Experimental and

Ernst Fehr University of Zürich and MIT

Fall 2004

This course provides an introduction into the techniques of and applies these techniques to important research questions in different fields of economics. At the end of the course students should be able to design and run their own experiments examining their preferred questions. I assume that students have a basic knowledge of microeconomic theory and game theory at the level of, for example, Hal Varian’s advanced textbook on “Microeconomic Analysis” and Robert Gibbons’ textbook on “Game Theory for Applied ”. Course requirements are Micro I (14.121) and Micro II (14.122). The course consists of 12 lectures. The course will take place on the following Wednesdays from 4-7 p.m.: Sept 15, Sept 22, Sept 29, Oct 6, Oct 13. In addition, there will also be a course on Friday, September 24 from 9-12 a.m.

The course takes place at MIT in room E51-372.

On the following pages you will find a short outline of the course, a description of your tasks and a reference list. I strongly recommend that students read the articles with an asterisk.

Lecture 1 (Sept 15): Methods, advantages and limitations of laboratory experiments

Lecture 2 (Sept 15): Competitive Experimental Markets (Double Auction & Gift Exchange)

Lecture 3-4 (Sept 22): Cooperation & Collective Action

Lecture 5-8 (Sept 24 & 29) Social Preferences – Theory and Evidence

Lecture 9-10 (Oct 6): The Behavioral Economics of Incentives (Relations, Threats & Loss

Aversion)

Lecture 11 (Oct 13): Limited Rationality & Strategic Interaction (The Case of Money

Illusion)

Lecture 12 (Oct 13): Neureconomics – The Neurobiological Foundations of Economic

Behavior

Your tasks during this course

1) Write a proposal for an experiment. The proposal should describe the economic problem that you want to understand with the help of the experiment. You should develop behavioral hypotheses and also speculate about the outcome of the experiment. This speculation is crucial because it tells us why your experiment could be interesting and might lead to new insights. The first two pages of your proposal are due September 29th (4th lecture) and roughly 4 pages will be due by Friday, October 8th.

Please email your proposals to me ([email protected]) and to my teaching assistant David Abrams ([email protected]). This enables us to give you feedback (either by email or in a meeting). The final proposal consists of 5-6 pages and must be sent to me and to David Abrams by 24th October.

Below is a list of questions that need to be answered in your proposal. This list will guide you in designing the experiment and in the write up of your proposal.

o Which economic question do you want to answer with your experiment? o What are the potential answers to your question? o What are the advantages and disadvantages of an experiment for answering your question? o What are the chances that the result of your experiment will surprise others? What are your hypotheses regarding the outcome of the experiment? Will anybody change his/her opinion? o How do you conduct the experiment? (Describe the design) o Is your design the simplest possible design to answer your question?

2) Homework assignments. This involves writing two 1-2 page referee reports on two papers and solving a problem sets related to course topics. A good referee report shortly summarizes the main questions and main results of a paper, evaluates whether the paper is important or not, and describes the achievements and the shortcomings of the paper. Suggestions for how the paper could be improved are also good.

Timeline of your tasks

Sept 22: Hand in first referee report. Sept 29: Hand in first 2 pages of your idea for an experiment (project proposal). Oct 6: Social preferences problem set due. Oct 8: Hand in 4 pages of your improved project proposal. Oct 15: Hand in second referee report. Oct 24: Hand in final version of your project proposal.

Lecture 1: Methods, Advantages and Limitations of Laboratory Experiments

Davis, Douglas and Holt, Charles (1993); Experimental Economics, Princeton University Press, Princeton, New Jersey: Chapter 1, Introduction and Overview Roth, Alvin E. (1988); "Laboratory Experimentation in Economics: A Methodological Overview", Economic Journal, Vol. 98, 974-1031. *Smith, Vernon L. (1989); “Theory, Experiment and Economics”, Journal of Economic Perspectives, Vol. 3, No. 1, 151-169. Smith, Vernon L. (1994); “Economics in the Laboratory”, Journal of Economic Perspectives, Vol. 8, No. 1, 113-131. *Smith, Vernon L. (1976); "Experimental Economics: Induced Value Theory", American Economic Review, Vol. 66, 274-279.

Lecture 2: Competitive Experimental Markets

Davis, Douglas and Holt, Charles (1993); Experimental Economics, Princeton University Press, Princeton, New Jersey: Chapter 3 (Double Auction Markets) and Chapter 4 (Posted Offer Markets). Smith, Vernon L. and Williams, Arlington W. (1990); “The Boundaries of Competitive Price Theory: Convergence Expectations and Transaction Costs”, in: L. Green and J. H. Kagel (eds.), Advances in Behavioral Economics, Vol. 2, Ablex Publishing Corporation, Norwood, New Jersey. *Roth, Alvin E. and Prasnikar, Vesna and Okuno-Fujiwara, Masahiro and Zamir, Shmuel (1991); "Bargaining and Market Behavior in Jerusalem, Ljubljana, Pittsburgh, and Tokyo: An Experimental Study", American Economic Review, vol. 81, 1068-95. Akerlof, George A. and Yellen, Janet L. (1988); "Fairness and Unemployment", American Economic Review (P&P), vol. 78, 44-49. *Fehr, Ernst and Kirchsteiger, Georg and Riedl, Arno (1993); "Does Fairness prevent Market Clearing? An Experimental Investigation", Quarterly Journal of Economics, Vol. 108, Issue 2, 437-460

Lecture 3-4: Cooperation and Collective Action

Dawes, R. and D. Thaler (1988); Cooperation, Journal of Economic Perspectives 2, 197-197. *Fehr, Ernst and Simon Gächter (2000); “Cooperation and Punishment in Public Goods Experiments”, American Economic Review 90, 980-994. Fischbacher, Urs, Simon Gächter and (2001); “Are people conditionally cooperative? Evidence from a public goods experiment”, Economics Letters 71, 397-404. Kandori, M. (1992): “Social Norms and Community Enforcement”, Review of Economic Studies 59, 63-80. *Ledyard John (1995); “Public Goods: A Survey of Experimental Research”, In: Kagel, John H. and Roth, Alvin E. (Eds.) Handbook of Experimental Economics, Princeton University Press, Princeton, New Jersey.

Lecture 5-8: Social Preferences – Theory and Evidence

Bolton, Gary and Axel Ockenfels (1999); “A Theory of Equity, Reciprocity, and Competition”, fortthcoming: American Economic Review 100: 166-193 Charness Gary and (2002); Understanding Social Preferences with Simple Tests”, Quarterly Journal of Economics 117: 817-869. Dufwenberg, Martin and Georg Kirchsteiger (1999); “A Theory of Sequential Reciprocity”, Games and Economic Behavior, 47, 268-298. Falk, Armin and Urs Fischbacher (1999); “A Theory of Reciprocity”, Working paper No. 6, Institute for Empirical Research in Economics, University of Zürich. Fehr, Ernst and Klaus Schmidt (1999); “A Theory of Fairness, Competition and Cooperation“, Quarterly Journal of Economics 114: 817-868. *Fehr, Ernst and Klaus Schmidt (2003); “Theories of Fairness and Reciprocity – Evidence and Economic Applications”, In: M. Dewatripont, L. Hansen and St. Turnovsky (Eds.), Advances in Economics and Econometrics – 8th World Congress, Econometric Society Monographs, Cambridge, Cambridge University Press Levine, David (1998); “Modeling Altruism and Spitefulness in Experiments” Review of Economic Dynamics 1: 593-622. Rabin, Matthew (1993); “Incorporating Fairness into Game Theory and Economics.” American Economic Review 83: 1281-1302. Roth, Alvin E. (1995); “Bargaining Experiments”, In: Kagel, John H. and Roth, Alvin E. (Eds.) Handbook of Experimental Economics, Princeton University Press, Princeton, New Jersey.

Lecture 9-10: The Behavioral Economics of Incentives (Relations, Threats, Loss Aversion)

Baker, G., Gibbons, R. and Murphy K. J. (1994): “Subjective Performance Measures in Optimal Incentive Contracts”, Quarterly Journal of Economics 109, 1125-56. Baker, G., Gibbons, R. and Murphy K. J. (2002): “Relational Contracts and the Theory of the Firm”, Quarterly Journal of Economics 117, 39-84. Brown, M., Falk, A. and Fehr, E. (2004); “Relational Contracts and the Nature of Market Interactions”, Econometrica 72: 747-780. Bull, C. (1987): “The Existence of Self-Enforcing Implicit Contracts” Quarterly Journal of Economics 102, 147-159. *MacLeod W. B. and Malcomson, J. M. (1998): “Motivation and Markets”, American Economic Review 88, 388-411.

*Fehr, Ernst and (2002); “Psychological Foundations of Incentives”, European Economic Review 46: 687 - 724. Fehr, Ernst and Bettina Rockenbach (2003); “Detrimental Effects of Sanctions on Human Altruism”, Nature 422, 137-140. Gneezy, U. and Rustichini, A., 2000a. A Fine is a Price. Journal of Legal Studies 29, 1-17. Gneezy, U. and Rustichini, A., 2000b. Pay Enough or Don’t Pay at All. Quarterly Journal of Economcis 115(2), 791-810.

Camerer, Colin, Linda Babcock, and (1997); “Labor Supply of New York City Cabdrivers: One Day at a Time”, Quarterly Journal of Economics 112: 407-41. *Card, David (1994), Intertemporal Labor Supply: An Assessment. In: Christopher Sims (Ed.), Advances in Econometrics: Sixth World Congress of the Econometric Society, Vol. II, 49 – 78. Ernst Fehr and Lorenz Goette (2002); „Do Workers work more if Wages are high? – Evidence from a Randomized Field Experiment“, Working paper No. 125, Institute for Empirical Research in Economics, University of Zürich. Oettinger, Gerald S. (1999): “An Empirical Analysis of the Daily Labor Supply of Stadium Vendors”, Journal of Political Economy 107: 360-92.

Lecture 11: Limited Rationality and Strategic Interaction – The Case of Money Illusion Lucas, Robert E. Jr. (1996); “Nobel Lecture: Monetary Neutrality”, Journal of Political Economy, Vol. 104, 661-682. Bernanke, Ben S. and Carey, Kevin (1996); “Nominal Wage Stickiness and Aggregate Supply in the Great Depression”, Quarterly Journal of Economics, Vol. CXI, 853-884. *Shafir, Eldar and Diamond, Peter and Tversky, Amos (1997); “Money Illusion”, Quarterly Journal of Economics, Vol. 112, No. 449, Akerlof, George and Dickens, William T. and Perry George L. (1996); “The Macroeconomics of Low Inflation”, forthcoming in: Brookings Papers on Economic Activity. Fehr, Ernst and Tyran, Jean Robert (2001); “Does Money Illusion Matter?” American Economic Review 91, 1239-1262. Fehr, Ernst and Tyran, Jean Robert (2002); Limited Rationality and Strategic Interaction, Institute for Empirical Research in Economics, University of Zürich, Working Paper No. 130.

Lecture 12: – The Neurobiological Foundations of Economic Behavior

Breiter, H. C.; Aharon, I.; Kahneman, D.; Dale, A. and Shizgal, P. (2001); Functional Imaging of Neural Responses to Expectancy and Experience of Monetary Gains and Losses. Neuron 30, 619-39. *de Quervain, D. J. F.; Fischbacher, U.; Treyer, V.; Schellhammer, M.; Schnyder, U.; Buck, A. and Fehr, E. (2004); The Neural Basis of Altruistic Punishment. Science 305, 1254-58. *Loewenstein G. and O’Donoghue T. (2004), Animal Spirits – Affective and Deliberative Processes in Economic Behavior, Discussion Paper. Rilling, James K; Gutman, David A; Zeh, Thorsten R; Pagnoni, Giuseppe; Berns, Gregory S and Kilts, Clinton D. (2002); A Neural Basis for Social Cooperation. Neuron, 35, 395-405. Sanfey, Alan G.; Rilling, James K; Aronson, Jessica A; Nystrom, Leigh E and Cohen, Jonathan D. (2003); The Neural Basis of Economic Decision-Making in the . Science 300, 1755-58. *Schultz, W. (2000); Multiple Reward Signals in the Brain. Nature Reviews Neuroscience, 1, 199- 207. Singer, T.; Kiebel, S. J.; Winston, J. S.; Kaube, H.; Dolan, R. J. and Frith, C. D. (2004); Brain Responses to the Acquired Moral Status of Faces. Neuron, 41, 653-62. Singer, T.; Seymour, B.; O'Doherty, J.; Kaube, H.; Dolan, R. J. and Frith, C. D. (2004); Empathy for Pain Involves the Affective but Not Sensory Components of Pain. Science, 303, 1157-62.