom another group of subjects notgiven mugs. These two groups, "sellers"and "choosers," faced precisely thesame choice between money and mugs,but their reference points differed:Those who were randomly given mugstreated the mugs as part of their refer-ence levels or endowments, and consid-ered leaving without a mug to be a loss,whereas individuals not given mugs con-sidered leaving without a mug as re-maining at their reference point. In oneexperiment, the inedian value placed onthe mug was $3.50 by clioosers but$7.00 by sellers. Such results have beenreplicated repeatedly by many re-searchers in many contexts.

As established by Knetsch and JohnSinden (1984), William Samuelson andRichard Zeekhauser (1988), and Knetseh(1989), a comparable phenomenon—the.•itatu.'i quo hias—liolds in multiple-goodchoice problems. Here, loss aversionimplies that individuals tend to preferthe status quo to changes that involvelosses of some goods, even when theselosses are offset by gains of other goods.Knetsch and Sinden (1984) and Knetsch(1989), for instance, randomly gave stu-dents either candy bars or decoratedmugs. Later, eacli student was offeredthe opportunity to exchange her gift forthe other one—a mug for a candy bar orvice versa. Ninety percent of both mug-owners and eandy-owners chose not totrade. Because the goods were allocatedrandomly and transaction costs were


minimal, the different behavior for thetwo groups of subjects presumably re-flected preferences that were inducedby the initial allocation. Knetscb (1989)and Tversky and Kahneman (]991)show that such preferences can be use-fully captured by utility functions de-fined over reference levels as well asconsumption levels.

In addition to loss aversion, anotiierimportant reference-level effect is di-inini.shing sensitivity: The marginal ef-fects in perceived well-being aregreater for changes close to one's refer-ence level than for changes furtheraway. As Kahneman and Tversky (1979)note, diminishing sensitivity is a perva-sive pattern of human perception,where our perceptions are a concavefunction of tlie magnitudes of change.For instance, we are more likely to dis-criminate between 3° and 6° changesin room temperature than between23° and 26° changes. This applies toboth increases and decreases in tem-perature. In the context of preferencesover uncertain monetary outcomes,diminishing sensitivity implies thatthe slope of a person's utility functionover wealth becomes (latter as herwealth gets further away from herreference level. Because for lossesrelative to the reference level "furtheraway" implies lower wealth levels, di-minishing sensitivity has a provocativeimplication: While people are likely tobe risk averse over gains, they are oftenrink-loving over losses. Kahneman andTversky (1979) found that 70 percentof subjects report that they would pre-fer a 3/4 chance of losing nothing and1/4 chance of losing $6,000 to a 2/4chance of losing nothing and 1/4 chanceeach of losing $4,000 or $2,000. Be-cause the preferred lottery here is amean-preserving spread of the less-pre-ferred lottery, the responses of 70 per-cent of the subjects are inconsistent

with the standard concavity assump-tion. *

In order to study the effects of refer-ence points in a dynamic utility-maximi-zation framework, we need to take intoacconnt how people feel about the ef-fects their current choices have on theirfuture reference points. To maximizetheir long-run utilities when referencepoints matter, people must determinetwo things beyond how they feel aboutdepartures from reference points: Howcurrent behavior affects future refer-ence points and how they feel aboutchanges in their reference points.Economists Ryder and Heal (1973)model the process by which referencepoints change with the formular, = ow;f-i+ (l-a)rf-t, where a G ( 0 , 1 ) is aparameter measuring how quickly peo-ple adjust their reference points. In arational-expectations model, people willtake this formula into account whenmaximizing their long run well being.Such an account of how reference levelsare determined seems intuitive, thoughthere seems to be little evidence on thistopic." Evidence is similarly sparseabout how people's preferences dependon changes in reference points.^ With-

'' Because this "risk-loving" tendenc)' is in con-flict with the diminishing marginal utihty of in-come, howevor, it has often been conjectiiretl thatrisk aversion may reappear for lar^e losses thatmight push a person to extremely low consump-tion levfls,

" Bowmaii, Minehart, and Rabin (1997) combine theRyder and Heal approach of rational-expectations, ref-erence-dependent utilitie,s with a titilit\' function thatincorporates loss aversion and di- mini.shiiig sensitivity,Duesenheny (1949) implicitly posited a referencefunction closer to r, = Miix {(\ ; t < ()—that h. a per-.son's reference level was her higliest past consumptionlevel.

^ For exceptions, see Loewenstein and NachiimSicherman ( 1991). Robert Frank (198.5 cli, 15,1989). and Frank and Robert Hutchens (1993),who have identified a tendency for people to pre-fer income profiles that are steady or increasingover time to same-sized decreasing profiles,strongly indicating that people prefer not to be-come accustonietl to levels of consumption theyknow they cannot maintain. For consiaeration of

16 Journal of Economic Literature, Vol. XXXM [March 1998)

out assumptions about these relation-ships, there will be a relatively small setof circumstances where loss aversionand diminishing sensitivity can be inte-grated into models of dynamic utilitymaximization.

There have bern some initial at-tempts to study loss aversion, the en-dowment effect, and the status quo biasin economic contexts. Raymond Hart-man, Michael Doane, and Chi-KeiingWoo (1991) find empirical evidence forthe existence of a status quo bias inconsumer demand for electricity; Bow-man, Minehart. and Rabin (1997) repli-cate evidence by John Shea (1995a,1995b) that consumers are more averseto lowering consumption in response tobad news about income than they are toincreasing consumption in response togood news, and argtie that this behavioris a natural implication of loss aversion.

B. Social Preference.^ and FairAllocations

It is common for undergraduates toencounter tlie following quote from TheWealth of Natiotis (Adam Smith 1776,pp. 26-27) at the beginning of Econom-ics 1:

It is not from the benevolence of the butcher,the hrewer. or the baker that we expect otirdinner, but Iroiii their regard for their ouaiinterest. We address ourselves not to theirhumanity, but to their self-love, and nevertalk to them of otir necessities, but of theiradvantage,

There is not much to disagree with inSmith's poetic analysis of the motiva-tions driving most market behavior, andprobably no other two-word descriptionof human motives comes close to "self-interest" in explaining economic behav-ior. Yet pure self-interest is far from a

sotne otber factors involved in the preference foriiitreasing wage profiles, see Loewenstein andSicberman (1991, pp, 7fi-82}.

complete description of human motiva-tion, and realism suggests that econo-mists should move away from thepresumption that people are solely self-interested. Robyn Dawes and thaler(1988, p. 195) eloquently set parame-ters for this endeavor:

In tbe rural areas around Jthaca it is commonfor farmers to put some fresh produce on thetable by the road. There is a cash box on thetable, and customers are expected to putmoney in tbe box in return for the vegetablesthey take. The box has just a small slit, somoney can only be put in. not taken out..^Iso. tbe box is attached to tbe table, so noone can (easily) make off witb tbe money. Wethink tbat the farmers have just about tberight model of liuman nattire. They feel thatenough people wil! volunteer to pay for thefresh corn to make it worthwhile to put it outtliere. The farmers also know tbat if it wereeasy enough to take the money, someonewould do so.

Examples of economic behavior in-duced by social goals are donations topublic television stations, voluntary re-ductions of water-use during droughts,and conservation of energy to help solvethe energy crisis (Kenneth Train,Daniel McFadden, and Andrew Goett1987). One context in which fairnesshas been studied is monopoly pricing(Thaler 1985; and Kahneman, Knetsch,and Thaler 1986a, 1986b). Might con-sumers see the eonventional monopolyprice as unfair, and refuse to buy at thatprice even when worth it in materialterms? If this is the case, then even aprofit-maximizing monopolist wouldprice below the level predicted by stan-dard economic theory. Finally, hun-dreds of researchers in psychology, in-dustrial relations, and economics haveinvestigated how equity, fairness,status-seeking, and other departuresfrom self-interest are important in em-ployee behavior. Indeed, the massivepsychological literature on equity the-ory was developed largely in the context

Rabin: Psychologtj ami Economics 17

of industrial relations (Stacy Adams1963; Akerlof 1982; and Akerlof andJanet Yellen 1990).

Experimental research makes clearthat preferences depart from pure self-interest in non-trivial ways: Subjectscontribute to public goods more thancan be explained by pure self-interest;they often sliare money when theycotild readily grab it for themselves: andthey often sacrifice money to retaliateagainst unfair treatment. Debates re-main, as some researchers have empha-sized the possibility of producinglaboratory environments (e.g., well-or-ganized, private-information double-auction spot tnarkets) that induce be-havior that is closer to purelyself-interested than is behavior in othersettings. Btit, disentangling debatesover the nature of preferences fromstrong ancillary assutnptions aboutwhich institutions and environmentsmatter in the real world, there does notappear to be debate atnong behavioralresearchers about whether underlyingpreferences depart non-trivially frompure self-interest.

One form of social motivations onwhich economists have focused is al-tniism, in the sense that people put posi-tive value on the well-being of others.Roughly, this approach says that person1 acts as if she is maximizing prefer-ences of the form t/i(,v) = (1 - r)ni(A)+ rn2(.T),where ni(.v) is person I's "ma-terial well-being" frotn outcome x. andn^(.r) is person 2 s material well-being.By letting r be stnalL we can capturethe idea that people are mostly self-in-terested; by assuming r>0, we can in-vestigate when and how concern forothers affects behavior and welfare.

Simple altruism may parsimoniottslycapture itiiportant phenomena in manycontexts. But there is a mass of experi-mental evidence that indicates it isoften a very wrong description of social

preferences.'' To get a sense for how so-cial preferences differ from simple al-truism, consider what can be called "be-havioral distribtitivo justice": How dopeople choose to divide resources?'*'There are two aspects to this question:First, what do people, when disinter-ested, feel are proper rules for alloca-tion? Second, to what degree do peoplesacrifice self-interest for the sake ofthese principles? Very roughly, imaginethat person I s utility function takes theform C/i =(1-r)ni-HrVV|(ni,n2), where\V[ is person I's view of the proper allo-cation, and rii is (as above) her self-in-terested payoff, and 0 < r < l measuresthe weight this person puts on self-in-terest verstts proper allocation. To un-derstand the implications of fairnessand justice for behavior, we need toknow both the nature of the VVi fune-tion, and the level of r.

To address the question of disinter-ested assessments, suppose two peopletogether find $10 worth of money orother goods on the grotind. Mow wouldthe average person, acting as a third

•'See Dennis Krebs (1970, U)S2) for sotiie psy-ehoiogkal evidence on altruism and need-basedhelping motives. Even where simple altruism mayadequately describe behavior (e.g., in donating tocharity), psychological research may be of valtiefor welfare economics. In particular, research hasexplored whether people who help others do sofor "truly" altruistic reason.s. in the sense tbat theactions they take will lower their experiencedwell-being, or whether they do so "only" to allevi-ate painful guilt, etc. Do you help a stranger wheninconvenient beeause it is the right thing to doeven though it makes you worse ofP Or do youlike bringing joy to others in ihe same way yon likeeating apples? Or do you know yon will have un-

f)loasant, guilt-induced nightmares if you don'tlelp? These distinctious will be important in wel-

fare analysis: Eveu if we think behavior is de-scribed Ii)' Max (.'|(.v)H(l - r) n](v) +;'n2(,v), wemust still resolve whether Person I's experiencedwell-being is deseribed by U]{x) or fiiCjc),

'"I nse the term "behavioral distributive jns-tiet*" to emphasize that I am reviewing evidenceon bow people actually feel about distributive jus-tice, uoi normative or philosophical questions ofwhat is the proper notion of distributive justice.

18 Journal of Economic Literature, Vol. XXX\7 [March 1998)

party, decide to split the surplus be-tween the two?" The simple-altruismperspective would suggest solutionssuch as giving tho surplus to the personwho is poorer—or for non-moneygoods—the person who values thegoods more. But research shows thatmany people in many contexts do notfind the "maximal-benefits" criterion at-tractive. One simple alternative norm isprevalent: Resources should be split50-50. Except in extreme cases, oftenwe ignore issues of relative usefulnessand feel that goods should be dividedeqiialty.

But the maximal-benefits criterionfares even worse than tliis. Many peoplefeel goods should be allocated accord-ing to a "maximin" criterion whieh equal-izes welfare improvements between thetwo people. That is, disinterested peo-ple often seem to maximize preferencesof the form VV(i= Minirii.ri^l. where ITiand TI2 are the gains in utility from di-viding resources. Because it takes agreater allocation to increase the utilityof a person who values a resource less,the maximin criterion typically impliesthat more tlian halftlie resources are al-located to the person who values thoseresources leas. Consider the followinghypothetical situation that Maya Yaariand Menaliem Bar-Hillel (1984, p. 8)posed to 163 subjects:

Q1:A shipment containing 12 grape-fruits and 12 avocados is to be distrib-uted between Jones and Smith. Thefollowing information is given, and isknown also to the two recipients:

" I assiiriK' tlie surplus is found so as to con-sider the tliouglit experiment tliat tieitlier partydeserve.^ the money more than the other. Desertwill obviously be relevant in many situations—andthe massive psychological literature on "eqnitytheory" .shows that people feel tbat those who haveput more effort into creating resources have moreclaim on those resources (I-^len Berscheid, DavidBoye, and Elaine Walster 1968),

Doctors have determined thatJoncss metabolism is such that hisbody derives 100 milligrammes of vita-min F from each grapefruit con-sumed, while it derives no vitamin Fwhatsoever from avocado.

- Doctors have also determined thatSmith's metabolism is such that hisbody derives 50 nulligrammes of vita-min F from each grapefruit consumedand also from eadi avocado con-sumed.

- Both persons, Jones and Smith, areinterested in the consumption ofgrapefniit or avocados only insofar assuch consumption provides vitaminF—and the more the better. All theother traits of the two fruits (such astaste, calorie content, etc.) are of noconsequence to them.

- No trades can be made after the di-vision takes place.

How should the fruits be divided be-tween Jones and Smith, if the division isto be just?

Grapefruits are wortli more to Jonesthan to Smith, and avocados are worth-less to Jones. The "socially efficient,"metabolism-maximizing allocation,therefore, is for Jones to get all thegrapefruits, and Smith to get all theavocados. (Such an allocation wouldseem to accord somewbat to 50-50norms.) The maximin allocation, how-ever, would be to give eight gnipelruitsto Jones, and give the remaining grape-fruits and all the avocados to Smith.

Subjects were given a menu of fivedifferent allocations, and asked to statewhich allocation they found the most"just." Yaari and Bar-IIillel (1984, p.10) report the percentage of respon-dents who chose each of the five alloca-tions. The five allocations are denotedby the number of grapefruits and avoca-dos to be distributed to Jones andSmith (denoted by their initials):


Distribution(J:6^, S:6-6)(j:6-0, S:6-12)(l:8-fl, S:4-12)(J:9-0, S;3-12)(1:12-^, S:0-12)

% of respondents80

8282

The vast majority of respondentschose to equalize welfare gains (J:8-0,S:4-12), rather than maximize total wel-fare gains (J:12-0, S:0-12). Because themaximin solution is suhtle, the resultsstrongly suggest subjects tliought aboutthe problem, and did not merely choosesome simple focal point.'-

Yaari and Bar-Hillel (1984, p, 11)then tested the robustness of tlie maxi-min criterion by posing a variant of theoriginal question, where stibjects weretold that Stnith derives only 20 milli-grams of Vitamin F from both fruits,rather than 50 milligrams. Subjects sup-ported the maximin criterion just asstrongly—now imposed at a greater costto.total social benefits. Indeed, Smith isnow given tnore than half the grape-fruits, though they are far less valuableto Smith than they are to Jones. Posit-ing that, "Sooner or later . . . [themaximin criterion] runs the risk of be-coming morally unsound," Yaari andBar-Hille! push the limits of the maxi-min criterion by telling subjects thatSmith derives only 9.1 milligratns of Vi-tamin F from both fruits, so that grape-fruits are 11 times more valuable toJones than Smith. While a far greaternumber of respondents now seetned

' -Tbe very subtlety of tbe maximin solution,bowever, points to a concern with these data tbatYaari and Bar-Hillel themselves draw attention to:The questions here were posed iu writing at theend of a college eutrance exam, which may baveinduced subjects to treat the questions as prob-lems to solve, ratber tbau as opinions they sfionldexpress. Informal sur\eys by Yaari aud Bar-Hillelin very different coutexts. and experimental re-sults reported below suggest that the problem-solviug eoutext does not Tully explain the patternsthey found in this study.

willing to tolerate unequal welfaregains, still only 12 percent of respon-dents felt that all 12 grapefruits shouldbe given to Jones. Moreover, only ISpercent thought that Jones should getmore than half the grapefruits wlule 38percent thought Smith should get morethan half.

While Yaari and Bar-Hillel studywhat disinterested people consider aproper allocation rule, to address thequestion of how people trade off self-interest against justice, we need a situ-ation where the allocator is not disinter-ested. If, for instance, an allocator mtistunilaterally choose how to divide moneybetween herself and a second party, herchoice will depend both on what shefeels is a just allocation and on howmuch she values a jtist otitcome relativeto her self-interest. Andreoni and JohnMiller (1996) consider just such a sitti-ation.''^ They asked each stibject to uni-laterally allocate money between herselfand an anonymous second party. Sub-jects were given various "exchangerates'' for allocating money; for in-stance, some subjects were told that forevery $1 they sacrificed, the otber partywould get $3. Over half the subjects be-haved in a way significantly inconsistentwith pure self-interest. Among thosewhose behavior was least self-inter-ested, two thirds chose approximatelythe maximin allocation rule, and onethird chose approximately the dollar-maximizing allocation. These results

''Anclreoui and Miller's and other monetary-stakes experiments are also useful for allayiug con-cerns one might have regarding the Yaari ana Bar-Hiliel survey, whieb asKed suiijeets to say whatthey considered the jti.it allocatiou. If subjectsconsidered "justice" to be only one component ofa proper allocation rule, the)- may not have inter-preted the question as meaning "Mow wonid youcboGse to allocate between these two parties?" An-dreoui aud Miller (1996) and liargainiiig experi-ment.s tv-piealN' do uot prompt subjects to evaluateallocations according to any criterion—but merelyto make a choice.

20 Joltrmi! of Economic Literature, Vol. XXXM [March 1998)

suggest that the maximin rule re.soiiateswith many people even wlien allocatingmoney, and even when self-interest is atstake. Allowing proportions of a "pie ' toliave different monetary value.s to dif-ferent parties has also been a theme inthe experimental bargaining researeh{Roth and J. Keith Mnrnighan 1982:and Kagel, Chung Kim, and DonaldMoser 1996). In these settings, dis-entangling self-interested bargainingstrategies from preferences for just allo-cations is quite difficult, but resultsseem comparable to Andreoni andMiller's,

In moving from abstract, context-freeallocation problems to ever>day eco-nomie fairness judgments, things be-come significantly more complicated.First, as elsewhere, reference levels areerueial. Thaler (1985) and Kahneman,Knetsch. and Thaler (1986a. 1986b)demonstrate that loss aversion plays avery strong role in people's notion offairness; firms have more of an obliga-tion not to hurt workers or customersrelative to reference transactions thanthey have to improve the terms oftrade. Relatedly, people's general per-ceptions of fair bdiavior may adjustover time. Kahneman. Knetsch. andThaler (1986a, p. 730) argue that,"Terms of exchange tliat are initiallyseen as unfair may in time acquirethe status of a referenee transaction.Thus, the gap between the behaviorthat people consider fair and the behav-ior that tiiey expect in the market-place tends to be rather small." RobertFranciosi et al. (1995) experimentallysupport this hypotliesis by testingreactions to unfair price increases in alaboratory posted-offers market; theyshow tliat the role of fairness con-siderations in price-determination di-minishes with repetition, suggestingthat in competitive spot marketspeople may eventually come to believe

that the prevailing market price is fair.Otber experiments find virtually nochange in either behavior or percep-tions of fairness over time (Fehr andArmin Falk 1996). In any event, be-cause adjustments of fairness judgmentsare not immediate, fairness considera-tions may help explain the sort ofmcdiuui-run wage and price stickinessstudied by macroeconomists, and evi-denee that market outcomes are likelyto be self-interested exists only for eom-petitive spot markets. See, for example,Fehr, Erich Kirchler, and AndreasWeiclibold (1994) for an experimentalstudy of labor markets where behaviornever converges to the self-interestedoutcome.

Finally, in attempting to capturebehavioral findings with models ofsocial preferences, it is important tonote that people seem to implicitly(but pervasively) eonsider equitablesharing over changes in total endow-ments, not total endowments tlierti-selves. Preferences defined over finalwealth states cannot plausibly explainrules such as 50/50 sharing or the lnaxi-min criterion. With plausible assump-tions about initial endowuients enteringany moderate size division-of-the-piesituation, aufj soeial welfare funetiondefined with respect to overall con-sumption levels will almost always yieldall-or-nothing allocations. Apparently,people generally have a one-pie-at-a-time conception of fair-division prob-lems. This is not an insurmovnitabletendency: If people are presentedwith several allocation problems to-gether, they will likely attend to theoverall implications of their severalchoices. Nevertheless, any attempt tocapture behavioral norms of fairnessand dis- tributional justice with formalmodels of social preference must con-front the "piecemeal" nature of thesenorms.


C. Reciprocity and Attribution

The previous subsection consideredevidence about social preferences de-fined over the allocations of goods. Psy-chological evidence indicates, however,that social preferences are not merely afunction of consumption levels, or evenchanges in consumption levels. Rather,social preferences over other people'sconsumption depend on the behavior,motivations, and intentions of thoseother people. The same people who arealtruistic toward deserving people areoften indifferent to the plight of unde-serving people, and motivated to htirtthose whom they believe to have misbe-haved. If somebody is being nice to youor others, you are inclined to be nice tohim; if somebody is being mean to youor others, vou are inclined to be meanto him.

This "reciprocal" nature of prefer-ences manifests itself in the distinc-tion between simple altruism, as out-lined earlier, and reciprocal altruism.Consider the question of why peopleconserve water during a drought.Clearly they perceive that conservationcontributes to the general good, whichat a small cost is something they eagerlydo. First note that, because the mar-ginal social valtie of water is greaterthe less water there is, there are ditiiin-ishing social benefits of conservation:If other people conserve, it is less ur-gent for you to do so; if other peopledon't conserve, it is more urgent for youto do so, If you were a simple altrtiist,therefore, learning that others werenot conserving would cause you to in-tensify your conservation efforts. Thisprediction is inconsistent with intuitionand empirical evidence: People aremore inclined to conserve water if theythink other people are conserving, notif they think others are splurging. Peo-ple reciprocate the lack of public spirit-

edness in others—they don't counteractit.

Evidence in support of reciprocal al-truism comes from experimental studiesof the voluntary provision of publicgoods. Dawes and Thaler (1988) con-clude that, for most experiments of one-shot public-good decisions in which theindividually optimal self-interested con-tribution is close to zero percent, thecontribution rate varies between 40 per-cent and 60 percent of the socially opti-mal level.'^ Many of these experimentshint that contributions toward publicgoods are not the result of simple altru-ism, though the evidence for reciprocalaltruism is varied, and often indirect.For instance, Rachel Croson (1995)finds a strong positive correlation be-tween subjects' contrib\ition levels to apublic good and their beliefs about howmuch others were contributing. Furtherindirect evidence is that pre-decisioncommunication greatly enhances coop-eration (David Sally 1995). One reasonwhy communication enhances contribu-tions may be that reciprocal altruism es-sentially turns public-goods situationsinto "coordination games," where highcontributions are efficient equilibria,and low contributions are inefficientequilibria. As in general coordinationgames, therefore, pre-game communi-cation can help players coordinate onthe efficient equilibria.

Indeed, the comtnon empiiasis whendescribing the prisoner's dilemma on

'•* Many of tbese experiments are problematic intbat their uuil lij'potbesis of completely self-inter-ested behavior corresponds to zero contributions,wbere zero contributions is also tlie most extremebehavior subjects could exhibit. Therefore, all de-partures from full rationality are necessarily in thedirection of generous" behavior, Audreoni (1995)sbows that, by a very conser\-ative estimate, atleast half the contributions to public goods are in-tentional rather than 'errors." See also ClaudiaKeser (1996) for evidence that generous contribu-tions are not merely an artifact of experimentaldesign.

22 Journal of Economic Literature, Vol XXX\^I (March 1998)

the inability of the two captured prison-ers to communicate with each other in-dicates that we implicitly believe thatthe prisoner's dilemma also reallyamounts to a coordination game. If de-fecting were truly a dominant strategy,pre-game communication would notmatter. More direet evidence of recip-rocal altruism, in the context of theprisoner's dilemma, comes from Shafirand Tversky (1992). When subjeetswere told that their anonymous partnerin a prisoners' dilemma had eooperated,16 percent also cooperated; when sub-jects were told that their partner didnot cooperate, only 3 percent cooper-ated.

Reciprocity motives manifest them-selves not only in people's refusal tocooperate with others wlio are beinguncooperative, but also in their willing-ness to sacrifice to hurt others who arebeing unfair. A consumer may refuse tobuy a product sold by a monopolist atan "unfair" price, even if she hurts her-self by foregoing the product. An em-ployee who feels he has been mis-treated by a firm may engage in costlyacts of sabotage, perhaps to the point ofviolently retaliating against his employ-ers. Members of a striking labor unionniay strike longer than is in their mate-rial interests because they want to pun-ish a firm for being unfair.

A crucial feature of the psychology ofreciprocity is that people determinetheir dispositions toward others accord-ing to motives attributed to these oth-ers, not solely according to actionstaken. When motivated by reciprocal al-truism, for instance, people differenti-ate between those who take a generousaction by ehoice and those who areforced to do so. Demonstrating both thebasic principle of reeiproeity and therole of volition, Richard Goranson andLeonard Berkowitz (1966, p. 229) con-ducted an experiment in which confed-

erates posing as subjeets were in a posi-tion to help real subjects fill out someworksheets. One third of the subjeetswere told that the confederate had vol-untarily offered to help; one third weretold that the experimenter had in-structed the confederate to help; andone third were told that the confederatemight be willing to help, but the con-federate was instructed to refuse tohelp. When the subjects were latergiven an opportunity to assist the eon-f"ederates, they reeiproeated earlierhelp, but did so signifieantly more whenit was voluntary than when it was invol-untary.

Volition is also central to the propen-sity to retaliate against negative actions.Sally Blount (1995) asked subjectsabout their willingness to aeeept take-it-or-leave-it offers made by anonymousother parties on how to split $10.'^ Onegroup of subjects was told that the ' ulti-matunv' was coming from anonymousother students, and that their responseswould determine the division betweenthem and these anonymous other stu-dents. Another group was told that athird part if (also an anonymous student)was to determine the offer made, Inthis variant, the person who would behurt by a subject's decision to reject anoffer did not partieipate in the offer,and the third party who made the offerswould not be affected by the subject'sdecision. A final group of' subjeets weretold that the offer would he generatedrandomUj by a computer-simulated ron-lette wheel. In one study, the averageminimal acceptable offers for thosegroups were $2.91, $2.08, aud $1.20.That is, people did reject very low of-

'•^Thf "ultiniatum game" of the sort studied byBlount was first developed by Werner Giitli, RolfSchniittberger, and Bernd Scliwar/e (1982). Forreviews of tlie (massive) literature developedsince, see Thaler (1988), Ciith and Reinhard Tietz(1990). and Caniprpr and Thaler (1995).


fers even if computer or third-partygenerated, but were less keen to rejectoffers which were not the re.sult of voli-tion by the person who would be hurtby the rejeetions.

The importance of intentions goeseven further, however, than considera-tion of whether a person's actions arevoluntary. Suppose, for instance, youare eating lunch with parents and achild when all of a sudden your handsflail across the table and knock apitcher of water all over the child. Howdo the parents react? If they thonghtyour .goal was to spill water on thechild, they are probably angry. If theythought you were worried that pitcherwas precariously perched next to thechild, and that your flailing arms werean uncoordinated attempt to ptevent aspill, they are probably less angry.'*'

Such examples indicate that inter-preting other peoples' motives dependon what we believe their heliefs aboutthe consequences of their actions are.Another example of the importance ofbeliefs is, if you think somebody hasbeen generous to you solely to get abigger favor from you in tlie future,then you do not view his generosity tobe as pure as if he had expected no reci-procity from you. For example, ArnoldKalin and Thomas Tiee (1973} foundthat subjects' reactions to others" state-ments of intentions depended onwhether they thought those makingstatements knew that their intentionswould be made known to the subjects.'"

1 I have confirmed this hypothesis in a fieldstudy conducted in Nortli London.

1" Frank (1994. p. 21) tells the following stor\'that colorfully summarizes the importance of in-tentions: There is an often told story of a boy whofound two ripe apples as he was walking homefrom school with a friend. He kept the larger onefor him.self. and gave the .smaller one to his friend."It wasn't fair lo lceep the larger one for yonrselT'.the friend replied. "What would you have don'e?"'the first hoy asked. "Id have given jou the largerone and kept the .smaller one for myseU," said Uie

The role of reciprocity and volitionappears in some important economiccontexts. Akerlof (1982) posits thatfirms and workers ean be thought of asengaging in "gift exchange." a view ofsocial exchange emphasized in sociologyand especially anthropology. If a firmpays a higher wage to an employee, thatemployee is likely to reciprocate withhigher quality work. Consequently,firms may give higher wages hopingworkers will reciprocate with higher ef-fort. Similarly, Akerlof (1982, 1984) andAkerlof and Yellen (1990) propose that"efficiency wages," above the inarket-elearing wages, will be paid to workersto induce higher effort by those work-ers. Fehr, Georg Kirciisteiger, and ArnoRiedl (1993) tested tins hypothesis inlaboratory models of labor inarket.s.Subjects were assigned roles as "firms"or "workers." Firms offered a wage—in-volving a real monetary transfer froinfirm to worker—and workers respondedby choosing an "effort" level, where thiseffort was monetarily costly to workers.The results were that most workerschose effort levels higher than theirmoney-maximizing levels. Moreover,while low wages induced little or no ef-fort by workers, workers rewarded firmsfor setting high wages by providing higheffort.

What is the source of high effort lev-

friend. To whidi the first hoy responded, "Well,we each got whal you wanted, so what are youcomplaining ahout?"

Tlie punch line of this story play-s off the ohvioussilliness ol presuming that the second boys satisfactionwith events only depends on the resulting allocation.Yet tl is comical presumption is the basis of most at-tempts by economists to model ".social preferences"defined solely over outcomes. To formalize the role ofintentions in fairness judgments. Rabin (1993) adoptstlie framework developed by John Gemiakoplos, DaxidPearce, and Ennio Stacchctti (1989), who modih' con-ventioniil game theor)' b\' allowing payoffs to dependon players' beliefs as well as their actions. By [lositingthat my beliefs about your beliefs are argiunents in myutility- function, we can model my beliefs about yourmotives as directly influencing my faJnicss judgments.


els by workers in response to highwages by firms? W'liile workers maysimply bo choosing to share some oftheir additional wealth from higherwages with the firm, they may also bereciprocating the volitional generosityof firms, Charness (1996) conducts ex-periments that helps us differentiatethese hypotheses. In Fehr, Kirchler,and Weiehbold (1994), it is clear to theworker-subjeets that the firms choosewages of their own volition, Charness(1996) replicates this condition, but alsocondticts variants of the experimentwhere wages are either ehosen ran-domly, or by a "third party" {the experi-menter). In these eonditions. a highwage is not an act of kindness by a firm,and a low wage is not act of meanness:both are beyond a firm s control. Re-sults indicated tliat the high-wages-yields-high-effort reaction lias both a"share-the-wealth" and an attributionelement: Workers were substantiallymore likely to reward higli wages witlihigh effort and punish low wages withlow effort when the wages reflected thevolition of the firm.

3. Biase.^ in Judgment

Economists traditionally have as-sumed that, when faced with uncer-tainty, people correctly form theirsubjective probabilistic assessments ac-cording to the laws of probability. Butresearchers have documented many sys-tematic departures from rationality injudgment under uncertainty. Tverskyand Kahneman {1974, p. 1124) helpeoneeptualize observed departures fromperfect rationality by noting that peoplerely on "heuristic principle,s whieh re-duce the complex tasks of assessingprobabilities and predicting values tosimpler judgmental operation.s." In gen-eral, these heuristics are quite useful,but sometimes thev lead to severe and

systematic errors. As the quote clearlysuggests, the research described heredoes not at all suggest economistsshould abandon the assumption thatpeople are intelligent and purposive intheir decision making. Rather the re-search explores how people depart fromperfect rationality, positing biases thatrepresent specific and systematic waysthat judgment departs from perfect ra-tionality. For the remainder of this sec-tion, I describe .some of this research,presenting two biases at length andmore quiekly outlining several others. Iconclude by discussing some evidencefor when people do and don't learn tocorrect biases,

A, The Law of Smnll Numbers

According to a bias called "the law ofsmall numbers" (Tversky and Kahne-man 1971), people exaggerate howclosely a small sample wil! resemble theparent population from which the sam-ple is drawn, ' We expect even smallclasses of students to contain very closeto the typical distribution of smart onesand personable ones. Likewise, we un-derestimate how often a good financialanalyst will be wrong a few times in arow. and how often a clneless analystwill be right a few times in a row. Be-

'^ Kahneman and Tversky relate the law of smallriiinihers to people's tendency to under-use baserates. Tver.sky and Kalmcman (1974) provide evi-dencE.' for the representativenefis hcurintic. Bayes'sLaw tt'Ils U.S that our assessment of likelilioodsshould combine representativeness witli base rates(the percentage of the population falling into vari-ous groups). Yet people under-nsc base-rate infor-matiou in forming their judgments. If we seesomebody who looks like a criminal, our assess-ment of the probability that he is a criminal tendsto under-use knowledge about the? percentage ofpeople who are criminals. Similarly, if a certainmedical te.st always comes out positive among peo-ple with a rare disease, and only occasionallyamong people without the disease, people willtend to exaggerate the likelihood of liaving the dis-ease given a positive result. Given the rarity of thedisease, the total number of false positives niav befar greater than the number of true positives.

Rabin: Vaijchologij and Economics 25

cause we expeet close to the same prob-ability distribution of types in stnallgroups as in large groups, for example,we tend to view it as comparably likelythat at least 80 percent of 20 coin flipswill come up heads than that at least SOpercent of 5 coin flips will come upheads; in fact, the probabilities areabout 1 percent and 19 percent, respec-tively. Kahneman and Tversky (19S2a,p. 44) asked undergraduates the follow-ing question:

A certain town is served by two hospitals, Inthe larger hospital about 45 babies are borneach day, and in the smaller hospital about 15babies are born each day. As you kuow, about50 percent of all babies are boys. However,the exact percentage varies from day to day.Sometimes it may be higher than 50 percent,soinetinies lower.

For a period of 1 year, each hospital re-corded the days on which more than 60 per-cent of the babies born were boys. Whichhospital do you think recorded more suchdays?

Twenty-two pereent of the subjectssaid tbat they thought fhat it was morelikely that the larger hospital recordedmore such days, and 56 percent saidthat they tbought the number of dayswould be about the same. Only 22 per-eent of subjects correctly answered thatthe smaller hospital would report moresuch days. This is the satne fraction asguessed exactly wrong. Apparently, thestjbjects simply did not see the rele-vance of the number of child births per

The law of small numbers implies

'^-'while people believe in the law of small num-bers, they apparently don t believp in the law oflarge numbers: We underestimate the resemblancetbat large sample.s will have to the overall popula-tion. Kalnieman and Tversky (1982a), for instance,found that subjects on average thought that therewas a more than 1/10 chance that more than 750of 1000 babies born on a given day would be male.The actual likelihood is way less than 1 percent.To overstate it a bit, people seem to have a univer-sal probability distribution over sample means thatis insensitive to the sample size.

that people exaggerate the likelihoodthat a short sequence of flips of a faireoin will yield roughly the same numberof heads as tails. What is commonlyknown as "the gambler's fallacy" is amanifestation of this bias: If a fair coinhas not (say) eome up tails for a while,then on the next flip it is "due" for atails, because a sequence of flips of afair eoin ought to include about as manytails as heads.

When the underlying probability dis-tribution generating observed se-quences is uncertain, the gambler's fal-lacy leads people to over-infer theprobability distribution ironi short .se-quences. Because we underestimate thefrequency of a mediocre finaticial ana-lyst makitig lucky gttesses three times ina row, we exaggerate t!ie likelihood thatan analyst is good if she is right tbreetimes in a row. This tendency to over-infer from short sequences, in ttirn,leads to misperception of rcf^ression tothe mean. Because we read too muchinto patterns that depart from thenorm, we don't expeet that further ob-ser\atiotis will look more normal. Asteachers, we exaggerate the extent towhich one good or bad performance ona test is a sign of good or bad aptitude,so we don't expect exceptional perfor-mances to be followed by unexceptionalperformances as often as they are. Mis-tinderstanding regression to the meangives rise to spurious explanations forobserved regression. When a sttidentperforms poorly on the midtertn butwell on the final, teachers infer that thesttident lias worked harder; if the stu-dent performs well on a midterm butpoorly on the final, teachers infer thatthe student has slacked off. Tversky andKahneman (1974) give another exam-ple. Flight-training instructors observedthat when they praised pilots forsmooth landings, performance usttallydeteriorated on the next landing, but


when they criticized pilots for poorlandings, perfortnance improved thenext time. But random performance willlead to "deterioration" followitig a goodlanding and ' improvetnent" following apoor landitig. These flight instructorsdeveloped a wrong theory of incentivesbased on erroneous statistical reason-ing.

Another implication oi the law ofsmall nnmbers is that people expect toofew lengthy streaks in sequences of ran-dom events. As with regression to themean, therefore, people tend to gener-ate spurious explanations for longstreaks that are determined by chance.For instance, there is widespread beliefin the "hot hand" in basketball—thatparticular basketball players are streakshooters who have "on" nights and "off"nights which cannot be explained byrandomness. Thomas Gilovieh, RobertVallone. and Tversky (1985) and Tver-sky and Cilovich (19S9a, 19S9b) haveargued that the almost universally ac-cepted phenomenon of the hot hand isnon-existent In basketball. The exagger-ated belief in hot hands seems partly ex-plained by the misperception thatpurely random streaks are too long tobe purely random.

B. Belief Perseverance aridConfirmatory Bias

A range of research suggests thatonce forming strong hypotheses, peopleare often too inattentive to new infor-mation contradicting their hypotheses.Once yoti become convinced that oneinvestment strategy is more lucrativethan another, you may not sufficientlyattend to evidence suggesting the strat-egy is flawed. A particularly elegantdemonstration of stieh "anchoring" isfound in Jerome Bruner atid Mary Pot-ter (1964). About 90 subjects wereshowu bltirred pictures that were gradu-ally brought into sharper focus. Differ-

ent subjects began viewing the picturesat different points in the foensing pro-cess, but the pace and final degree offoetis were identical for all subjects. Ofthose subjects who began their viewingat a severe-blur stage, less than a quar-ter eventtially identified the picturescorrectly, whereas over half of thosewho began viewing at a light-blur stagewere able to correctly identify the pic-tnres. Bruner and Potter (1964, p. 424)conclude that "Interference may be ac-counted for partly by the difficulty ofrejecting incorrect hypotheses based onsubstandard cues," That is, people whouse weak evidenee to form initial hy-potheses have difficulty correctly inter-preting subsequent, better informationthat contradicts those initial hypothe-ses. David Perkins (1981) argues thatsuch experiments provide support forthe perspective that "fresh" thinkerstnay be better at seeing solutions toproblems than people who have medi-tated at length on the problems, be-canse the fresh thinkers are not over-whelmed by the "interference" of oldhypotheses.

This form of anchoring does not nec-essarily imply that people nminterjjretadditional evidence, only that they ig-nore additional evidence. Psychologicalevidence reveals a stronger and moreprovocative phenomenon: People tendto misread evidence as additional sup-port for initial hypotheses.-'* If ateacher initially believes that one stu-dent is smarter than another, she hasthe propensity to confirm that hypothe-sis when interpreting later perfor-mance.

Some evidence for confirmatory biasis a series of experiments demonstratinghow providing the same ambiguous in-formation to people who differ in their

20 a formal model of confirmatory bias, seeRabin and Schrag (1997).


initial beliefs on some topic can movetheir beliefs/wj /itT apart. To illustratesuch polarization, Charles Lord, LeeRoss, and Mark Lepper (1979, pp.2102) asked 151 undergradnates tocomplete a questionnaire that includedthree questions on capital punishment.Later, 48 of these students were re-cruited to participate in another experi-ment. Twenty-four of them were se-lected because their answers to theearlier questionnaire indicated that theywere ""proponents' who favored capitalpunishment, believed it to have a deter-rent effect, and thought most of therelevant research supported their ownbeliefs. Twenty-four were opponents ofcapital punishment, doubted its deter-rent effect and thought that the rele-vant research supported their views."These subjects were then asked tojudge the merits of randomly selectedstudies on the deterrent efficacy of thedeath penalty, and to state whether agiven study (along with criticisms ofthat study) provided evidence for oragainst the deterrence hypothesis. Sub-jects were then asked to rate, on 16point scales ranging from -S to +8, howthe studies they had read moved theirattitudes toward the death penalty, andhow they had changed their beliefs re-garding its deterrent efficacy. At confi-dence levels of ;; < .01 or stronger.Lord, Ross, and Lepper found that pro-ponents ofthe death penalty became onaverage more in favor of the death pen-alty and believed more in its deterrentefficacy, while opponents became evenless in favor of the deatli penalty andbelieved even less in its deterrent effi-cacy. Scott Pious (1991) replicates theLord, Ross, Lepper results in the con-text of judgment about tlie safety of nu-clear technology.^'

^' Lord, Ross, anti Lepper posit that even pro-fessional scientists are susceptible to svich "same-evidence polarization." Indeed, many economists

John Darley and Paget Cross (1983)demonstrate a related and similarlystriking form of polarization. Seventyundergraduates were asked to assess anine-year-old girl's academic skills inseveral different academic areas. Beforecompleting this task, the students re-ceived information about the girl andher family and viewed a video tape ofthe girl playing in a playground. Onegroup of subjects was given a fact sheetthat described the girl's parents as col-lege graduates who held white-collarjobs; these students viewed a video ofthe giri playing in what appeared to bea well-to-do suburban neighborhood.The other group of subjects was given afact slieet that described the girl's par-ents as high sdiool graduates who heldblue-collar jobs; these students vieweda video of the same girl playing in whatappeared to be an impoverished innercity neighborhood. Without being sup-plied any more information, half of eachgroup of subjects was then asked toevaluate the girl's reading level, meas-ured in terms of equivalent grade level.There was a small difference in the twogroups" estimates—those subjects whohad viewed the "inner-city" video ratedthe girl's skill level at an average of 3.90(I.e., 9/10 through 3"' grade) whilethose who iiad viewed tlie "suburban"video rated the girr.s skill level at an av-

and other academics have probably obsen'ed howdiffering schools of thoiignt interpret ambiguousevidence. A colleague saw the same model—cali-brating the elasticity' of demand facing a Cournotoligopolist as a function of the number of firms inan industry-—described at the University of Chi-cago and at M.I.T. A Chicago economist derivedthe formuhi and said. "Look liow few firms youneed to get close to infinite elasticities and perfectcompetition." An M.I.T. economist derived thesame formula and said, "Look at how large n hasto he before you get anvvyhere cio.fe to an infiniteelasticity and^ perfect competition." These differ-ent schools each interpreted the same inathemati-eal formula as evidence reinforcing their respec-tive views.

Journal of Economic Literature, Vol. XXXVI (March 1998)

erage of 4,29. The remaining subjects ineach gfotip were shown a second videoof the girl answering (with mixed suc-cess) a series of questions. Afterwards,they were asked to evaluate the girl'sreading level. The inner-city videogroup rated the girl's skill level at anaverage of 3.71. significantiy below the3.90 estimate of the inner-city subjectswho did not view the question-answervideo. Meanwhile, the suburban videogroup rated the girls skill level at anaverage of 4.67, significantly above the4.29 estimate of the suburban stibjectswho did not view the second video.Eveti thotigh the two groups viewed theidentical quostion-and-answer video,the additional information further po-larized their assessments of the girl'sskill level. Darley and Gross (1983) in-terpret this result as evidence of confir-matory bias—subjects were influencedby the girl's background in their initialjudgments, but their beliefs were evi-dently influenced even more strongly bythe effect their initial hypotheses hadon their interpretation of further evi-dence.

Certain types of evidence flows seemto be most conducive to confirmatorybias. Ambiguity of evidence is widelyrecognized to be an important mediat-ing lactor in both confirmatory biasand overconfidence (see, e.g., GideonKeren 1987; and Dale Griffin and Tver-sky 1992). Keren (1988) notes the lackof confirmatory bias in visual percep-tions, and concludes that confirmatorytendency depends on some degree ofabstraction and the need for interpreta-tion not present in simple visual tasks.Lord, Ross, and Lepper (1979, p. 2099)posit that when faced with cotnplex andambiguous evidence, we emphasize thestrength and reliability of confirmingevidence but the weaknesses and unreli-ability of disconfirming evidence. Theyalso report an impression that may re-

sound with those observing economists'reactions to behavioral evidence thatmight be damaging to habitual econom-ics assumptions:

With coiifirnning evidence, we suspect thatboth lay and professional scientists rapidly re-duce the complexity of the information andremember only a few well-chosen supportiveimpressions. With disconfirming evidence,they continue to reflect npon any informationthat snggests less damaging "alternative inter-pretations* Indeed, they may even come toregard the ambiguities and conceptual flawsin the data oppo.'iin^ their hypotheses assomehow snggestivc of the fnndamental cor-rectness of those hypotheses.

The above passages hint at the rolethat selective scrutiny of evidence playsin confirmatory bias. Another form of"scrutiny-based" confirmatory bias iswhat I sliall call h\}pothesis-b(ised filter-iuii,. While it is sensible to interpret am-biguous data according to current hy-potheses, people tend to use theconsequent "filtered" evidence inappro-priately as further evidence for theseliypotheses. If a student gives an un-clear answer to an exam question, it isperfectly reasonable for a teacher to beinfluenced in his evaluation of tiie an-swer by his prior perceptions of thatstudent's mastery of the material. How-ever, after assigning differential gradesto students according differential inter-pretation of comparable answers, it is amistake to then use differential gradeson the exam as further evidence of thedifferences in the students' abilities.Lord, Ross, and Lepper note a similardistinction in reflecting on the bias intheir experiment: It is legitimate forpeople to differentially assess proba-tiveness of different studies accordingto their current beliefs about the meritsof the death penalty. The "sin" is in us-ing their hypotJiesis-based interpreta-tions of the strength of different studiesas further support for tbeir beliefs.

Even when each individual datum is

Rabin: P.sychology and Economics 29

unambiguous, confirmatory bias can begenerated wlien people must statisti-cally assess correlations extended overtime. Richard Nisbett and Ross (1980)argue tiiat the inability to accuratelyperceive correlation is one of the mostrobust shortcomings in human reason-ing, and people often imagine correla-tions between events when no suchcorrelation exists.-- Deiuiis Jennings.Teresa Amabile, and Ross (1982) arguethat illusory correlation can play an im-portant role in the confirmation of falsehypotheses, finding that people under-estimate correlation when they have notheory of the correlation, but exagger-ate correlation and see it where it is notwhen tliey have a preconceived theoryof it.

C. Other Biases

I briefly outline a few more biasesthat might interest economists.^^ Thefirst is anchoring and adjustment, Slovieand Sarah Liehtenstein (1971) demon-strate that, in forming ninnerical esti-mates ot uncertain quantities, adjust-ments in assessments away from(possibly arbitrary) initial values aretypically insufficient. Tversky andKahneman {1974, pp. I12S) provide thefollowing example:

Chapman and Jean Chapman (1967,1969, 1971) cfemoiistrate that clinicians andlavpcople often ptrceive entirely illuson' correla-tion among (for instance) pictures and the person-ality traits of the people who drew the pictures,Charles Stangor {198S) and David Hamilton andTerrence Rose (1980) also discti,ss the rote of illu-sory correlation in the context of coafirmatorv-like phenomena. More generally, as Jennings.Amabile, and Ross (1982, p, 212) put it. "even tliestaiiiichest defenders of the lavperson's capacitiesas an intuitive scientist . . . have had little thatwas flattering to .say about (he layperson's han-dling of bivariale observation."

2' For a more thorongh introduction to this lit-erature, see Kahneman. Paul Slovic. and Tversky(1982). or. for an outstanding review of this mate-rial, .md of individual decision making more gen-erally, see Canierer (199.5).

[S]uhjects were asked to estimate variousfjuatitities. stated in percentages (for exam-ple, the percentage of African countries inthe United Nations), For each quantity, anumber between 0 and 100 was determinedby spinning a wheel of fortune in the sub-jects' presence. The subjects were instructedto indicate first wliether that number washigher or lower than the value of the quan-tity, and then to estimate tlie value of thequantity by moving upward or downwardfrom the given inimber. Different groupswere given different numbers for each qnan-tit)-. and these arbitrary numbers had amarked effect on estimates- For example, themedian estimates of the percentage of Afri-can countries in the United Nations were25 and 45 for groups that received 10 and65, respectively, as starting points. Payoffsfor accuracy did not reduce tlie anchoring ef-fect.

While this example is somewhat arti-ficial, Tversky and Kahneman point outthat anchoring can occur as a naturalpart of the assessment process itself. Ifwe ask an individual to construct aprobability distribution for the level ofthe Dow Jones, her likely beginningpoint would be to estimate a medianlevel. This value would likely then serveas an anchor for her further probabilityassessments. By contrast, if she wereasked by somebody to coustruet theprobability assessments by stating thelikelihood of the Dow Jones exceeding apre-speeified value. ,she woulcl likely an-chor on this value. The two procedures,therefore, are likely to load to differentpreclictions, with the first procedureyielding a probability distribution moreconcentrated around the median thantlie second.

One of the most widely studied biasesill the judgment literature is the liind-sight bias.-^-^ Barucli Fiseliiioff (1975,

-•' For Iwo excellent recent reviews of the liiiid-sight bias, see Scott Hawkins and Reid Hastie(1990) and Jay Christenscii-Szahinski and CynthiaWillham (1991), Christensen-Szalanski and Will-ham eondiict a nieta-analysis of the literature—ag-gregating tbe findings of 122 different studies,gathereef through an unbiased proceilure. to test


p. 288) first proposed this bias byobserving that "(a) Reporting atioutcome's occurrence increases itsperceived probability of occurrence;and (b) people who have received out-come knowledge are largely unawareof its having changed their percep-tions [along the lines of (a)]." Combin-ing these, the literature on the hind-sight bias shows tliat people exaggeratethe degree to wliich tlieir beliefs beforean informative event would be similarto their current beliefs. We tend tothink we "knew it would liappen allalong." After a politician wins election,people label it as inevitable—and be-lieve that they always thought it was in-evitable.

One example of Fischlioffs (1975)original demonstration of this effect wasto give sul)jecls a historical passage re-garding British intrusion into India andmilitary interaction with the Gurkas ofNepal. Without being told the outcomeof this interaction, some subjects wereasked to predict the likelihood of eachof four possible outcomes: 1) Britishvictory, 2) Gurka victory, 3) militarystalemate with a peace settlement, 4)military stalemate without a peace set-tlement. Four other sets of subjectswere each told a different one of thefour outcomes was the true one (thereal true outcome is that the two sidesfought to a stalemate without reaching apeace settlement). For each reportedouteome, when compared to a controlgroup not told any outcome, subjects'average ex post guesses of their hypo-tlietieal ex ante estimates were 15 per-cent higher than those of the controlgroup. People don t snfficicntly "sub-tract" information they currently haveabout an outcome in imagining what

for the existence of the bias. They conclude thatthe bias is ver\- real. (They also argue that the ef-fects are "smafl.")

they would have thought without thatinformation.-^

A pervasive fact about human judg-ment is that people disproportionatelyweight salient, memorable, or vivid evi-dence even when they have bettersources of information. ' For instance,our assessment of a given city's crimerate is likely to be too influenced bywhetlier we personally know somebodywho has been assaulted, even if we arefamiliar with much more relevant gen-eral statistics. Likewise, dramatic sto-ries by people we know about difficul-ties with a brand of car are likely to beoverly influential even if we are famil-iar, via Consumer Reports, with generalstatistics of the reliability of differentbrands. In both these cases, and inmany others, the more salient Informa-tion should have virtually no influenceon our beliefs in the face of much morepertinent statistical information. Tver-sky and Kahneman (1973) discuss, forexample, how salience may distort clini-cians' assessments of the relationshipbetween severe depression and suicide.Incidents in which patients commit sui-

-•''The derinition of hindsight bias regards pfo-ple'.s perceptious of how they themselves wouldhave answered a particular question absent infor-mation they now have. As et-onomists. we arelikely to care nicstly about a person s behefs aboutother people, not about herself. In general, it ishard to control experimentally for the fact thatpeople have different information, and hard to iso-late the hindsight bias when asking subjects whatother."; would have believed absent certain uifor-mation. Subjects may believe that others have dif-ferent beliefs for a variety of reasons (eg,, youcould believe that other people arc not as smart asyou). I feel, however, that the evidence sugge.ststhat we have a tendency to think that other peopleshould have known" as well (Hawkins and Hastie

1990. p. 319).-''In Tversky and Kahneman s (1973) foriiinla-

tion; "l.\\ person is said to employ the avmlabilityheuristic whenever he estimates frequency orprobability hy the ease with which instancos or as-sociations could be brought to mind." For moregeneral reviews of the role of salience and vivid-ness, see Susan Fiske and Shelley Taylor (1991,chs. 5,7).


cide are much more likely to be remem-bered than are in.stances where patientsdo not commit suicide. This is likely tolead to an exaggerated assessment ofthe probability that depressed patientswill commit suicide.

Finally, there is a mass of psychologi-cal research that finds people are pronetoward overconfidence in their judg-ments. The vast majority of researchersargue that such overconfidence is per-vasive, and mo.st of the research con-cerns possible explanations (of whichconfirmatory bias discussed ahove isone), 2'

D. Do Learning and ExpertiseEliminate Biases?

The conjecture that experience helpsovercome hiases often leads economiststo douht the relevance of laboratory evi-dence from inexperienced subjects. It iscommonly argued that if important eco-nomic activity is performed by special-ists and experts, or consists of tasksdone repeatedly by the same individu-als, the assumption of full rationalityfares much better than some of the psy-chological evidence indicates.

Do experience, expertise, and learn-ing virtually eliminate biases? These arereasonable conjectures, and such fac-tors probably do on average moderatebiases. But the eonjectures do not ap-pear to be nearly as valid as econouiistsimagine. Kahneman and Tversky(19S2a) and Tversky and Kahneman(1982), for instance, juresent experi-ments with subjects who vary in theirlevel of statistical sophistication, to testwhether general knowledge of statistics

^' See. e,g,, Stuart Oskamp (1965), layashreeMahajan (1992). and Paul Paese and MaryellenKiuaaly (1993), An early paper arguing this isFischhoff, Slovic, and Liehtenstein (1977). whoalso tested tbe robustness of ox'erL-oiifideiice witbnionetar)' stakes rather than reported judgments.No decrease in overconfidence was found relativeto the no-mouey-stakes condition.

reduces or eliminates observed biases.The results are surprisingly negative.More generally, the research leads tomixed conclusions about when and howlearning takes place, but veiy muchdoes not stipport the strong versions ofthe cxperts-get-things-right and in-the-real-world-pcople-Iearn hypotheses.

Research also suggests we should useextreme caution in defining the relevantnotion of learning, because many peo-ple who do learn general principles donot apply those principles in particnlarsituations. In the context of overcoufi-dence, for instance. Griffin and Tversky(1992) and Andrea Baumann. Raisa De-ber, and Gail Thompson (1991) con-clude that people wlio are aware oftlieir own accuracy overall are overcon-fident on a case-by-case basis. Whenpeople understand the limits in theirabilities to predict events accurately,they tend not to apply this generalknowledge in calibrating the appropri-ate confidence in individual cases;Kahneman and Tversky (1982b, p. 495)call such errors errors of applications.and note that "An error of application istnost convincingly demonstrated when aperson, spontaneously or with minimalprompting, clutches his head and ex-claims: 'How cotild I have missedthat?'" Even if people learn the rele-vant statistical truths of their environ-ment, they may continue to make errorsin tlieir judgments and decision makingin every single case. One fears thateconomists may sloppily interpret suchhead-clutching as evidence for the ra-tionality hypothesis, rather than againstit. But evidence that people see theirerrors when confronted with them doesnot boost the rationality assumption aseconomists use it. Our models use therationality assumption as a realized fea-ture of human behavior, not merely ahuman potential.

As was demonstrated in the context


of confirmation bias discussed above,"learning" can even sometimes tend toexacerbate errors. Relatedly, Griffinand Tversky (1992), address the rela-tionship between expertise and over-confidence. When certain forms of pre-dictability are high and when feedbacktakes tlie form of nnambigiions statisti-cal evidence, experts tend to have apretty good sense of how accurate theirpredictions are. In such eases, expertsnot only know more, but are more real-istic than laypersons about how nnic!ithey know. But when predictabiHty islow, experts are often more susceptibleto overconfidence than are laypersons.Griffin and Tversky (1992, p. 430) pro-vide illustrations:

If the future stale of a mental patient, theRussian ccouoiny. or the stock market fanuotbe predicted from present data, then expertswho have rich models of the system in ques-tion are more hkely to exhibit overconfidencethan lay people who have a very limited un-derstanding of these systems. Studies of clini-cal psychologists (e.g.. Oskamp 1965) andstock market analysts (e.g., Yates t990) arecon.sistent with tliis hypothesis.

While a reasonable conjecture is thatgreater thoughtfuhiess and intelligentlysearching for patterns in the world wouldhelp douse biases, the quote speeificallytargets (economists take note . . .) as sus-ceptible to overconfidence those "ex-perts vi'ho have rich models of the systemin question." Indeed, many authors havehypothesized the role of the reasoningprocess itself in e.xacerbatiug the confir-matory bias discnssed above, whieh inturn leads to overconfidence (see, e.g.,Craig Anderson, Lepper, and Ross 1980;Ross et al. 1977; and Timothy Wilsonand Jonathan Schooler 1991). Wilson andSuzanne LaF^eur (1995. pp. 23-24) con-duct an experiment on the role of "rea-soning" in strengthening confidence:Members of six sororities at the Univer-sity of Virginia were asked at the begin-

ning of the semester to predict their ownfuture beiuiviors toward fellow sororitymembers. Each subject was asked to pre-dict "yes" or "no" whether she would en-gage in each of six different behaviors—and to assess her confidence in herprediction. Randomly, some of the mem-bers were asked to list "why they mightor might not perfonn eacli of the . . .be-haviors . . . People were given a separatepage ou which to list their reasons foreach behavior. They were told that thepurpose of this task was to 'organizetheir thoughts." tiiat 'no one will actuallyread what you have written,' and that•your reasons will be discarded." Theywere urged to 'list as many reasons asyou can think of. filling up this page ifyou can'." Otiier subjects were asked tomake the same six predictions, but notasked to think of reasons for their behav-

ior,At the end of the semester, .subjects

were asked if they had actually per-formed each of the six activities. Theresults from this experiment showedthat the act oi' reasoning increased sub-jects' overconfidence regarding theirpredictions of their own behavior.While those who rea.soned about theirpredictions were roughly as confidentas those who did not reason (roasonerspredicted thoir own Yes/No predictionswould be accurate 80 percent of thetime, while the control group predictedtheir accuracy at 82 percent), the rea-soners were in fact significantly le.'is ac-curate than the control group in theirpredictions; reasoners' predictions wereaccurate 71 percent of the time, com-pared to 79 percent for the controlgroup.

4. Is "Maximizing, Utility" the RightModel?

The varied material of this sectionsuggests that it may be wrong to con-


ceptualize some types of economic be-havior in terms of an agent wlio maxi-mizes a stable, coherent ntility function.Indeed, some of the material here alsocalls into question some of the interpre-tations presented earlier. For instance,loss-averse behavior may often reflect aflawed rule of thumb employed becausepeople misperceive their own long-runwell-being, rather than a modified util-ity function as suggested in Section 2.By calling into question the utility-maximization interpretation of behaviorgiven in Section 2, such material sug-gests greater difficulty in improving thebehavioral realism of formal economics.On the other hand, the material at theend of the section on self-control prob-lems provides a great opportunity to im-prove the realism of economics; Re-searchers have shown that a (relatively)simple multiple-self model of time-in-consistent discounting tractably modi-fies our familiar exponential model toyield a model that is manifestly morerealistic behaviorally and surely has im-portant economic consequences.

A. Do We Know What Makes Us Happy?

The research on biases reviewed inSection 3 indicates that people mis-judge the probabilistic consequences oftheir decisions. But other research sue-

o

gests that, even when they correctlyperceive the physical consequences oftheir decisions, people systematicallymisperceive the well-being they derivefrom such outcomes. We often system-atically mispredict our future experi-enced utility, even when those predic-tions rely only on accurate assessmentsof our past experienced utility (Kahne-man 1994; and Kahneman, Peter Wak-ker, and Rakesh Sarin 1997). As Kahne-man (1994, p. 21) puts it, "Theseconsiderations suggest an explicit dis-tinction between two notions of utility.The experienced utility of an outcome is

the measure of the hedonic experienceof that outcome. . . . The decision util-ity of an outcome . . . is the weight as-signed to that outcome in a decision."The realization that decision and expe-rienced utility may be systematicallydifferent cuts to the core of our modelsof choice. It also cuts to the core of ourmethods of research, requiring us toformulate ways of inferring and elicitingpreferences that go beyond a "revealedpreference" method to attempt to inferpeople's hedonic experiences, throughsuch methods as self reports of satisfac-tion and even psychological measure-ments.

How do people misperceive theirutilities? One pattern is that we tend tounderestimate how quickly and howfully we will adjust to changes, not fore-seeing that our reference points willchange. In a classic study, Piiilip Brick-man, Dan Coates, and Ronnie Janoff-Bulman (1978) interviewed both lotterywinners (with average winnings of about$479,545) and a control group; theyfound virtually no difference in ratedhappiness of lottery non-winners andwinners. While such interview evidenceis inconclusive, the researchers con-trolled for alternative explanations(such as selection bias or biased presen-tation by interviewers). Two effectsseemed to e.xplain why lottery winnerswould be less happy tlian the winnershad presumably anticipated. First, mun-dane experiences become less satisfyingby contrast to the "peak" experience ofwinning the lottery. Second, we becomehabituated to our circumstances: Alongthe lines of the material presented iuSection 2. eventually the main carriersof utility become not the absolute levelsof consumption, but departures fromour (new) reference level.^^

. Coatps, and janoff-Bulmaii (197S)also fotmd more equivocal evidencp for the.sc ef-fects by inlprviewing 29 paraplegics and quadri-

34 Journal of Economic Literature, Vol. XXX\^I {March 1998)

People do not anticipate the degreeof snch adaptation, and hence exagger-ate expected changes in tJtility causedhy changes in their lives.-^ Tliis sug-ge.st.s (hat the "dccisioii-titility" aversionpeople have to losses is not consonantwith "experienced utility," Ttii.s realiza-tion, in tnrn, calls for a reexaininationof the first topie of Section 2: Are lossaversion, the endowment effect, andotlier reference effects rational or irra-tional? If people experience losses rela-tive to a status quo as quite unpleasant,then lo.ss-averse behavior i.s rational, he-eause people are correetly anticipatingand avoiding unpleasant sensations.And, the remembered "loss'' of anowned mug may earry over time, or inany event be substantial relative to thelong-term utility eonsequenees of own-ing the mug.

Yet loss aversion often seems to be ajudgmental bias: In decision.s with sig-nificant long-run conseqnetices, peopleshould put less weight than they do ontheir initial experience of losses. In-deed, some researchers invoke lossaversion more as an irrational rule ofthumb than as a rational utility fune-tion. Shlomo Benartzi and Thaler(1995) argue that the equity-premiumpuzzle can be explained by investors'aversion to short-term finaticial losses.

plegics about their happiness before tlieir aeci-dents, tbeir current happiness, and their expectedfuture happiness. Paraplegics felt less well off onaverage than tbey felt before, and rated tbeir bap-piness as lower than did lotter)- winners or thecontrol group. Moreover, they did nut currentlyenjoy mundane activities more than lottery win-ners or the control group However, accident vic-tims put more emphasis on. and took a more posi-tive view of, mundane pleasures—they rated ootlipast pleasure and anticipated futnre plea.snre fromsncb mundane activities slightly higher than eitherthe lotteiT winners or the control group.

2 'In the- simple model of reference-point ad-justment discussed in Section 2, this can oe trans-lated as saying that people systematically underes-timate the parameter a.

even though they will not be spendingtheir investment in the short term.Canierer et al. (1997) argue that NewYork taxi drivers decide when to quitdriving for the day by a rule of tliumbthat says they should make stire tomatch their usual take for the day. Insome more extreme examples of lossaversion it is hard to believe that the"transition utility" ean rationally rankhigh rehitive to long-term utility. Forinstance. Thaler (1980) compared sub-jects' willingness to pay for a cure for adisease that leads to a qniek and pain-less death with probability .001 versusthe minimum price you would accept tovoluntarily subject yourself to the samedisease. Stibjects often required an or-der of magnitude more money to exposethemselves to the disease than theywould pay for a cure. People chargelieavy premiums for losses relative totheir .status quo, even when it is hardto imagine tliat any experienced "tran-sition utility" is significant relativeto long-term utility consequences—

- here, whether or not you live beyond aweek.

Another example of how peoplemisperceive utility eonsequenees oftheir choices is Riciiard Herrnstein andPrelec's (1992b) theory of meliora-tion. Based on a mass of evidence gath-ered from people and other animals,they argue that people tend to makeenrrent choices according to whichchotee directly yields the highest utility,withotit taking into aecottnt the choice'seffect on the utilities from futurechoices. That is. people often ignore' internalities"—the effects a currentchoice has on the utilities of laterchoices. Say you eat at one of tworestaurants every night, either Blon-dies or Fat Slice. Yon enjoy Fat Slicemore, but because you also enjoy vari-ety, your utility each evening is as fol-lows:

Rabin: P.sychology and Economics 35

Utility from Fat Slice = 7 if you ate at Blon-d'te'ft last nightUtility from Fat Slice = 5 if you ate at FalSlice Ia.st nightUtility from Blondie's = 4 if you ate at FatSlice last nightUtility from Blondie's = 3 if you ate at Blon-die's last night

On any given day, no matter your re-cent eating pattern, you get higher util-ity from eating at Fat Slice than atBlondie's. Yet your utility-maximizingconsumption program is to alternate be-tween Fat Slice and Blondie's (thus al-ternating between payoffs of 7 and 4,for an average of 5.5) rather than eatingall the time at Fat Slice (thus getting apayoff of 5 each period). Yet, because ateach moment vi'e tend to ask, "Whichwill yield me more pleasure—Fat Slieeor Blondie's?," we may eat too often atFat Slice.

Of course, we do often train our-selves, or learn over time, to take intoaeeount internalities, btit the evidencesuggests that we take too little accountof the global utility effects of individualchoices. Herrnstein and Prelec (1992b,pp. 257-58) argue that even when peo-ple do seem aware of the shape of theirglobal utility functions, they may notproperly maximize those preferencesbecause they take an overly "piecemeal"

JA major way people predict utility

they will derive frotn future experiencesis to recollect utility from comparablepast experiences. While we might pre-sume that people accurately recollecttheir utility from familiar experiences,research on the endowment effect hintsthat this presumption may not be accu-rate: If we systematically misperceivethe long-run consequences of giving up

••'"See Herrnstein and Prelec (1992, p. 236) for anice discussion of how economists glide over thedistinction between global and piecenmal maximi-zation. See also Fehr and Peter Zych (1994) for anexperimental exploration of this distinction.

minor consumer items such as mugs, wemay not have learned to assess correctlythe utility consequences of even oureveryday choices. Additional researclieven more dramatically demonstratessystematic differences between people'se'xperienced utility of episodes and theirrecollections of those episodes. Severalrecent experiments compare recollectedutility to experienced utility for epi-sodes extended over time, by collectingperiodic hedonic reports by subjects oftheir current well-being. In evaluatingthe overall utility from such an ex-tended episode, one must formulate cri-teria for adding up flows of experiencedwell-being. Kahneman (1994) positsthat an uncontroversial criterion forcomparing episodes is teniporal mono-tonicity—that adding tnoments of painto an otherwise tinchanged experiencedecreases overall well-being, and thatadding episodes of pleasure increasesoverall well-being. Kahneman (1994)argues that experiments suggest biasesin how people s own retrospectiveevaluations of episodes compare totheir experienced well-being. First, inevaluating past episodes, people tend toremember the extremes of pain andpleasure more than the average. Sec-ond, when an "episode" is well-defined(e.g.. a vacation), people tend to put toomuch weight on the end of the episode(e.g., the last night of the vacation) iuassessing their overall experience of theepisode. Finally, we tend to neglect theduration of an episode. In assessing thedissatisfaction of an extremely unpleas-ant medical procedure (colonoscopy),for instance, patients seem to all but ne-glect the duration of the procedure—which ranged from 4 to 69 minutes. Ofcourse, one uuist carefully consider thepain and pleasure associated with anepisode before and after the actual epi-sode; anticipation and recollection ofpain, for instance, are clearly important


influences on long-run utility, just asanticipation and recollection of a vaca-tion are very significant in evaluatingthe overall well-being associated withvacations. Such an interpretation ofmost of the experitnental evidence,however, seems tenuous.

The fact that we don't always cor-rectly predict experienced utility is ob-viously important for welfare implica-tions of choice, and it prescribescaution in reliance on revealed-prefer-ence-based welfare eeonomics. Butthere may be important behavioral im-plications of a related phenomeiionwhereby people misperceive their fu-ture behavior. Loewenstein and DanielAdler (1995) performed an experimentbased on the endowment-effect experi-ments of Kahneman. Knetseh, andThaler (1991) discussed in Section 2.Some subjects were first asked to"imagine that we gave yoti a mug ex-actly like tlie one you can see. and thatwe gave you the opportunity to keep itor trade it for some money." Ail sub-jects were then given a mug. and theirminimal selling prices were elicited. Be-fore receiving the mtigs, subjects on av-erage predicted their own mininia] sell-ing price at $3.73. Once they had themugs, however, their actual minimalselling price averaged $4.89. That is,subjects systematically underestimatedthe endowment effect, and behaved sig-nificantly differently than they had pre-dicted about themselves moments ear-lier. (Stieh a ptocedure tinderestiniatesthe true degree oi nnsperception, be-cause people don't like to contradict re-cently expressed predictions of theirown behavior. Indeed, stibjects who hadm,ade no prediction averaged a sellingprice of $5.62.)

C. Elicitation Effects

People often lack stable preferencesthat are robust to different ways of elic-

iting those preferences,'^' The mostprominent set of research that points tosuch an interpretation of choice behav-ior concerns/ra;nnig effects: Two logi-cally equivalent (btit not transparentlyeqnivalent) statements of a problemlead decision makers to choose differ-ent options. An important and predict-able influence of framing on choice re-lates to loss aversion and diminishingsensitivity, as outlined in Section 2above. Because losses resonate withpeople more than gains, a frame thathighlights the losses associated with achoice makes that choice less attractive.Similarly, a frame that exploits dimin-ishing sensitivity by making lossesappear small relative to the scalesinvolved makes that choice more attrac-tive. Tversky and Kaimeman (1986. pp.S254-55) give the following example offraming effects, taken from a study ofmedical decisions by Barbara McNeil etal. (1982):

Respondents were given statistical iiifornia-tion aboul tlio outcomes of two treatments oflung cancer. Tlie same statistics were pre-sented to some respondents in terms of mor-tality rates and to otliers in terms of survivalrates. The respondeuts then indicated tlieirpreferred treatment.

Tiie information was presented |exactly] asfollows.Pioblem 1 (Survival frame)Surgery: Of 100 people having surgery 90 livethrough the post-operative period, 68 areali\'e al the end of the first year and 34 arealive at the end of five years.

Radiation Therapy; Of 100 people having ra-diation therapy al! live througli tlie treatment.77 are alive at the end of one year and 22 arealive at the end of five years.

Proljlein 1 (Mortality frame)Surgery: Of 100 people having stirger)' 10 dieduring surgery or the post-operative period,

•'I The hypersensitivity of "preferences" to themethod of eliciting those preferences is a key is-sue in the emerging debate on "contingent valu-ation": see. e.g.. Diamond and Jerry Haiisnian(1994).


32 die by the end of the first year ami 66 dieby the end of five years.Radiation Therapy: Of 100 people having ra-diation therapy, none die during treatment,23 die by the end of one year and 78 die bythe end of five years.The inconsequontial difference in formula-tion produced a marked effect. The overallpercentage of respondents who favored radia-tion therapy rose from 18% in the siir\'ivalframe (N = 247) to 44% iii the mortalityframe (N = 336). The advantage of radiationtherapy over surgery evidently looms largerwhen stated as a reduction of the risk of im-mediate death from 10% to 0% rather than asan increase from 90% to 100% in the rate ofsurvival. The framing effect was not smallerfor experienced physicians or for statisticallysophisticated business students than for agroup of clinic patients.

This question is hypothetical, butsimilar framing effects were found inchoices over lotteries with stnall mone-tary stakes, and Tversky and Kahneman(1986) cite some important real-worldexamples of fratning effects. For in-stance, people react differently to firmscharging different prices for differentservices (or the same service at differ-ent times) depending on whether thelower price is called a diseount or thehigher priee is called a surcharge. Simi-larly, Thomas Sehelling (1981) noticedhuge differences in his students' atti-tudes toward tax deductions for chil-dren depending on how the deductionswere framed. Money illusion providesperhaps the hest example of the impor-tance of framing effects for economics.Kahneman, Knetsch, and Thaler(1986a) provide survey evidence thatpeople are very attentive to nominalrather than real changes in wages andprices in assessitig the fairness of firmhehavior. A nominal wage increase of 5percent in a period of 12 percent infla-tion offends people's sense of fairnessless than a 7 pereent decrease in a timeof no inflation. More generally, peoplereact tnore to decreases in real wages

when they are also nominal decreases,and react negatively to nominal priceincreases even if they represent no in-crease in real prices (Shafir, Diamond,and Tversky (1997).

Framing effects can often be viewedas hetiristic errors—people are bound-edly rational, and the presentation of achoice may draw our attention to differ-ent aspects of a problem, leading us tomake mistakes in pursuing our trtie. un-derlying preferences. As such, fratningeffects to some extent are a topic forSeetion 3. But sometimes framittg ef-fects cut more deeply to economists'model of choice: More than confusingpeople in ptirsuit of stable underlyingpreferences, the "frames" may in factpartially determine a person's prefer-ences.

Related phenotnena even morestrongly call into doubt the view thatchoices reflect stable, well-definedpreferences. Preference rever.^tds havebeen studied widely by economists andpsychologists over the years: Whenconfronted with certain pairs of gam-bles with roughly the same expectedvalue, people often choose one of thepair over the other, while pricing theother more highly. To use an examplefrom Tversky and Thaler (1990),consider an H bet that with 8/9chance yields $4 and with 1/9 chanceyields $0, and an L bet with a 1/9chance to win $40 and 8/9 chance of $0.Most subjects choose the H bet over theL bet when asked to choose betweenthe two. But when asked to state thelowest price at which they would bewilling to sell eaeh gamble, most sub-jeets put a higher price on the L bet.More generally, people choose betswith a high chance of winning smallamounts, but put a higher price on betswith a low chance of winning bigamounts; economic theory predictsthese two different elicitation proce-

38 Joumal of Economic Literature, Vol. XXXVI {March 1998)

dures should yield tlic same prefer-ences.

Itaniar Sinionson and Tversky (1992)provide examples of context effects,where the addition of u new option to amenu of choices may actually increasethe proportion of consumers whochoose one of the existing options. Forexample, the proportion of consumerswho chose a particular model of micro-wave oven increased when a second,more expensive model was added totheir choice set. (Subjects were firstasked to look at a catalogue containingthe prices and descriptions of all therelevant choices from which their even-tual choice sets were drawn, so the re-sults seem unlikely to be due to any in-formation revealed by the choice sets.)As another example, Simonson andTversky (1992) ran an experiment thatillustrates that elicited subjects" prefer-ence for an elegant Cross pen versus re-ceiving $6. White only 36 percent ofsubjects choosing only between theCross pen and the $6 chose the Crosspen, 46 percent of subjects who werealso given the choice of a less attractivepen chose the Cross pen. In both theseexamples, the addition of an option thatcompared unfavorably (as more expen-sive or lower quality) to an existing op-tion enhanced the perceived attractive-ness of the existing option.

Wliile people are often unaware thatthe menu of choices influences their de-cisions. Simonson and Tversky note thatat other times decision makers explicitlyrationalize their choices with refer-ences to their choice sets. For instance,people may state explicitly tliat a givenchoice is a compromise between twoother choices. Indeed, such findingssuggest an alternative to the utility-maximization framework that may helpexplain framing effects, preference re-versals, and context effects: People maymake choices in part by asking them-

selves whether they have a "reason" tochoose one option over another (Sliafir,Simonson, and Tversky 1993).

D. Time-Variant Preferences

People have a taste for immediategratification. We procrastinate on taskssuch as mowing the lawn that involveimmediate costs and delayed rewardsand do soon things sucb as seeing amovie that involve immediate rewardsand delayed costs. Economists tradi-tionally model such tastes by assumingtliat people discount streams of utilityover time exponentially. An importantqualitative feature of exponential dis-counting is that it implies that a per-sons intertemporal preferences aretime-consistent: A person feels thesame about a given intertemporal trade-off no matter when she is asked.

Casual obsenation, introspection,and psychological r(?search ail suggestthat the assumption ot time-consistencyis importantly wrong. Our short termtendency to pursue immediate gratifica-tion is inconsistent with our long termpreferences. While today we feel that itis best that we not overeat tomorrow,tomorrow we tend to overeat; while to-day we feel we should write a refereereport tomorrow, tomorrow we tend toput it off. More generally, when consid-ering tradeoffs between two future mo-ments, we give stronger relative weiglitto the earlier moment as it gets closer.Kris Kirby and Herrnstein (1995), forinstance, asked subjects to state theirpreferences among a series of pairs, ineach case choosing between a smaller,earlier reward and a larger, later re-ward. Subjects were (truthfully) toldthat one ot their choices would be im-plemented. In two experiments withmonetary rewards, 23 of 24 subjects"consistently reversed their choicesfrom the smaller, earlier reward to thelater, larger reward as the delay to both

Rabin: Fsychology and Economics 39

rewards increased." Both the monetarystakes and the delays were substantial—subjects received an average of about$21.50, with an average delay of about21/2 weeks.••J2

Hence, a person's preferences todayover her future delays in rewards aredifferent than her future preferencesover those same delays, so that prefer-ences are not time consistent. Formalmodels of such time-variant prefer-ences have been developed.''^ EdmundPhelps and Robert Pollak (]968) cap-ture the taste for itnmediate gratifica-tion with a simple two-parameter modelthat slightly modifies exponential dis-counting. Let (// be the instantaneousutility a person gets in period t. Thenher intertemporal preferences at time t,U', can be represented by the followingutility function, where both p and 5 liebetween 0 and 1:

For all f, T

The parameter 6 determines how"titne-consistently patient" a person is.just as in exponential discounting, IfP= 1, then these preferences are simplyexponential discounting. Btit for P<1,these preferences capture in a parsimo-nious way the type of time-inconsistentpreferences so widely observed. To seeliow these preferences capture the pref-erence for immediate gratification, sup-pose that you liad a choice between do-ing ten hours of an unpleasant task on

2 These numbers are calculated from the datapresented by Kirby and Herrnstein (1995, p. 85-86). Otlier psychofogical research showing prefer-ences are not time-consistent includes Sriin-HoChung and Herrnstein (1967). George Ainslie(1991), Ainslie and Herrnstein (1981), Thaler(1981), and Loewenstein and Prolec (1992).

^^ For economics papers on time-inconsistentdiscounting, see. e.g., Robert Strotz (1955),Steven Goldman (1979, 1980). Schelline (1978).Thaler and Hersh Shefrin (1981). DavicT Laibson(1994, 1997). and O'Donoglme and Rabin (1997a.1997b).

April 14, versus spending eleven hoursto complete the same task on April 15.Assume that your instantatieous disutil-ity from doing work is simply the num-ber of hours of work— »,(10) = -10 andui(\l) = -\] for all t. Suppose that 5 =1, but that p - .8 for a one-day delay:You are willing to suffer a given loss inutility tomorrow for a gain in utility to-day that is 80 percent as large.

Suppose that April 14 has arrived andyou are considering wliethor or not towork. You can experience a disutility of-10 by working today, or experience adiscounted utility of .8 (-11) = -8.8 bydelaying the work until tomorrow. Yotiwill, therefore, delay work. Contrastthis with what your decision wotild beif, instead of choosing when to work onApril 14, you are told by your boss thatyou tnust decide on February 1. Be-cause from February 1 you discounthoth dates by p, yoti will choose to work10 hours on April 14 rather than 11hours on April 15. From the Febniary 1point of view, you find procrastinatingin April an undesirable thing. For theexact same probletn, your choice onFebruary 1 is different than yottr choiceon April 14. Irrespective of its specificprediction, exponential discountingwould predict that your choice wouldbe the same whether you made thatchoice on February 1 or April 14. Thisexatuple seems well-calibrated: OnApril 14, most of us are apt to put offthe work until April 15, even if it meansa little tnore work. Absent a substantivedifference between the two dates, virtu-ally no one would choose the delay ifasked on February L

To examine dynamic choice giventime-variant preferences given thesepreferences, for each point in time, aperson is modeled as a separate "agent"who chooses her current behavior tomaximize her current long-run prefer-ences, whereas each of her future


selves, with her own preferences, willchoose her future behavior to maximizeher preferences. On one level, this ideaof multiple selves—that a single humandoes not have unified preferences thatare stable over time—is a radical de-parture from the utility-maximizationframework. But because this conceptu-alization of intertemporal choice uses afamiliar tool—dynamic game theory—itis ready-made for adoption by eeono-ntists interested in improving the be-havioral realism of our models.

The behavior predicted by models oftime-variant preferences often differsdramatically from the behavior pre-dicted by the exponential model. Themost notorious examples are efforts atself control: Because you may not likethe way you will behave in the future,you may .scheme to manipulate your fu-ture options. Consider again the workexample. Instead of your boss tellingyou that you tnu.'it clioose on February 1wlien to work, suppose now she givesyou three options: You commit to dothe task on April 14; you commit to dothe task on April 15; or you wait untilApril 14 and then choose on which dayto do the task. W'hich would youchoose? The advantage of waiting ismanifest: By not precluding either ofyour options, if there are any uncertain-ties that may be resolved between nowand April, the flexibility you have re-tained may be valuable. Yet we some-times engage in behavior precisely torestrict our own future flexibility. Ifthere were few uncertainties, you mightwant to commit on February 1 to theApril 14 date. Given your current pref-erence to do the task earlier, you wishto restrict your future self from procras-tinating. More generally, researchershave explored many self-commitmentdevices we employ to limit our futurechoices. Such self-commitment devicesinclude alcohol clinics and fat farms

from which you eannot check out, notowning a television, contributing to a"Christmas Club" from which you arenot allowed to witiidraw money untilChristmas, or buying only small pack-ages of enticing foods so that you won'tovereat when you get home. More sub-tly, you may try to control yourselfthrough a variety of internal "rules"(e.g., never drink alcohol), even if youhave no external mechanisms of self-control.

Attempts to control our own futurebehavior indicate an awareness that wemay not behave as we would wish to be-have. This raises the question of howaware people are of their time-ineonsis-teney. You may have expectations aboutyour propensity to misbehave, or youmay naively believe that your prefer-ences in the future will match your cur-rent preferences. If today you prefernot to overeat tomorrow, you maynaively believe that you will feel thesame way when facing an enticing bowlof ice cream tomorrow. If on February1 you prefer less work on April 14 tomore work on April 15, you may believeyou'll feel the same way in April.

Strotz (1955) labels people who arefully aware of their future self-controlproblems as sophisticated, and peoplewho are fully unaware that they willhave a self-control problem as naive.While some degree of sophistication isimplied by the existence of some of theself-commitment devices illustratedabove, it does appear that people un-derestimate the degree to which theirfuture behavior will not match theircurrent preferences over future behav-ior. This accords with the evidenee dis-cussed earlier, that people often incor-rectly predict their own futurepreferences: As with predicting the ef-fects of changes in reference points,here too knowing your future prefer-ences means that you know your prefer-


ences won't accord with your currentpreferences. For example, people mayrepeatedly not have the "will power" toforego tempting foods or quit smokingwhile predicting that tomorrow theywill have this will power, While behav-ioral evidence that calibrates the degreeof sophistication seems sparse, Loewen-stein (1996, pp. 281-82) reaches theconclusion that people may be naiVe in-directly from psychological findingssucli as the evidence of people mispre-dicting changes in ntility.

Whether they are sophisticated ornaive, people's time-inconsistent pro-pensity for immediate gratification isimportant in a variety of economicrealms. As investigated by several re-searchers (see, e.g.. Thaler and Shefrin1981; and Laibson 1997), such prefer-ences may be important to savings be-havior becanse the benefits of currentconsumption are immediate, whereasthe increased future consumption thatsaving allows is delayed. Self-controlproblems are also clearly important inthe demand for addictive goods andfatty foods. Similarly, the role of self-control in purchasing decisions is wellknown among marketing experts(Stephen Hoch and Loewenstein 1991).Naughty goods are sold in small pack-ages because people tend to avoid largepackages of such goods to prevent over-consumption.

5. Conclusion

Over the years, economists have prof-fered many reasons for downplaying therelevance of behavioral research chal-lenging our habitual assumptions.Claims abound that evidence inconsis-tent with our traditional model of hu-man behavior can be neglected becausethe evidence derives from obser\ationsof people insufficiently motivated to be-have themselves according to economic

assumptions, or because it fails to bearsufficiently great burdens of proof, orbecause the implied behavior is unlikelyto matter in the types of (market) set-tings that economists care about. Be-cause behavioral research is so often as-sessed in light of such arguments, it iscommon when presenting p.sychologicalfindings to discuss broad methodologi-cal objections and attempt to rebutthem.

I refrain from doing so. It is mystrong impression that many of the ar-guments invoked against the reality orrelevance of behavioral research derivefrom unfamiliarity with the details ofthis research. Hence, my hope andguess is that as economists becomemore familiar with this research, sucharguments will dissipate. And as the ag-gressive uncuriosity shown in the pasttoward behavioral research continues todiminish, we can look forward to focus-ing entirely on its substance.

While none of the broad-stroke argu-ments for inattention to psychologicalresearch are compelling, obviously notall psychological research will be bothconfirmed by field data and proven tobe of great economic importance. In-deed, abandoning the view that hy-potheses departing from rationality,self-interest, or other habitual assump-tions are methodologically illicit canfree us to evaluate these hypotheseswith the same rigorous standard.s thatour discipline, at its best, applies else-where. \Ve can confront plausible hy-potheses about human behavior withboth healthy skepticism and genuine cu-riosity, empirically test their validity,and carefully draw out their economieimplications. And, as we apply these rig-orous standards, we can then begin totreat claims that (say) investors irration-ally infer too much from short-termperformance, or that employees feel re-sentful when mistreated, as presump-


tively plausible and presumptively rele-vant hypotheses worth keeping in mindin our economic analysis.

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