A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Levine, David K. Book — Published Version Is Behavioral Economics Doomed?: The Ordinary versus the Extraordinary Provided in Cooperation with: Open Book Publishers Suggested Citation: Levine, David K. (2012) : Is Behavioral Economics Doomed?: The Ordinary versus the Extraordinary, ISBN 978-1-906924-96-6, Open Book Publishers, Cambridge, http://dx.doi.org/10.11647/OBP.0021 This Version is available at: http://hdl.handle.net/10419/182374 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-sa/3.0/deed.en www.econstor.eu DAVID K. LEVINE Is Behavioral Economics Doomed? The Ordinary versus the Extraordinary LLevineFront&BackCovers.inddevineFront&BackCovers.indd 1 99/10/12/10/12 3:563:56 PPMM IS BEHAVIORAL ECONOMICS DOOMED? behaviouraleconomics.indd 1 9/6/12 5:43 PM David K. Levine is John H. Biggs Distinguished Professor of Economics at Washington University in St. Louis. He is currently serving as President of the Society for the Advancement of Economic Theory. He is also a fellow of the Econometric Society, an Economic Theory Fellow, a research associate of the NBER, and of the Federal Reserve Bank of St. Louis, managing editor of NAJ Economics, and co-director of the MISSEL laboratory. His scientific research is supported by grants from the National Science Foundation. He is the author of Against Intellectual Monopoly (with Michele Boldrin) and Learning in Games (with Drew Fudenberg) and the editor of several conference volumes. He has published extensively in professional journals, including The American Economic Review, Econometrica, The Review of Economic Studies, The Journal of Political Economy, The Journal of Economic Theory, The Quarterly Journal of Economics, and The American Political Science Review. Levine’s current research interests include the study of intellectual property and endogenous growth in dynamic general equilibrium models, models of self-control, of the endogenous formation of preferences, institutions and social norms, learning in games, evolutionary game theory, virtual economies, and the application of game theory to experimental economics. At the graduate level, his teaching focuses on economic dynamics; at the undergraduate level, he teaches intermediate level microeconomics, focusing largely on elementary game theory. behaviouraleconomics.indd 2 9/6/12 5:43 PM IS BEHAVIORAL ECONOMICS DOOMED? The Ordinary versus the Extraordinary Edited by David K. Levine behaviouraleconomics.indd 3 9/6/12 5:43 PM Open Book Publishers CIC Ltd., 40 Devonshire Road, Cambridge, CB1 2BL, United Kingdom http://www.openbookpublishers.com © 2012 David K. Levine Some rights are reserved. This work is licensed under a Creative Commons Attribution-ShareAlike 3.0 Unported License. This license lets others remix, tweak, and build upon the work even for commercial purposes, as long as they credit the author of the work and license their new creations under the identical terms. Details of allowances and restrictions available at: http://creativecommons.org/licenses/by-sa/3.0/deed.en As with all Open Book Publishers titles, digital material and resources associated with this volume are available from our website: http://www.openbookpublishers.com/product/77 ISBN Hardback: 978-1-906924-93-5 ISBN Paperback: 978-1-906924-92-8 ISBN Digital (pdf): 978-1-906924-94-2 ISBN e-book (epub): 978-1-906924-95-9 ISBN e-book (mobi): 978-1-906924-96-6 Cover image: Joan M. Mas http://www.flickr.com/photos/dailypic/2072852387/in/photostream Typesetting by www.bookgenie.in All paper used by Open Book Publishers is SFI (Sustainable Forestry Initiative), PEFC (Programme for the Endorsement of Forest Certification Schemes) and Forest Stewardship Council (FSC) certified. Printed in the United Kingdom and United States by Lightning Source for Open Book Publishers behaviouraleconomics.indd 4 9/6/12 5:43 PM Contents Page Acknowledgements vii Introduction 1 Does Economic Theory Work? 5 Why Is the World so Irrational? 21 Does Economic Theory Fail? 47 You Can Fool Some of the People… 63 Behavioral Theories I: Biases and Irrationality 77 Behavioral Theories II: Time and Uncertainty 93 Learning and Friends 111 Conclusion: Psychology, Neuroscience and Economics 123 References 131 Index 139 behaviouraleconomics.indd 5 9/6/12 5:43 PM To Milena Davidson-Levine and Catharina Tilmans behaviouraleconomics.indd 6 9/6/12 5:43 PM Acknowledgements I owe an immeasurable intellectual debt to my coauthors Michele Boldrin, Drew Fudenberg, Salvatore Modica, Zacharias Maniadis, Tom Palfrey, and Jie Zheng with whom I’ve worked, discussed and debated the issues discussed here for many years. Tim Sullivan encouraged me to write this up in the form of a book, and took the time to read and comment on the first draft. Rupert Gatti, economics editor of Open Book Publishers, Alessandra Tosi and two exceptional referees have enormously improved that original draft. Juan Block proofread the book – for sense as well as typos – and provided the index. This book originated as a Max Weber lecture presented at the European University Institute. Much of it was written while on sabbatical leave in the Economics Department there. I am grateful to the EUI and the Economics Department. I also owe a special debt of gratitude to the Max Weber program and to Ramon Marimon, Karin Tilmans and the Weber fellows for the invitation to speak, for a very constructive presentation, and for encouragement and assistance in writing up the lecture. I have presented variations of this lecture in various venues including FUR, the NYU Experimental Workshop, the Neuroeconomics Meetings and the Milan Neuroeconomics Conference. I am grateful to Glenn Harrison, Guillame Frechette, and Colin Camerer for those invitations and to them and the meeting participants for helpful comments and criticism. Like Guillame and Colin, Rosemarie Nagel disagrees with practically everything written here – but her constant provocation has resulted in a much more coherent book. In the other dimension – Charlie Plott’s work in a direction similar to mine has been an example and an inspiration. Although we may disagree – hopefully with respect – I could not have written this book without my many behavioral, neuroscientific and psychological friends. George Ainslie, Gary Charness, Ernst Fehr, Paul behaviouraleconomics.indd 7 9/6/12 5:43 PM Glimcher, Len Green, Joel Myerson, David Laibson, Camillo Padoa- Schioppa, Drazen Prelec, Aldo Rustichini and Klaus Schmidt have through their careful research contributed to my understanding of behavioral economics. I am also grateful to my daughter Milena Davidson-Levine, to Catharina Tilmans and to my many students both graduate and undergraduate at Washington University in St. Louis. To the outstanding faculty there and the fine research organization at the Federal Reserve Bank of St. Louis I am also indebted for constant feedback and support. Finally, I would like to thank the National Science Foundation and grants SES-03-14713 and SES-08-51315 for financial support. behaviouraleconomics.indd 8 9/6/12 5:43 PM 1. Introduction Under these conditions, the erotic relation seems to offer the unsurpassable peak of the fulfillment of the request for love in the direct fusion of the souls of one to the other. The boundless giving of oneself is as radical as possible in its opposition to all functionality, rationality, and generality. It is so overpowering that it is treated “symbolically”: as a sacrament. The lover realizes himself to be rooted in the kernel of the truly living, which is eternally inaccessible to any rational endeavor. He knows himself to be freed from the cold skeleton hands of rational orders, just as completely as from the banality of everyday routine. Max Weber, 1958 Even Max Weber – one of the early proponents of the social analysis of rational man – recognized the essential irrationality of emotions such as love. Today it has become so very fashionable to criticize economic theory for focusing too much on rationality and ignoring the imperfect and emotional way in which decisions are reached in the “real world.” Psychologists and other social scientists have been especially vocal in their dismay. A bright new group of behavioral economists has picked up the criticism: Economics traditionally conceptualizes a world populated by calculating, unemotional maximizers that have been dubbed Homo economicus. The standard