Behavioral Economics
Department: Economics
Instructor: Prof. David Cesarini
Course Number: V31.0342
Frequency: The course will be offered annually beginning in the Spring 2011 semester.
Points and pre-requisites: The course will carry four points. This course is open to students
who have taken Intermediate Microeconomics (V31.0010), Topics in Econometrics (V31.0380)
and Calculus II (V63.0122); or Microeconomics (V31.0011), Introduction to Econometrics
(V31.0266), and Calculus II (V63.0122). Exceptions require the instructor’s permission.
Properties: The course will meet two times each week for one hour and fifteen minutes each.
No unusual audio-visual or technological aids will be used.
A. SYLLABUS
Course Description and Aims
This course introduces students to the field of behavioral economics, which seeks to insert more
behavioral realism into economic theory. Typically we try to accomplish this by making nonstandard assumptions about human preferences, but occasionally our approach will be to explore
non-standard beliefs or emphasize the limitations of our decision making faculties. Topics
covered include, but are not restricted to, prospect theory, mental accounting, other-regarding
preferences and hyperbolic discounting. We will usually approach a topic by examining evidence
of some departure from the assumptions made in the canonical economic model. We then ask
how such departures can be formalized theoretically and how the resulting models can be tested
empirically. The course requires a command of basic microeconomic theory and econometric
analysis of microeconomic data.
We start by reviewing the standard expected utility theory framework, which will serve as our
baseline model throughout much of the course. We then study some of the empirical evidence
suggesting that people respond to changes in wealth levels more than the expected utility model
would predict, and that there appears to be an asymmetry between the evaluation of losses and
gains. We then proceed to formally develop prospect theory and its various extensions, for
example models of reference dependent preferences. We conclude this topic by reviewing the
empirical evidence on the significance of prospect theoretic preferences outside of the
laboratory.
In the next part of the course study how people discount the future, with special emphasis on
models of inter-temporal choice in which people appear to exhibit present bias. We examine the
empirical evidence of such present-biased preferences and explore various models which have
attempted to formalize the intuition that humans have a tendency to too often grab immediate
rewards. Our basic analytical framework is used to try to illuminate economic questions such as
excessive credit borrowing and saving for retirement. We also ask what, if any, implications
these ideas have for public policy.
We then turn to models in which the assumption that people are narrowly self-interested is
relaxed. We ask under what situations people manifest such “other-regarding” preferences,
surveying the standard experimental paradigms which have been used to elicit social preferences
and some of the objections which have been raised to this work. We consider several formal
models of non-selfish behavior and explore their implications, with special emphasis on the labor
market.
We next study to non-standard beliefs, focusing on a number of other deviations from normative
decision theory such as overconfidence and erroneous statistical reasoning. We ask under what
circumstances the human decision making machinery functions well, under what circumstances
it does not and what implications this has for institutional design. We conclude the course by
covering discussing recent work by economists which seeks to explain individual differences in
the susceptibility to behavioral anomalies, often using tools from differential psychology.
Course materials and Resources
Most of the readings will be based on notes provided by the instructor and journal articles as part
of the course packet described below. Lecture notes will also be provided. A recommended text,
containing much of the required readings, is:
Choices, Values, and Frames, Daniel Kahneman and Amos Tversky (eds.), Cambridge
University Press, 2000.
Course Requirements
There will be one final exam and approximately 8 assignments for this class. The main purpose
of the assignments is to develop model-solving skills.
The exam will count for 60% of the grade, and the assignments will count for 40% of the grade.
SCHEDULE
Below is an outline of topics for the course with the corresponding chapters from Kahneman and
Tversky (hencefort K&T) or the relevant journal articles, which are listed after the schedule.
Introduction and Review of the Expected Utility Framework – 2 lectures

Introduction to Behavioral Economics (Ashraf et al., 2005; Rabin, 1998)

The Expected Utility Framework (Instructor’s Notes)
Prospect Theory – 6 lectures

Motivating Empirical Evidence (Kahneman et al., 1991; K&T, chapter 1)

Prospect Theory (K&T, chapters 2-3, Instructor’s Notes)

Models of Reference Dependent Preferences (Köszegi and Rabin, 2006, Instructor’s
Notes)

Empirical Extensions and the Endowment Effect (Rabin and Thaler, 2006; Kahneman et
al., 1990; Fehr and Goette, 2007, List, 2004)
Hyperbolic Discounting – 6 lectures

The Exponential Discounting Model (Instructor’s Notes)

Empirical Evidence on Hyperbolic Discounting / Present Bias (Mischel et al., 1999;
Ariely and Wertenbroch, 2002; Frederick et al., 2002)

The Beta-Delta Model with Sophistication and Naïveté (O'Donoghue and Rabin, 1999)

Empirical Extensions (Della Vigna and Malmendier, 2004, 2006; Shapiro 2005, Meier
and Sprenger, 2010)

Present-Bias and Public Policy (Jolls et al., 1998; Glaeser, 2006)
Other-Regarding Preferences & Reciprocity – 6 lectures

Empirical Evidence (Camerer and Fehr, 2004; Fehr and Gächter, 2002)

External Validity (Levitt and List, 2007, Smith, 2003)

Formal Models of Inequity Aversion and Reciprocity (Fehr and Schmidt, 1999; Charness
and Rabin, 2002)

Empirical Extensions (Bandiera et al., 2005)
Miscellaneous Topics – 4 lectures

Heuristics and Biases (Kahneman and Tversky, 1974)

Ecological Validity (Cosmides and Tooby, 1994; Gigerenzer, 1991, Smith, 2003)

Mental Accounting (K&T, chapters 12, 14-15)

Individual Differences (Benjamin et al., 2006; Frederick, 2005; Cesarini et al., 2009)
JOURNAL ARTICLES

Ariely, D., and K. Wertenbroch. 2002. Procrastination, Deadlines, and Performance: SelfControl by Pre-Commitment. Psychological Science 13 (3): 219–224.

Ashraf, N, C.F. Camerer, and G. Loewenstein. 2005. Adam Smith, Behavioral
Economist. Journal of Economic Perspectives 19(3): 131–145.

Benjamin, D., Brown, S., and J. Shapiro. 2006. Who is "Behavioral"? Cognitive Ability
and Anomalous Preferences. Manuscript.

Bandiera, O., Barankay, I., and I. Rasul. 2005. Social Preferences and the Response to
Incentives: Evidence from Personnel Files. Quarterly Journal of Economics 120(3): 917–
962.

Camerer, C.F., and E. Fehr. 2004. Measuring Social Norms and Preferences using
Experimental Games: A Guide for Social Scientists. Institute for Empirical Research in
Economics University of Zurich Working Paper No. 97.

Cesarini D., Dawes C.T, Johannesson M., Lichtenstein P., and B. Wallace. 2009. Genetic
Variation in Preferences for Giving and Risk-Taking. Quarterly Journal of Economics
124(2): 809–842.

Charness, G., and M. Rabin. 2002. Understanding Social Preferences with Simple Tests.
Quarterly Journal of Economics 117(3): 817–869.

Cosmides, L. and Tooby, J. 1994. Better than Rational: Evolutionary Psychology and the
Invisible Hand. American Economic Review 84(2): 327-332.

DellaVigna, S., and U. Malmendier. 2004. Contract Design and Self Control: Theory and
Evidence. Quarterly Journal of Economics 119(2): 353–402.

DellaVigna, S. and U. Malmendier. 2006. Paying Not to Go to the Gym. American
Economic Review 96(3): 694–719.

Fehr, E. and, S. Gächter. 2002. Altruistic Punishment in Humans. Nature 415(6868):
137–140.

Fehr, E., and L. Goette. 2007. Do Workers Work More when Wages are High? Evidence
from a Randomized Field Experiment. American Economic Review 97(1): 298–317.

Fehr, E. and Schmidt, K.M. 1999. A Theory of Fairness, Competition, and Cooperation.
Quarterly Journal of Economics 114(3): 817–868.

Frederick, S. 2005. Cognitive Reflection and Decision Making. Journal of Economic
Perspectives 19(4), 24–42.

Frederick, S. and Loewenstein, G. and O'Donoghue, T. 2002. Time Discounting and
Time Preference: A Critical Review. Journal of Economic Literature 40(2): 351-401.

Gigerenzer, G. 1991. How to Make Cognitive Illusions Disappear: Beyond "Heuristics
and Biases". European Review of Social Psychology 2: 83-115.

Glaeser, E.L. 2006. Paternalism and Psychology. University of Chicago Law Review 73:
133–156.

Jolls, C. and Sunstein, C.R. and R. Thaler. 1998. A Behavioral Approach to Law and
Economics. Stanford Law Review 50(5): 1471–1550.

Kahneman, D., J. L Knetsch, and R.H. Thaler. 1991. Anomalies: The Endowment Effect,
Loss Aversion, and Status Quo Bias. Journal of Economic Perspectives 5(1): 193–206.

Kahneman, D, Knetsch, J.L., and R. Thaler. 1990. Experimental Tests of the Endowment
Effect and the Coase Theorem. Journal of Political Economy 98(6): 1325–1348.

Kahneman, D, and A. Tversky. 1974. Judgment under Uncertainty: Heuristics and
Biases. Science 185(1457): 1124–1131.

Köszegi, B., and M. Rabin. 2006. A Model of Reference-Dependent Preferences.
Quarterly Journal of Economics 121(4): 1133–1165.

Levitt, S.D., and J.A. List. 2007. What Do Laboratory Experiments Measuring Social
Preferences tell us about the Real World? Journal of Economic Perspectives 21(2): 153–
174.

List, J.A. 2004. Neoclassical Theory Versus Prospect Theory: Evidence from the
Marketplace. Econometrica 72(2): 615–625.

Meier, S., and C. Sprenger. 2010. Present-Biased Preferences and Credit Card
Borrowing. American Economic Journal: Applied Economics 2(1): 193–210.

Mischel, W., Shoda, Y., and M.L. Rodriguez. 1989. Delay of Gratification in Children.
Science 244(4907): 933–938.

O'Donoghue, T., and M. Rabin. 1999. Doing It Now or Later. American Economic
Review 89(1): 103-124.

Rabin, M. 1998. Economics and Psychology. Journal of Economic Literature 36(1): 11–
46.

Rabin, M., and R. Thaler. 2001. Anomalies: Risk Aversion. Journal of Economic
Perspectives 15(1): 219–232.

Shapiro, J. 2005. Is There a Daily Discount Rate? Evidence from the Food Stamp
Nutrition Cycle. Journal of Public Economics, 89(2): 303–325.

Smith, V.L. 2003. Constructivist and Ecological Rationality in Economics. American
Economic Review 93(3): 465–508
B. INFORMATION ABOUT THE COURSE IN THE CURRICULUM OF CAS
The course will only serve economics majors. No course will be dropped to make way for this
one.
C. STATEMENT BY THE DIRECTOR OF UNDERGRADUATE STUDIES
Behavioral economics is the latest modern contribution to the development & extension of micro
analysis. We are very lucky to have acquired the talents of David Cesarini to spearhead our
contribution in this new and rapidly advancing field. I welcome this course with pleasure and
relief in that it fills a long tolerated gap in our instructional program.
This course does not overlap any other course in CAS.
BEHAVIORAL ECONOMICS
CAS Bulletin: This course introduces students to the field of behavioral economics, which seeks
to insert more behavioral realism into economic theory. Topics covered include, but are not
restricted to, prospect theory, mental accounting, non-materially maximizing preferences and
hyperbolic discounting. We will usually approach a topic by surveying evidence which
documents a departure from an assumption made in the canonical economic model. We then
examine how such departures can be formalized theoretically and how the resulting models can
be tested empirically.