INTRODUCTION TO BEHAVIOURAL ECONOMICS (EC200) Course duration: 54 hours lecture and class time (Over three weeks) Summer School Programme Area: Economics LSE Teaching Department: Department of Economics Lead Faculty: Dr Matthew Levy and Dr Gianluca Benigno (Dept. of Economics) Pre-requisites: Introductory macroeconomics and microeconomics. Aims: This course will provide students with a clear introduction to the principles and methods of Behavioural Economics. Behavioural economics considers the ways that people are more social, more impulsive, less adept at using information, and more susceptible to psychological biases than the standard economic models assume. We will explore key departures, and the consequences for individuals, firms, and policy. - To provide students with an introduction to the principles and methods of Behavioural Economics. - To provide an overview of how behavioural principles have been applied to economic problems both in microeconomics and macroeconomics. 1 Objectives: By the end of the course students should be able to: - Identify and evaluate evidence for systematic departures of economic behaviour from the predictions of the neoclassical model, and psychological explanations for these anomalies. - Incorporate psychologically motivated assumptions into economic models, and interpret the implications of these assumptions. - Explain how these models change the predictions for equilibrium behaviour and welfare analysis, and assess the implications for optimal policy. - Compare the predictions of neoclassical and behavioural models, and evaluate the best method for approaching a given topic. Content: This course provides an introduction to the foundations of behavioural economics. The focus of the course is on the understanding of the principles behind the behavioural approach in addressing economics problems and on the development of up-to-date analytical tools, drawn from recent research, and their application to a variety of economic situations. The course will be thematically organized as ‘behavioural macroeconomics’ and ‘behavioural microeconomics’. In the behavioural macro part, there will be an introduction on the rational expectations Course content is subject to change. Last updated: January 2018 framework and then there will be an overview of a variety of applications of behavioural models to finance, labour market, saving choices and monetary policy to address “anomalies”. We also plan to cover models of learning and applications of sunspot theories. Behavioural micro will focus on departures from the assumptions of selfishness, time consistency, rational inference, and strategic sophistication with applications to markets, policy, and strategic settings. Behavioural game theoretic models (e.g. “level-k”) will be introduced (Nash equilibrium not required as a prerequisite). Assessments: Formative assessments One problem set for each part of the course (Behavioural Microeconomics and Behavioural Macroeconomics) will be graded. For Behavioural Microeconomics the assessment will be problem set 2 and the feedback will be provided by Monday of week two. For Behavioural Macroeconomics the assessment will be problem set 2 and the feedback will be provided by Monday of week three. This will not count towards students’ final overall grade, but should provide good preparation for the summative assessments. Summative assessments Mid-session examination A two-hour mid-session exam (worth 50% of the overall grade) will take place on Tuesday of week two. Results will be released by Monday of week three. The precise time and location of the exam will be circulated during the programme. 2 Final examination A two-hour final exam (worth 50% of the overall grade) will take place on Friday of week three. Results will be released within a week of the exam. The precise time and location of the exam will be circulated during the programme. Reading: One suggested (non-mandatory) textbook for the course is An Introduction to Behavioural Economics by Nick Wilkinson and Matthew Klaes. Another good reading is Animal Spirits by George Akerlof and Robert Shiller. Almost all of the journal articles in the reading list can be accessed via the LSE Library electronic journals collection. Hyperlinks are given for working and discussion papers. CC refers to Course Collection. General: - An Introduction to Behavioral Economics, N. Wilkinson and M. Klaes (2012), Palgrave Macmillan. - Animal Spirits, G. Akerlof and R. Shiller (2009), Princeton University Press. Course content is subject to change. Last updated: January 2018 Review: Students wishing to review their microeconomic theory should consult a textbook on intermediate microeconomic theory, such as Morgan, Katz and Rosen (2006) Microeconomics, McGraw Hill (CC HB172 M84) or J Perloff (2008) Microeconomics: Theory and Applications with Calculus, Pearson (CC HB172 P45). Please note: You should not attempt to read everything on the reading list; the supplementary readings are provided for students interested in pursuing a particular topic in more depth or for those seeking an alternative approach. It is not important to read a huge amount, but vastly important to really understand what you do read. PART I – Behavioural Microeconomics 1. Introduction: what is behavioural economics? Introduction to the themes and methods of behavioural economics. Anticipation and information avoidance as introductory example. - Loewenstein (1987) “Anticipation and the Valuation of Delayed Consumption”. Economic Journal, 97(387): 666— 684. - Oster, Emily, Ira Shoulson, and E. Ray Dorsey. 2013. "Optimal Expectations and Limited Medical Testing: 3 Evidence from Huntington Disease." American Economic Review, 103(2): 804-30. - Brunnermeier, Markus, K., and Jonathan A. Parker (2005). "Optimal Expectations." American Economic Review, 95(4): 1092-1118. 2. Making Choices Under Risk: Prospect Theory How to people really make choices when faced with uncertainty? The role of reference-dependent preferences in both risky (loss-aversion) and risk-free (the endowment effect) choices. - Kahneman and Tversky (1979) “Prospect Theory: An Analysis of Decision Under Risk”, Econometrica, 47(2): 263– 291. - List (2003) “Does Market Experience Eliminate Market Anomalies?”, Quarterly Journal of Economics, 118(1): 41– 71. - Koszegi and Rabin (2006), “A Model of Reference-Dependent Preferences”, Quarterly Journal of Economics, 121(4): 1133–1165. - Sydnor, Justin. 2010. "(Over)insuring Modest Risks." American Economic Journal: Applied Economics, 2(4): 177-99. 3. Social Preferences How do people care about those around them? Both distributional social preferences (altruism, inequality aversion) and intentions-based social preferences (reciprocity, fairness). The possibility of self-deception. Course content is subject to change. Last updated: January 2018 - Charness and Rabin (2002) “Understanding Social Preferences with Simple Tests” Quarterly Journal of Economics, 117(3): 817–869. - Lazear, Edward P., Ulrike Malmendier, and Roberto A. Weber. 2012. "Sorting in Experiments with Application to Social Preferences." American Economic Journal: Applied Economics, 4(1): 136-63. - DellaVigna, List, Malmendier. 2012. “Testing for Altruism and Social Pressure in Charitable Giving”. Quarterly Journal of Economics, 127(1): 1–56. - Rabin (1993) “Incorporating Fairness into Game Theory and Economics”, American Economic Review, 83(5): 1281– 1302. - Fehr and Gachter, (2000),“Fairness and Retaliation: The Economics of Reciprocity”, Journal of Economic Perspectives, 14(3): 159–181. - Fehr, E. and Schmidt, K. (1999) “A Theory of Fairness, Competition, and Cooperation” The Quarterly Journal of Economics, 114(3): 817—868. - Thaler, Richard H. 1988. "Anomalies: The Ultimatum Game." Journal of Economic Perspectives, 2(4): 195-206. 4. Heuristics and Biases How do people make predictions about the world around them? The heuristics and biases displayed in judgment and decision-making. - Tversky, A. and Kahneman, D. (1974) “Judgment Under Uncertainty: Heuristics and Biases”, Science, 185(4): 1124– 1131. - Rabin (2002) “Inference by Believers in the Law of Small Numbers”, Quarterly Journal of Economics, 117(3): 775– 816. 4 - Matthew Rabin, Joel L. Schrag (1999) “First Impressions Matter: A Model of Confirmatory Bias”, The Quarterly Journal of Economics, 114(1),37–82. 5. State-Dependent Preferences and Mis-Prediction How do people make predictions about their own future utility? State-dependent preferences (e.g. habit- formation and addiction) and projection bias. - Stigler, G., & Becker, G. (1977). “De Gustibus Non Est Disputandum”. The American Economic Review, 67(2), 76- 90. - Loewenstein, G, O’Donoghue, T, and M Rabin (2003) "Projection Bias in Predicting Future Utility, Quarterly Journal of Economics 118(4), 1209-1248. - Meghan R. Busse, Devin G. Pope, Jaren C. Pope, Jorge Silva-Risso (2015) “The Psychological Effect of Weather on Car Purchases”, Quarterly Journal of Economics, 130(1), 371–414. - Acland and Levy (2015) “Naivete, Projection Bias, and Habit Formation in Gym Attendance”, Management Science, 61(1):146-160. 6. Behavioural Game Theory How do people make predictions about their opponents in strategic interactions? Models of limited social inference (level-k reasoning, cursedness). Course content is subject to change. Last updated: January 2018 - Stahl, Dale and Wilson, Paul. "On Players' Models of Other Players: Theory and Experimental Evidence". Games and Economic Behavior, 10, 1995. - Thaler, Richard H. 1988. "Anomalies: The Winner's