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American Economic Association

Psychology and Economics
Author(s): Matthew Rabin
Reviewed work(s):
Source: Journal of Economic Literature, Vol. 36, No. 1 (Mar., 1998), pp. 11-46
Published by: American Economic Association
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[ournal of EconomicLiterature
Vol. XXXVI (March 1998), pp. 11-46

Psychology and Economics

MATTHEW RABIN
University of California at Berkeley
For- commnents oni. this e:sosy or discussion o01 r-ela.ted topics, I thanik Henry Aari-on.,Geor-ge
Akerlof, James And1reon.i, Steveni. Blatt, Gary Charn-^1ess,Eddie Dekel, Peter Diamond Jon.
Elster, Erik Eyster, Ernst Fehr, David I. Levine, George Loewenistein, Rob MacCotwi-, Jamnes
Montgomniery, Vali-La-ini.Mid, Ted O'Donoghute, Dra^zen.Pr^elec, llya Segal, Eldai Sha fir Genie
Smiiolensky,Joel Sobel, AmitosTversky, foutr anonymous referees, anid especially ColilhnCamiterer-,
Danny Kahnenman, and Richiari-dThaller. Co-authors oni, resear^chii-elated to the topics of this
essay include David Bowman, Deborah Minehart, Ted O'Donoghtue, anid Joel Sch t-ag. Helpfill
research assistance wcaspr-ovided by Gadi Barlevy, Nikki Blasberg, Gail Brennan, Paul Ellick-
son, April Franco, Marcus Henzg, Br-uce Hstu, Jini, Woo Jtunig, and especially Ste-veui Blatt,
V
Jinumty Chani, Erik Eyster-, and Clara Wang. I amitextremitely grateftul to the Nationial Scienice,
Ruissell Sage, Alfred P. Sloain, and MacArthur Fouindatiols for finian.cial stuppor-t oni t-esearch
verbose an.d citationi-he7avy version of this essay, covering a few
related to thi.s essay. A mitori-e
additional topics, is avvailable as Uniiversity of Californtia. at Berkeley Departmiienitof Econiomit-
ics Working Paper No. 97-251.

1. Introduction person's preferences are often deter-
mined by changes in outcomes relative
BECAUSE PSYCHOLOGY systemati- to her reference level, and not merely
cally explores human judgment, be- by absolute levels of outcomes. In par-
havior, and well-being, it can teach us ticular, relative to their status quo (or
important facts about how humans differ other reference points), people dislike
from the way tlhey are traditionally de- losses significantly more than they like
scribed by economists. In this essay I gains. I then discuss how people depart
discuss a selection of psychological find- from pure self-interest (as narrowly de-
ings relevant to economics. fined) to pursue "other-regarding"goals
Economics has conventionally as- such as fairness, reciprocal altruism,
sumed that each individual has stable and revenge.
and coherent preferences, and that she By focusing on evidence consistent
rationally maximizes those preferences. with rational choice, Section 2 reviews
Given a set of options and probabilistic evidence that requires relatively small
beliefs, a person is assumed to maxi- modifications of tlhe familiar economic
mize the expected value of a utility framework. Section 3 reviews research
function, U(x). Psychological research on biases in judgment under uncer-
suggests various modifications to this tainty; because these biases lead people
conception of human choice. Section 2 to make errors when attempting to
provides examples of what psychological maximize U(x), this research poses a
research can teach us about making more radical challenge to the econom-
U(x) more realistic than under standard ics model. I discuss two biases in de-
economic assumptions. I begin by dis- tail-how we infer too much from too
cussing research which suggests that a little evidence and how we misread evi-
11

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12 Journal of EcononmicLiterature, Vol. XXXVI (March 1998)
dence as confirming previously held hy- sic motivation" (e.g., the internal drive
potheses-and briefly explain a few to excel at your vocation); and a mass of
more. I also discuss some of the psycho- research on learning from cognitive and
logical evidence on whether and when developmental psychology. 1
experience and learning lead people to Two other limitations of scope are
overcome these biases. conspicuous. First, I emphasize what
The array of psychological findings psychologists and experimental econo-
reviewed in Section 4 points to an even mists have learned about people, rather
more radical critique of the economics than how they have learned it. Conse-
model: Even if we are willing to modify quently, the focus of this essay is not at
our standard assumptions about U(x), or all on experimental methods per se.2
allow that people make systematic er- Second, my primary emphasis is on re-
rors in judgment when attempting to viewing what psychology tells us about
maximize U(x), it is sometimes mislead- modifying our general assumptions
ing to conceptualize people as attempt- about individual behavior, rather than
ing to maximize a coherent, stable, and on any of its specific economic applica-
accurately perceived U(x). I begin by tions. For instance, while fairness and
reviewing evidence that people have reference-level effects (reviewed in
difficulties evaluating their own prefer- Section 2) and framing effects (re-
ences-we don't always accurately pre- viewed in Section 4) are likely to con-
dict our own future preferences, nor tribute to downward stickiness in
even accurately assess our experienced wages, I leave the exploration of these
well-being from past choices. I then dis- implications to other forums.
cuss research on framing effects, pref- Mainstream economics employs a
erence reversals, and related phenom- powerful combination of methods:
ena in which people prefer some option methodological individualism, mathe-
x to y when the choice is elicited one matical formalization of assumptions,
way, but prefer y to x when the choice logical analysis of the consequences of
is elicited another way. I conclude Sec- those assumptions, and sophisticated
tion 4 with a discussion of self-control empirical field testing. I believe these
problems and other phenomena that methods are tremendously useful, and
arise because people have a short-run
propensity to pursue immediate gratifi- 1 Another topic I have omitted is "non-psycho-
cation that is inconsistent with their logical" modeSs of bounded rationality. Re-
searchers have formulated models of bounded ra-
long-run preferences. tionality (based on intuition, computer science, or
The customary disclaimer of review artificial intelligence) meant to capture cognitive
essays-that they do not pretend to be limits of economic actors, but which do not invoke
research on the specific patterns of errors that hu-
exhaustive-applies even more here man beings make. For an excellent review of the
than usual: The topics covered are only role of bounded rationality in economics, see John
a small fraction of economically rele- Conlisk (1996).
2 Descriptions of experimental methods em-
vant psychology. Some omitted topics of ployed by psychologists can be found in virtually
obvious economic relevance are non- any psychology text. For an excellent set of re-
expected utility; status, envy, and social views of the results of experimental economics,
see John Kagel and Alvin Roth (1995). While most
comparisons; conformity and herd be- of the findings I p resent in this essay come from
havior; self-serving biases and moti- psychologists, I often draw on evidence from ex-
vated cognition; the tendency of "ex- perimental economics as well. My focus, however,
is on experiments that explore the psychological
trinsic motivation" (e.g., organizational nature of individuals, not on research seeking to
incentive schemes) to drive out "intrin- replicate economic institutions in the laboratory.

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Instead of utility at aware of the shortcomings of our mod. while nificantly more averse to losses than Section 2 discusses approaches to modeling loss aversion fully within tihe rational-choice frame. and keep sumption. and Harl Ryder and Geoffrey Heal 1973). Preferences lems for doing full justice to behavioral reality: Because of the h-igh premium This section discusses how psycho- economics places on the logic and pre. it is fair to say that habitual assumptions about human be. Rabin: PstlcholoLytand Econonmics 13 an underlying premise of this essay is what research shows some of those de- that we should strive to understand psy. But even in those analysis such factors as habitual levels cases. some reference level than to the abso- "tractability" and "parsimony" should be lute characteristics of the situation guiding principles in our efforts to (Harry Helson 1964). 4 There have been some earlier examples of work. attending to all facets of human nature is neither feasible nor A.4 Researchers have identified a pervasive 3 Indeed. "reference level. Richard Easterlin 1974. Understanding that ous enough that we should begin the people are often more sensitive to process of integrating them into eco. partures are. Of course it is possible. economnists have over the years incorpo- ble" that behavioral research identifies rated reference dependence into their important departures from economists' economic analysis. it may also depend on a our eyes open for ways to remedy them. logical findings suggest we modify the cision of arguments and the quantifica. I review fully been appreciated by economists. determined by fac- While I conclude in Section 5 by briefly tors like past consumption or expecta- discussing the general endeavor of tions of future consumption. For instance. not same temperature that feels cold when pretexts for avoiding this task. and Losses tails of human behavior must be ig. the make our research more realistic. some important psychological may appear hot when we are adapted to findings seem tractable and parsimoni. regret these shortcomings. more general form. the ways and degrees to which refer- havior. Adaptation. however. people are sig- into the economics framework. and in ence points influence behavior have not fact it is true. utility maximization. 2. As it now we are adapted to hot temperatures stands. For instance. cold temperatures. desirable. changes than to absolute levels suggests nomics.ct). I have omitted from ut(rt. At times. chological findings in light of these methods. in- incorporating psychological findings stead of a utility function of the form into economics. time t depending solely on present con- els. The realization that many de. Hence. humans are often more sensitive to how stitutionalized complacency about the their current situation differs from behavioral validity of our assumptions. This content downloaded on Sun. ut(rt. I have organized the essay to reflect feature of reference dependence: In a this premise. Reference Levels. Incorporating other findings that we ought incorporate into utility will take longer. utility functions economists employ. In this essay.ct). economists ought to become of consumption. tion of evidence. Wlile somie arguments about whether it is "possi." rt.3 These methods raise prob. material in Section 4 suggests loss aversion economists considering reference dependence isn't always best conceived of as compatible with (James Duesenberiy 1949. Overwhelming evidence shows that nored. should not license in. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . ct. utility should be written in a this essay many of the classical meta. difficulties in organization belie deeper difficulties of how to fit this research wide variety of domains.

and consid- stance. a comparable phenomenon-the bration theorem" that indeed shows status quo bias-holds in multiple-good that no concave utility function can si. each student was offered Thaler (1980): Once a person comes to the opportunity to exchange her gift for possess a good. and "choosers. even when these tion is required to explain such risk atti. choice problems. treated the mugs as part of their refer- ple dislike even small-scale risk. One realm where such loss aver. But loss aversion says but their reference points differed: that the value function abruptly changes Those who were randomly given mugs slope at the reference level. for instance." faced precisely the mists typically use as the explanation same choice between money and mugs. (1989). whereas individuals not given mugs con- ing $11. the median value placed on such risk attitudes. Such results have been stein and Stanley Zin (1990) have. Here. Tversky and Kahneman each to one group of students. implies that individuals tend to prefer scale and large-scale risk attitudes. Minimal "prices"-sums of twice as much as equal-sized gains. In one simply not a plausible explanation of experiment. "sellers" concave utility function. and Rabin (1997) provides a "cali. Knetsch. which econo. searchers in many contexts. nicely illustrate this phenomenon. Knetsch and Sinden (1984) and Knetsch work. for replicated repeatedly by many re- instance. Because the goods were allocated aversion outside the expected-utility framework. most people prefer their status ered leaving without a mug to be a loss. dents either candy bars or decorated ing endowmnent effect identified by mugs. patible procedure that ensured honest people value modest losses roughly reports). quo to a 50/50 bet of losing $10 or gain.50 by choosers but Edward Prescott (1985) and Larry Ep. loss aversion multaneously explain plausible small. $7. so that peo. ence levels or endowments.00 by sellers. tudes within the expected-utility frame. owners and candy-owners chose not to however. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . (Kahneman. randomly and transaction costs were This content downloaded on Sun. she immediately values the other one-a mug for a candy bar or vice versa. sidered leaving without a mug as re- function explanation for risk aversion is maining at their reference point. Jack Knetsch. Rajnish Mehra and the mug was $3. Sinden (1984). A the status quo to changes that involve reference-based kink in the utility func. and others. Minimal (1991) suggest that in the domain of selling prices were elicited from those money (and in others where the sizes of given the mugs (with an incentive-com- losses and gains can be measured). and Thaler (1990) 1990). Ninety percent of both mug- 5Uzi Segal and Avia Spivak (1990). utility framework cannot simultaneously As established by Knetsch and John explain both the small-scale and large. XXXVI (March 1998) they are attracted to same-sized gains it more than before she possessed it. losses of some goods. For in. develop a model of such first-order risk trade.14 Journal of EconomnicLiterature. money such that they would choose that That the displeasure from a monetary sum rather than the mug-were elicited loss is greater than the pleasure from a from another group of subjects not same-sized gain is also implied by a given mugs. The standard concave-utility. and Knetsch data. randomly gave stu- Loss aversion is related to the strik. losses are offset by gains of other goods. They sion plays out is in preferences over randomly gave mugs worth about $5 wealth levels. and Thaler Kahneman.5 (1989). observed that the expected. William Samuelson and scale risk attitudes implied by macro Richard Zeckhauser (1988). for risk aversion. These two groups. Later. Vol.

000 to a 2/4 8 For exceptions. the responses of 70 per. For consideration of This content downloaded on Sun. over time to same-sized decreasing profiles. As Kahneman and Tversky (1979) Economists Ryder and Heal (1973) note. parameter measuring how quickly peo- For instance. and Frank and Robert Hutchens (1993). 15. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . Ryder and Heal approach of rational-expectations. In a criminate between 30 and 6? changes rational-expectations model. fects their current choices have on their fined over reference levels as well as future reference points. Knetsch (1989) ence points in a dynamic utility-maximi- and Tversky and Kahneman (1991) zation framework. tion. In the context of preferences are determined seems intuitive. di. points change with the formula where our perceptions are a concave + rt. diminishing sensitivity is a perva. people will in room temperature than between take this formula into account when 23? and 26? changes. and Rabin (1997) combine the be risk averse over gains.8 With- wealth gets further away from her 6 Because this "risk-loving" tendency is in con- reference level. strongly indicating that people prefer not to be- ferred lottery. away. risk aversion may reappear for large losses that might push a person to extremely Tow coinsump- minishing sensitivity has a provocative tion levels. 1/4 chance of losing $6. a per- son's reference level was her highest past consumption fer a 3/4 chance of losing nothing and level. function closer to rt Max {cT t < t-that is. departures from reference points: How fects in perceived well-being are current behavior affects future refer- greater for changes close to one's refer. account how people feel about the ef- fully captured by utility functions de. ence points and how they feel about ence level than for changes further changes in their reference points. they are ofter.Minehart. Kahneman and incorporates loss aversion and di.1) is a function of the magnitudes of change. there seems to be little evidence on this diminishing sensitivity implies that topic. This applies to maximizing their long run well being.es in reference points. Such an account of how reference levels perature. another points matter.000. it has often been conjectured that away" implies lower wealth levels. ple adjust their reference points. see Loewenstein and Nachum chance of losing nothing and 1/4 chance Sicherman (1991).6 flected preferences that were induced In order to study the effects of refer- by the initial allocation. though over uncertain monetary outcomes. Robert Frank (1985 ch.minishing sensitivity. two things beyond how they feel about minishing sensitivity: The marginal ef. who have identified a tendency for people to pre- cause the preferred lottery here is a fer income profiles that are steady or increasing mean-preserving spread of the less-pre. the different behavior for the with the standard concavity assump- two groups of subjects presumably re. their long-run utilities when reference In addition to loss aversion. ref- erence-dependent utilities with a utility function that risk-loving over losses. To maximize consumption levels. we need to take into show that such preferences can be use. where cc e (0. come accustomed to levels of consumption they cent of the subjects are inconsistent know they cannot maintain. however.occt-i (1-oc)rt-1. Tversky (1979) found that 70 percent Duesenberry (1949) implicitly posited a reference of subjects report that they would pre. implication: While people are likely to 7 Bowmnan. model the process by which reference sive pattern of human perception. Because for losses flict with the diminishing marginal utility of in- relative to the reference level "further come. Be. each of losing $4. both increases and decreases in tem.7 Evidence is similarly sparse the slope of a person's utility function about how people's preferences depend over wealth becomes flatter as her on chang. people must determine important reference-level effect is di. Rabin: Psuchologu and Economics 15 minimal.000 or $2. 1989). we are more likely to dis.

There is a cash box on the man. not taken out. XXXVI (March 1998) out assumptions about these relation. Finally. so money can only be put in. dinner. but of their advantage. and other departures from self-interest are important in em- ployee behavior. voluntary re- It is common for undergraduates to ductions of water-use during droughts. Examples of economic behavior in- B. complete description of human motiva- ships. price below the level predicted by stan- tions driving most market behavior. and Andrew Goett ics 1: 1987). 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . and refuse to buy at that talk to them of our necessities. pp. Robyn Dawes and Thaler maximization. 195) eloquently set parame- There have been some initial at. see Loewenstein and psychological literature on equity the- Sicherman (1991. price even when worth it in material terms? If this is the case. Yet pure self-interest is far from a status-seeking. 76-82). and Rabin (1997) repli. and argue that this behavior would do so. Knetsch. and never price as unfair. but to their self-love. encounter the following quote from The and conservation of energy to help solve Wealth of Nations (Adam Smith 1776. hun- probably no other two-word description dreds of researchers in psychology. 1986b). They feel that to lowering consumption in response to enough people will volunteer to pay for the fresh corn to make it worthwhile to put it out bad news about income than they are to there. presumption that people are solely self- grated into models of dynamic utility interested. but from their regard for their own and Thaler 1986a. someone good news. The box has just a small slit. and Chi-Keung table. The farmers also know that if it were increasing consumption in response to easy enough to take the money. 26-27) at the beginning of Econom. and economics have interest" in explaining economic behav. and realism suggests that econo- of circumstances where loss aversion mists should move away from the and diminishing sensitivity can be inte. Raymond Hart. then even a There is not much to disagree with in profit-maximizing monopolist would Smith's poetic analysis of the motiva. ior. fairness. dustrial relations. One context in which fairness It is not from the benevolence of the butcher. ters for this endeavor: tempts to study loss aversion. and customers are expected to put Woo (1991) find empirical evidence for money in the box in return for the vegetables the existence of a status quo bias in they take. in- of human motives comes close to "self. Michael Doane. Daniel McFadden.16 Journal of Economic Literature. We address ourselves not to their sumers see the conventional monopoly humanity. one can (easily) make off with the money. or the baker that we expect our (Thaler 1985. Minehart. the en- In the rural areas around Ithaca it is common dowment effect. there will be a relatively small set tion. the energy crisis (Kenneth Train. think that the farmers have just about the 1995b) that consumers are more averse right model of human nature. investigated how equity. Social Preferences and Fair duced by social goals are donations to Allocations public television stations. has been studied is monopoly pricing the brewer. the box is attached to the table. We cate evidence by John Shea (1995a. Might con- interest. pp. table by the road. so no man. (1988. Bow- Also. Indeed. Vol. and Kahneman. the massive solne other factors involved in the preference for increasing wage profiles. and the status quo bias for farmers to put some fresh produce on the in economic contexts. is a natural implication of loss aversion. ory was developed largely in the context This content downloaded on Sun. consumer demand for electricity. p. and dard economic theory.

we must still resolve whether Person l's experienced Simple altruism may parsimoniously well-being is described by Ui(x) or fli(x). capture important phenomena in many 10 I use the term "behavioral distributive jus- contexts.(1 . well-being. terested payoff. This content downloaded on Sun. we need to over the nature of preferences from know both the nature of the W. guilt-induced nightmares if you don't terested.(1. we can in.where Ill(x) is person I's "ma. etc. In particular. To un- self-interested than is behavior in other derstand the implications of fairness settings. people choose to divide resources?10 interest in non-trivial ways: Subjects There are two aspects to this question: contribute to public goods more than First.r). which institutions and environments To address the question of disinter- matter in the real world. form Ul . and sacrifice self-interest for the sake of they often sacrifice money to retaliate these principles? Very roughly. is person l's view of the proper allo- laboratory environments (e. Akerlof 1982. this approach says that person for welfare economics. and Ill is (as above) her self-in- ganized.W1(n1J 12). and ate painful guilt. imagine against unfair treatment. acting as a third pure self-interest. helping motives.r)-. private-information double. in donating to tive value on the well-being of others. tice" to emphasize that I am reviewing evidence on how people actually feel about distributive jus- mental evidence that indicates it is tice. scribed by Max Ul(x) .g. help? These distinctions will be important in wel- vestigate when and how concern for fare analysis: Even if we think behavior is de- others affects behavior and welfare. But. Do you help a stranger when inconvenient because it is the right thing to do H2(x) is person 2's material well-being. eating apples? Or do you know you will have un- pleasant. chological evidence on altruism and need-based truism. the weight this person puts on self-in- havior that is closer to purely terest versus proper allocation. even though it makes you worse off? Or do you By letting r be small.Inl + r. what do people. in the sense that people put posi. to what degree do people could readily grab it for themselves. well-or. 1982) for some psy- which economists have focused is al. disentangling debates and justice for behavior. explored whether people who help others do so for "truly" altruistic reasons. we can capture like bringing joy to others in the same way you like the idea that people are mostly self-in.g. as some researchers have empha. that person l's utility function takes the main. not normative or philosophical questions of often a very wrong description of social what is the proper notion of distributive justice. cation. and Akerlof and cial preferences differ from simple al- Janet Yellen 1990). ested.. psychological research may be of value Roughly. by assuming r>0. or whether they do so "only" to allevi- terial well-being" from outcome x. and 0O?<r?1 measures auction spot markets) that induce be.(1 . consider what can be called "be- Experimental research makes clear havioral distributive justice": How do that preferences depart from pure self. truism. when disinter- can be explained by pure self-interest.9 To get a sense for how so- 1963. feel are proper rules for alloca- they often share money when they tion? Second. suppose two people appear to be debate among behavioral together find $10 worth of money or researchers about whether underlying other goods on the ground. Debates re. Rabin: Psychology and Economics 17 of industrial relations (Stacy Adams preferences. func- strong ancillary assumptions about tion. charity). But there is a mass of experi. One form of social motivations on 9 See Dennis Krebs (1970. where sized the possibility of producing W. in the sense that the ences of the form U1(x). How would preferences depart non-trivially from the average person. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions .lH(x) + rH2(x). research has 1 acts as if she is maximizing prefer. and the level of r. there does not ested assessments. Even where simple altruism may adequately describe behavior (e.r)Il(x) actions they take will lower their experienced + rH2(x)..

Min[rli. less to Jones.No trades can be made after the di- ple often seem to maximize preferences vision takes place. often sumed. and Smith to get all the and Menahem Bar-Hillel (1984.Both persons. two people. resources less. Because it takes a tween Jones and Smith. The fruits and all the avocados to Smith. goods more. taste." located to the person who values those metabolism-maximizing allocation. how- Q1:A shipment containing 12 grape- ever.) The maximin allocation. . 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . But research shows that . Consider the following therefore. Grapefruits are worth more to Jones the maximnin criterion typically implies than to Smith. where Ill and 112 are the gains in utility from di. Doctors have determined that tween the two?11 The simple-altruism Jones's metabolism is such that his perspective would suggest solutions body derives 100 milligrammes of vita- such as giving the surplus to the person min F from each grapefruit con- who is poorer-or for non-money sumed." Yaari and Bar-Hillel (1984. following information is given. etc. calorie content. (Such an allocation would posed to 163 subjects: seem to accord somewhat to 50-50 norms.) are of no izes welfare improvements between the consequence to them. XXXVI (March 1998) party. The "socially efficient. and give the remaining grape- uted between Jones and Smith.18 Journal of Economic Literature. grapefruit or avocados only insofar as But the maximal-benefits criterion such consumption provides vitamin fares even worse than this. sider the thought experiment that neither party 10) report the percentage of respon- deserves the money more than the other. "just.Doctors have also determined that many people in many contexts do not Smith's metabolism is such that his find the "maximal-benefits" criterion at. Jones and Smith. while it derives no vitamin F goods-the person who values the whatsoever from avocado. would be to give eight grapefruits fruits and 12 avocados is to be distrib- to Jones. How should the fruits be divided be- viding resources. Except in extreme cases. One simple alternative norm is min F from each grapefruit consumed prevalent: Resources should be split and also from each avocado con- 50-50. and avocados are worth- that more than half the resources are al. p. Vol. Desert will obviously be relevant in many situations-and dents who chose each of the five alloca- the massive psychological literature on "equity tions. body derives 50 milligrammes of vita- tractive. and is Subjects were given a menu of five known also to the two recipients: different allocations. Smith (denoted by their initials): This content downloaded on Sun. disinterested peo- . and Elaine Walster 1968).n2]. That is. we ignore issues of relative usefulness . Many people F-and the more the better. David dos to be distributed to Jones and Boye. The five allocations are denoted theory" shows that people feel that those who have by the number of grapefruits and avoca- put more effort into creating resources have more claim on those resources (Ellen Berscheid. other traits of the two fruits (such as ing to a "maximin" criterion which equal. p. is for Jones to get all the hypothetical situation that Maya Yaari grapefruits. All the feel goods should be allocated accord. 8) avocados. of the form Wo. decide to split the surplus be. if the division is greater allocation to increase the utility to be just? of a person who values a resource less. and asked to state which allocation they found the most III assume the surplus is found so as to con. are and feel that goods should be divided interested in the consumption of equally.

30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . . dreoni and Miller (1996) and bargaining experi- sults reported below suggest that the problem. S:0-12) 2 percent thought that Jones should get more than half the grapefruits while 38 percent thought Smith should get more The vast majority of respondents than half. some subjects were told that for ing that. Informal surveys by Yaari and Bar-Hillel choose to allocate between these two parties?" An- in very different contexts. Andreoni and John rather than 50 milligrams. Subjects sup. S:A-12) 82 (J:9-0. for in- to Smith than they are to Jones. the maximin allocation rule. stance. jects were given various "exchange fruits. This content downloaded on Sun. rather than as opinions they should preted the question as meaning "How would you express. S:0-12). Smith is and an anonymous second party. Among those min criterion by telling subjects that whose behavior was least self-inter- Smith derives only 9. what disinterested people consider a fare gains (J:12-0. Indeed. a proper allocation rule. points to a concern with these data that cerns one might have regarding the Yaari and Bar- Yaari and Bar-Hillel themselves draw attention to: Hillel survey. which may have considered "justice" to be only one component of induced subjects to treat the questions as prob. her min criterion by posing a variant of the choice will depend both on what she original question. Because the proper allocation rule.13 They asked each subject to uni- strongly-now imposed at a greater cost laterally allocate money between herself to total social benefits. Posit. Sub- now given more than half the grape. Over half the subjects be- coming morally unsound. they may not have inter- lems to solve. Moreover. to make a choice. and experimental re. the other party maximin criterion] runs the risk of be. stakes experiments are also useful for allaying con- however. chose to equalize welfare gains (J:8-0." Yaari and haved in a way significantly inconsistent Bar-Hillel push the limits of the maxi. ments typically do not prompt subjects to evaluate solving context does not fully explain the patterns allocations according to any criterion-but rnerely they found in this study. S:6-12) 0 dents felt that all 12 grapefruits should (J:8-0. "Sooner or later . [the every $1 they sacrificed. two thirds chose approximately tamin F from both fruits. with pure self-interest. between herself and a second party. we need a situ- the problem. only 18 (J:12-0. for instance.12 ested. still only 12 percent of respon- (J:6-0. to her self-interest. p. These results number of respondents now seemed 13 Andreoni and Miller's and other monetary- 12 The very subtlety of the maximin solution. though they are far less valuable rates" for allocating money. While Yaari and Bar-Hillel study S:4-12). S:6-6) 8 gains. . If subjects end of a college entrance exam. Rabin: Psychology and Economics 19 Distribution % of respondents willing to tolerate unequal welfare (J:6-6. the results question of how people trade off self- strongly suggest subjects thought about interest against justice. to address the maximin solution is subtle. much she values a just outcome relative grams of Vitamin F from both fruits. Miller (1996) consider just such a situ- ported the maximin criterion just as ation. S:3-12) 8 be given to Jones. While a far greater maximizing allocation. rather than maximize total wel. 11) unilaterally choose how to divide money then tested the robustness of the maxi. so that grape. ested.1 milligrams of Vi. and did not merely choose ation where the allocator is not disinter- some simple focal point. where subjects were feels is a just allocation and on how told that Smith derives only 20 milli. If. would get $3. which asked subjects to say what The questions here were posed in writing at the they considered the just allocation. an allocator must Yaari and Bar-Hillel (1984. and one fruits are 11 times more valuable to third chose approximately the dollar- Jones than Smith.

in attempting to capture First. and evi- entangling self-interested bargaining dence that market outcomes are likely strategies from preferences for just allo. suggesting models of social preference must con- that in competitive spot markets front the "piecemeal" nature of these people may eventually come to believe norms. XXXVI (March 1998) suggest that the maximin rule resonates that the prevailing market price is fair. Keith Murnighan 1982. See. social preferences. With plausible assump- ceptions of fair behavior may adjust tions about initial endowments entering over time. Knetsch. come significantly more complicated. Chung Kim. situation. people's general per. Kahneman. Erich Kirchler. with many people even when allocating Other experiments find virtually no money. This is not an insurmountable place tends to be rather small. 1986b) note that people seem to implicitly demonstrate that loss aversion plays a (but pervasively) consider equitable very strong role in people's notion of sharing over changes in total endow- fairness. but results petitive spot markets. Apparently. they choices. they will likely attend to the reactions to unfair price increases in a overall implications of their several laboratory posted-offers market.tributional justice with formal minishes with repetition. Allowing proportions of a "pie" to tions of fairness over time (Fehr and have different monetary values to dif. context-free study of labor markets where behavior allocation problems to everyday eco. Armin Falk 1996). and even when self-interest is at change in either behavior or percep- stake. and Donald medium-run wage and price stickiness Moser 1996). lems. tions may help explain the sort of and Kagel. (1995) experimentally with several allocation problems to- support this hypothesis by testing gether. and Andreas Miller's. to be self-interested exists only for com- cations is quite difficult. and dis. Vol. Nevertheless. never converges to the self-interested nomic fairness judgments. and Thaler (1986a. p. In any event. Weichbold (1994) for an experimental In moving from abstract. be- ferent parties has also been a theme in cause adjustments of fairness judgments the experimental bargaining research are not immediate. studied by macroeconomists. and any moderate size division-of-the-pie Thaler (1986a. any social welfare function "Terms of exchange that are initially defined with respect to overall con- seen as unfair may in time acquire sumption levels will almost always yield the status of a reference transaction." Robert tendency: If people are presented Franciosi et al. Relatedly. dis. firms have more of an obliga. capture behavioral norms of fairness siderations in price-determination di. In these settings. the gap between the behavior people generally have a one-pie-at-a- that people consider fair and the behav. as elsewhere. outcome. all-or-nothing allocations. time conception of fair-division prob- ior that they expect in the market. fairness considera- (Roth and J. Thus. min criterion. 730) argue that. it is important to Knetsch. reference levels are behavioral findings with models of crucial. not total endowments them- tion not to hurt workers or customers selves. seem comparable to Andreoni and Fehr. Finally. any attempt to show that the role of fairness con. Preferences defined over final relative to reference transactions than wealth states cannot plausibly explain they have to improve the terms of rules such as 50/50 sharing or the maxi- trade. things be. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions .20 Journal of Economic Literature. Thaler (1985) and Kahneman. This content downloaded on Sun. ments. for example.

at more inclined to conserve water if they least half the contributions to public goods are in- think other people are conserving. goods. If other people conserve. it is more urgent for you to do so. As in general coordination ginal social value of water is greater games. Dawes and Thaler (1988) con- that social preferences are not merely a clude that. cation can help players coordinate on ishing social benefits of conservation: the efficient equilibria. which contributions are efficient equilibria. if somebody is being mean to you tween subjects' contribution levels to a or others. First note that. why communication enhances contribu- Consider the question of why people tions may be that reciprocal altruism es- conserve water during a drought. Further This "reciprocal" nature of prefer. and intentions of those cent and 60 percent of the socially opti- other people. Andreoni (1995) and empirical evidence: People are shows that. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions ." See also Claudia Keser (1996) for evidence that generous contribu- if they think others are splurging. communication greatly enhances coop- tion between simple altruism. Reciprocity and Attribution edness in others-they don't counteract it. all de- prediction is inconsistent with intuition partures from full rationality are necessarily in the direction of "generous" behavior. therefore. and reciprocal altruism. as out. pre-game communi- the less water there is. indirect evidence is that pre-decision ences manifests itself in the distinc. Therefore.14 Many of these experiments altruistic toward deserving people are hint that contributions toward public often indifferent to the plight of unde. not conserving would cause you to in. where zero contributions is also the most extreme tensify your conservation efforts. haved. 14 Many of these experiments are problematic in therefore. If you were a simple altruist. The previous subsection considered Evidence in support of reciprocal al- evidence about social preferences de. you are inclined to be nice to finds a strong positive correlation be- him. Rabin: Psychology and Economics 21 C. One reason lined earlier. This behavior subjects could exhibit. at a small cost is something they eagerly and low contributions are inefficient do. eration (David Sally 1995). sentially turns public-goods situations Clearly they perceive that conservation into "coordination games. The same people who are mal level. you are inclined to be mean public good and their beliefs about how to him. because the mar. altruism is varied. there are dimin. the common emphasis when gent for you to do so. however. if other people describing the prisoner's dilemma on don't conserve. If somebody is being nice to you For instance. it is less ur. by a very conservative estimate." where high contributes to the general good. not tentional rather than "errors. design. learning that others were that their null hypothesis of completely self-inter- ested behavior corresponds to zero contributions. goods are not the result of simple altru- serving people. individually optimal self-interested con- social preferences over other people's tribution is close to zero percent. Peo. of the voluntary provision of public chological evidence indicates. Rachel Croson (1995) or others. Rather. the consumption depend on the behavior. Psy. contribution rate varies between 40 per- motivations. equilibria. truism comes from experimental studies fined over the allocations of goods. though the evidence for reciprocal those whom they believe to have misbe. for most experiments of one- function of consumption levels. or even shot public-good decisions in which the changes in consumption levels. tions are not merely an artifact of experimental ple reciprocate the lack of public spirit. and often indirect. much others were contributing. and motivated to hurt ism. Indeed. This content downloaded on Sun.

it-or-leave-it offers made by anonymous ness to sacrifice to hurt others who are other parties on how to split $10. was to determine the offer made. untarily offered to help. told that the experimenter had in- pre-game communication would not structed the confederate to help. More direct evidence of recip. one third were told that the confederate rocal altruism. Guth and Reinhard Tietz ducted an experiment in which confed. tion to help real subjects fill out some dicates that we implicitly believe that worksheets. minimal acceptable offers for those truism.08. ish a firm for being unfair. In one study. only 3 percent cooper. randomly by a computer-simulated rou- ers. people did reject very low of- action by choice and those who are forced to do so. In ers. $2. offer did not participate in the offer. perhaps to the point of third party (also an anonymous student) violently retaliating against his employ. This content downloaded on Sun. Volition is also central to the propen- Reciprocity motives manifest them. for instance. When motivated by reciprocal al. and matter. ate between those who take a generous That is. p. Richard Goranson and Schmittberger. help. Roif role of volition. and that their responses self by foregoing the product. people differenti. and the third party who made the offers A crucial feature of the psychology of would not be affected by the subject's reciprocity is that people determine decision. When subjects help. when sub. one third were fecting were truly a dominant strategy. If de. but did sa significantly more when jects were told that their partner did it was voluntary than when it was invol- not cooperate. even if she hurts her. ated. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . untary. the average taken. Vol. see Thaler (1988). and Bernd Schwarze (1982). An em. in the context of the m-ight be willing to help.15 One being unfair. Members of a striking labor union this variant. told that the offer would be generated ing to motives attributed to these oth. A final group of subjects were their dispositions toward others accord. them and these anonymous other stu- treated by a firm may engage in costly dents. sity to retaliate against negative actions. hurt by a subject's decision to reject an rial interests because they want to pun.22 Journal of Economic Literature. the person who would be may strike longer than is in their mate. One third of the subjects the prisoner's dilemma also really were told that the confederate had vol- amounts to a coordination game. but also in their willing. For reviews of the (massive) literature developed Leonard Berkowitz (1966. XXXVI (March 1998) the inability of the two captured prison. (1990). since. When the subjects were later were told that their anonymous partner given an opportunity to assist the con- in a prisoners' dilemma had cooperated. not solely according to actions lette wheel. and Camerer and Thaler (1995). and $1. selves not only in people's refusal to Sally Blount (1995) asked subjects cooperate with others who are being about their willingness to accept take- uncooperative. A consumer may refuse to group of subjects was told that the "ulti- buy a product sold by a monopolist at matum" was coming from anonymous an "unfair" price. Demonstrating both the 15 The "ultimatum game" of the sort studied b basic principle of reciprocity and the Blount was first developed by Werner Gtith. groups were $2. comes from Shafir federate was instructed to refuse to and Tversky (1992).20. Another group was told that a acts of sabotage. federates.91. erates posing as subjects were in a posi- ers to communicate with each other in. but the con- prisoner's dilemma. would determine the division between ployee who feels he has been mis. they reciprocated earlier 16 percent also cooperated. other students. 229) con.

that voluntary." a view of The importance of intentions goes social exchange emphasized in sociology even further." above the market- child. Moreover. Fehr. beliefs is. Rabin (1993) adopts found two ripe apples as he was walking home the framework developed by John Geanakoplos. Georg Kirchsteiger. or "workers. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . ventional game theory by allowing payoffs to depend "It wasn't fair to keep the larger one for yourself'. For example. child when all of a sudden your hands firms may give higher wages hoping flail across the table and knock a workers will reciprocate with higher ef- pitcher of water all over the child. we can model my beliefs about your one and kept the smaller one or myself. statements knew that their intentions we each got what you wanted. but were less keen to reject appears in some important economic offers which were not the result of voli. if you think somebody has The results were that most workers been generous to you solely to get a chose effort levels higher than their bigger favor from you in the future. however. If a firm tion of whether a person's actions are pays a higher wage to an employee. "Well. He kept the larger one Pearce. "What would you have done?" that my beliefs about your beliefs are arguments in my the first boy asked. where this Another example of the importance of effort was monetarily costly to workers. Akerlof (1982) posits that tion by the person who would be hurt firms and workers can be thought of as by the rejections. Suppose. so what are you complaining about?" would be made known to the subjects. Akerlof (1982. p. Consequently. defined solely over outcomes. by choosing an "effort" level. and that your flailing arms were Riedl (1993) tested this hypothesis in an uncoordinated attempt to prevent a laboratory models of labor markets. will be paid to workers thought you were worried that pitcher to induce higher effort by those work- was precariously perched next to the ers. and Arno child. What is the source of high effort lev- ments of intentions depended on whether they thought those making friend. and gave the smaller one to his friend. 21) tells the following story tempts by economists to model "social preferences" that colorfully summarizes the importance of in. 1984) and do the parents react? If they thought Akerlof and Yellen (1990) propose that your goal was to spill water on the "efficiency wages. than considera. that subjects' reactions to others' state. for instance. they are probably less angry. "I'd have given you the larger utility function. Similarly. fort by workers. and Ennio Stacchetti (1989). This content downloaded on Sun. To which the first boy responded. engaging in "gift exchange. spill. Arnold for setting high wages by providing high Kahn and Thomas Tice (1973) found effort.16 Subjects were assigned roles as "firms" Such examples indicate that inter. contexts. David from school with a friend. Rabin: Psychology and Economics 23 fers even if computer or third-party The role of reciprocity and volition generated. on players' beliefs as well as their actions. How fort." Firms offered a wage-in- preting other peoples' motives depend volving a real monetary transfer from on what we believe their beliefs about firm to worker-and workers responded the consequences of their actions are. then you do not view his generosity to while low wages induced little or no ef- be as pure as if he had expected no reci. By positing the friend replied. you employee is likely to reciprocate with are eating lunch with parents and a higher quality work. who modify con- for himself.'17 The punch line of this story plays off the obvious silliness of presuming that the second boy's satisfaction 16 I have confirmed this hypothesis in a field with events only depends on the resulting allocation. money-maximizing levels. and especially anthropology. Yet this comica presumption is the basis of most at- 17 Frank (1994. If they clearing wages. they are probably angry. study conducted in North London." said the motives as directly influencing my fairness judgments. workers rewarded firms procity from you. To formalize the role of tentions: There is an often told story of a boy who intentions in fairness judgments.

24 Journal of Econonic Literature. or by a "third party" (the experi. Yet people under-use base-rate infor- and Kahneman (1974. people will simpler judgmental operations. In these conditions.18 We expect even small high effort and punish low wages with classes of students to contain very close low effort when the wages reflected the to the typical distribution of smart ones volition of the firm. Rather the re- of firms. for when people do and don't learn to menter). As the quote clearly wages by firms? While workers may suggests. it is clear to the that judgment departs from perfect ra- worker-subjects that the firms choose tionality. Likewise. these heuristics are quite useful. conclude by discussing some evidence domly. if a certain medical test always comes out positive among peo- duce the complex tasks of assessing ple with a rare disease. Vol. people who are criminals. This content downloaded on Sun. Given the rarity of the eral. Biases in Judgment analyst will be wrong a few times in a row. The Law of Small Numbers both are beyond a firm's control. According to a bias called "the law of sults indicated that the high-wages. but also presenting two biases at length and conducts variants of the experiment more quickly outlining several others. Bayes's researchers have documented many sys. Ra- sumed that. 1124) help mation in forming their judgments. when faced with uncer- 18 Kahneman and Tversky relate the law of small tainty. and a low wage is not act of meanness. wage is not an act of kindness by a firm. For the remainder of this sec- wages of their own volition. p. positing biases that these hypotheses. tend to exaggerate the likelihood of having the dis- ease given a positive result. I describe some of this research. a high correct biases. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . Tversky and Kahneman (1974) provide evi- cording to the laws of probability. our assess- conceptualize observed departures from ment of the probability that he is a criminal tends perfect rationality by noting that people to under-use knowledge about the percentage of rely on "heuristic principles which re. will he ricTI X fewj tim9. Re. A. Similarly. small numbers" (Tversky and Kahne- yields-high-effort reaction has both a man 1971). they may also be people are intelligent and purposive in reciprocating the volitional generosity their decision making. search explores how people depart from periments that helps us differentiate perfect rationality. the research described here simply be choosing to share some of does not at all suggest economists their additional wealth from higher should abandon the assumption that wages with the firm. I where wages are either chosen ran. Tversky ous groups). the total number of false positives may be but sometimes they lead to severe and far greater than the number of true positives." In gen. we un- derestimate how often a good financial 3. rates. If we see somebody who looks like a criminal. Charness tion. Charness (1996) conducts ex. people exaggerate how "share-the-wealth" and an attribution closely a small sample will resemble the element: Workers were substantially parent population from which the sam- more likely to reward high wages with ple is drawn. (1996) replicates this condition. disease. represent specific and systematic ways and Weichbold (1994). Law tells us that our assessment of likelihoods should combine representativeness with base rates tematic departures from rationality in (the percentage of the population falling into vari- judgment under uncertainty. and how often a clueless analyst Economists traditionally have as. But dence for the representativeness heuristic. people correctly form their numbers to people's tendency to under-use base subjective probabilistic assessments ac. XXXVI (March 1998) els by workers in response to high systematic errors. Kirchler. and only occasionally probabilities and predicting values to among people without the disease. In Fehr. and personable ones. in X row.

Rabin: Psychology and Economics 25 cause we expect close to the same prob. Only 22 per. if the stu- bers. 44) asked undergraduates the follow. the gambler's fal- each day. However. performance usually is insensitive to the sample size. the student has slacked off. that people exaggerate the likelihood ability distribution of types in small that a short sequence of flips of a fair groups as in large groups. Apparently. in fact. quences. and 56 percent said servations will look more normal. because a sequence of flips of a tively. As you know. Flight-training instructors observed The actual likelihood is way less than 1 percent. ing question: When the underlying probability dis- tribution generating observed se- A certain town is served by two hospitals. When a student The law of small numbers implies performs poorly on the midterm but well on the final. tails as heads. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . Mis- subjects simply did not see the rele. Kahneman and Tversky (1982a. Because we underestimate the the exact percentage varies from day to day. they apparently don't believe in the law of large numbers: We underestimate the resemblance dent performs well on a midterm but that large samples will have to the overall popula. the smaller hospital would report more so we don't expect exceptional perfor- such days. which one good or bad performance on cent of subjects correctly answered that a test is a sign of good or bad aptitude. As that they thought the number of days teachers. about probability distribution from short se- 50 percent of all babies are boys. In the larger hospital about 45 babies are born quences is uncertain. teachers infer that tion. each hospital re. we exaggerate the extent to would be about the same. Kahneman and Tversky (1982a). ple. lyst making lucky guesses three times in For a period of 1 year. a row. days? leads to misperception of regression to Twenty-two percent of the subjects the mean. we don't expect that further ob- more such days. understanding regression to the mean vance of the number of child births per gives rise to spurious explanations for day. teachers infer that the 19While people believe in the law of small num- student has worked harder. Tversky and found that subjects on average thought that there was a more than 1/10 chance that more than 750 Kahneman (1974) give another exam- of 1000 babies born on a given day would be male. but This content downloaded on Sun. respec. for instance. an analyst is good if she is right three cent of the babies born were boys. deteriorated on the next landing. and in the smaller hospital about 15 lacy leads people to over-infer the babies are born each day. the probabilities are then on the next flip it is "due" for a about 1 percent and 19 percent. that when they praised pilots for To overstate it a bit. What is commonly that at least 80 percent of 20 coin flips known as "the gambler's fallacy" is a will come up heads than that at least 80 manifestation of this bias: If a fair coin percent of 5 coin flips will come up has not (say) come up tails for a while. Which times in a row. for example.'9 observed regression. poorly on the final. frequency of a mediocre financial ana- Sometimes it may be higher than 50 percent. This is the same fraction as mances to be followed by unexceptional guessed exactly wrong. we exaggerate the likelihood that corded the days on which more than 60 per. in turn. coin will yield roughly the same number we tend to view it as comparably likely of heads as tails. This tendency to over- hospital do you think recorded more such infer from short sequences. fair coin ought to include about as many p. people seem to have a univer- sal probability distribution over sample means that smooth landings. tails. Because we read too much said that they thought that it was more into patterns that depart from the likely that the larger hospital recorded norm. the performances as often as they are. sometimes lower. heads.

conclude that "Interference may be ac- dom events.26 lournal of Economic Literature. formation to people who differ in their ter (1964). 424) few lengthy streaks in sequences of ran. whereas over half of those ing. be- cepted phenomenon of the hot hand is cause the fresh thinkers are not over- non-existent in basketball. These flight instructors at a severe-blur stage. people port for initial hypotheses. rejecting incorrect hypotheses based on ate spurious explanations for long substandard cues.Vol. less than a quar- developed a wrong theory of incentives ter eventually identified the pictures based on erroneous statistical reason. About 90 subjects were shown blurred pictures that were gradu. 20 For a formal model of confirmatory bias. XXXVI (March 1998) when they criticized pilots for poor ent subjects began viewing the pictures landings. A particularly elegant is a series of experiments demonstrating demonstration of such "anchoring" is how providing the same ambiguous in- found in Jerome Bruner and Mary Pot.20 If a are often too inattentive to new infor. dent is smarter than another. and Tversky (1985) and Tver. David Perkins (1981) argues that nights which cannot be explained by such experiments provide support for randomness. use weak evidence to form initial hy- For instance. attend to evidence suggesting the strat. who began viewing at a light-blur stage Another implication of the law of were able to correctly identify the pic- small numbers is that people expect too tures. people who streaks that are determined by chance. The exagger. plained by the misperception that This form of anchoring does not nec- purely random streaks are too long to essarily imply that people misinterpret be purely random. Belief Perseverance and evidence reveals a stronger and more Confirmatory Bias provocative phenomenon: People tend A range of research suggests that to misread evidence as additional sup- once forming strong hypotheses. Thomas Gilovich. Of landing and "improvement" following a those subjects who began their viewing poor landing. only that they ig- nore additional evidence. correctly. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . But random performance will cess. but the pace and final degree of lead to "deterioration" following a good focus were identical for all subjects. This content downloaded on Sun. hypotheses. 1989b) have problems than people who have medi- argued that the almost universally ac. may be better at seeing solutions to sky and Gilovich (1989a. therefore. she has Once you become convinced that one the propensity to confirm that hypothe- investment strategy is more lucrative sis when interpreting later perfor- than another. Some evidence for confirmatory bias egy is flawed. Differ. Rabin and Schrag (1997). see ally brought into sharper focus. additional evidence. Bruner and Potter (1964. Robert the perspective that "fresh" thinkers Vallone. you may not sufficiently mance. better information particular basketball players are streak that contradicts those initial hypothe- shooters who have "on" nights and "off' ses. tated at length on the problems. Psychological B. whelmed by the "interference" of old ated belief in hot hands seems partly ex. there is widespread belief potheses have difficulty correctly inter- in the "hot hand" in basketball-that preting subsequent. p. performance improved the at different points in the focusing pro- next time. teacher initially believes that one stu- mation contradicting their hypotheses. As with regression to the counted for partly by the difficulty of mean. people tend to gener." That is.

many economists tive views. ents as high school graduates who held vant research supported their views. and to state whether a plied any more information. and the girl's skill level at an average of 3.. Seventy Ross. Lee striking form of polarization.e. Charles Lord. doubted its deter.T." blue-collar jobs. At confi. ceived information about the girl and cruited to participate in another experi. her family and viewed a video tape of ment. One lected because their answers to the group of subjects was given a fact sheet earlier questionnaire indicated that they that described the girl's parents as col- were "'proponents' who favored capital lege graduates who held white-collar punishment. on 16 There was a small difference in the two point scales ranging from -8 to +8. (i. "Look at how large n has clear technology. video rated the girl's skill level at an av- Lord. meas- against the deterrence hypothesis. undergraduates were asked to assess a 2102) asked 151 undergraduates to nine-year-old girl's academic skills in complete a questionnaire that included several different academic areas.90 how they had changed their beliefs re. believed it to have a deter. same formula and said. jobs. Scott Plous (1991) replicates the the formula and said. A Chicago economist derived cacy." An M. To illustrate demonstrate a related and similarly such polarization. and Lepper posit that even pro. Before three questions on capital punishment. pp. and Lepper found that pro- ponents of the death penalty became on average more in favor of the death pen. "Look how few firms you Lord. 48 of these students were re.I. while opponents became even brating the elasticity of demand facing a Cournot less in favor of the death penalty and oligopolist as a function of the number of firms in an industry-described at the University of Chi- believed even less in its deterrent effi. and thought most of the the girl playing in what appeared to be relevant research supported their own a well-to-do suburban neighborhood. the students re- Later. Lepper results in the con. beliefs. jects were then asked to rate. economist derived the text of judgment about the safety of nu. Twenty-four were opponents of The other group of subjects was given a capital punishment.21 to be before you get anywhere close to an infinite elasticity and perfect competition.I. 9/10 through 3rd grade) while garding its deterrent efficacy. Twenty-four of them were se. completing this task. those who had viewed the "suburban" dence levels of p < . and Mark Lepper (1979. Ross. ent schools each interpreted the same mathemati- fessional scientists are susceptible to such "same. the girl playing in a playground." These differ- 21 Lord. and other academics have probably observed how differing schools of thought interpret ambiguous alty and believed more in its deterrent evidence. Ross. cago and at M. Sub. Rabin: Psychology and Economics 27 initial beliefs on some topic can move John Darley and Paget Gross (1983) their beliefs further apart. This content downloaded on Sun. cal formula as evidence reinforcing their respec- evidence polarization. A colleague saw the same model-cali- efficacy. ured in terms of equivalent grade level. fact sheet that described the girl's par- rent effect and thought that the rele. half of each given study (along with criticisms of group of subjects was then asked to that study) provided evidence for or evaluate the girl's reading level. these students viewed These subjects were then asked to a video of the same girl playing in what judge the merits of randomly selected appeared to be an impoverished inner studies on the deterrent efficacy of the city neighborhood.01 or stronger. these students viewed a video of rent effect. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . Without being sup- death penalty.T. need to get close to infinite elasticities and perfect competition. how groups' estimates-those subjects who the studies they had read moved their had viewed the "inner-city" video rated attitudes toward the death penalty. Ross." Indeed.

people to differentially assess proba- Lord. also report an impression that may re. it is a Keren 1987. significantly below the remember only a few well-chosen supportive impressions. clear answer to an exam question. significantly above the in the data opposing their hypotheses as somehow suggestive of the fundamental cor- 4. tions. Another form of larized their assessments of the girl's "scrutiny-based" confirmatory bias is skill level. ics assumptions: they were asked to evaluate the girl's With confirming evidence. e.71. If a student gives an un- on their interpretation of further evi. and Lepper (1979. their experiment: It is legitimate for tion not present in simple visual tasks. The "sin" is in us- strength and reliability of confirming ing their hypothesis-based interpreta- evidence but the weaknesses and unreli. Ambiguity of evidence is widely student's mastery of the material.67. tions of the strength of different studies ability of disconfirming evidence. who did not view the second video.90 estimate of the inner-city subjects they continue to reflect upon any information who did not view the question-answer that suggests less damaging "alternative inter- video. mistake to then use differential grades sky 1992). that selective scrutiny of evidence plays the additional information further po. The remaining subjects in sound with those observing economists' each group were shown a second video reactions to behavioral evidence that of the girl answering (with mixed suc.29. perfectly reasonable for a teacher to be Certain types of evidence flows seem influenced in his evaluation of the an- to be most conducive to confirmatory swer by his prior perceptions of that bias.. we suspect that reading level. differences in the students' abilities." Indeed.29 estimate of the suburban subjects rectness of those hypotheses. consequent "filtered" evidence inappro- dently influenced even more strongly by priately as further evidence for these the effect their initial hypotheses had hypotheses. 3. Darley and Gross (1983) in. they may even come to group rated the girl's skill level at an regard the ambiguities and conceptual flaws average of 4. Ross. While it is sensible to interpret am- matory bias-subjects were influenced biguous data according to current hy- by the girl's background in their initial potheses. and concludes that confirmatory Lord. XXXVI (March 1998) erage of 4. How- recognized to be an important mediat. ing. Afterwards. but their beliefs were evi. Keren (1988) notes the lack on the exam as further evidence of the of confirmatory bias in visual percep. and Lepper note a similar tendency depends on some degree of distinction in reflecting on the bias in abstraction and the need for interpreta. it is dence. Vol. ever. people tend to use the judgments. The inner-city video both lay and professional scientists rapidly re- group rated the girl's skill level at an duce the complexity of the information and average of 3. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions .28 Journal of Economic Literature. and Dale Griffin and Tver. 2099) tiveness of different studies according posit that when faced with complex and to their current beliefs about the merits ambiguous evidence. Meanwhile. the suburban video pretations. Ross. in confirmatory bias. They as further support for their beliefs. we emphasize the of the death penalty. might be damaging to habitual econom- cess) a series of questions.g. Even when each individual datum is This content downloaded on Sun. With disconfirming evidence. after assigning differential grades ing factor in both confirmatory bias to students according differential inter- and overconfidence (see. p. Even though the two groups viewed the The above passages hint at the role identical question-and-answer video. Gideon pretation of comparable answers. what I shall call hypothesis-based filter- terpret this result as evidence of confir.

with the first procedure tion among (for instance) pictures and the person. and these arbitrary numbers had a marked effect on estimates. Richard Nisbett and Ross (1980) number between 0 and 100 was determined argue that the inability to accurately by spinning a wheel of fortune in the sub- perceive correlation is one of the most jects' presence. 24 For two excellent recent reviews of the hind- dling of bivariate observation. to indicate first whether that number was higher or lower than the value of the quan- ing. p. level.23 The we ask an individual to construct a first is anchoring and adjustment. her likely beginning strate that. see Kahneman. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . pp. (1990) and Jay Christensen-Szalanski and Cynthia erature. Amabile. and Ross (1982) argue were given different numbers for each quan- that illusory correlation can play an im. "even the in the judgment literature is the hind- staunchest defenders of the layp erson's capacities sight bias. adjust. erally. see Camerer (1995). and people often imagine correla. and then to estimate the value of the tions between events when no such quantity by moving upward or downward correlation exists. for an outstanding review of this mate. 1969. Paul Slovic. confirmatory bias can be [S]ubjects were asked to estimate various generated when people must statisti. finding that people under. stated in percentages (for exam- ple. Christensen-Szalanski and Will- (1982). tity. or. quantities. By contrast. If that might interest economists. Payoffs ate correlation and see it where it is not for accuracy did not reduce the anchoring ef- fect. the portant role in the confirmation of false median estimates of the percentage of Afri- hypotheses. see Scott Hawkins and Reid Hastie 23 For a more thorough introduction to this lit.24 Baruch Fischhoff (1975. as an intuitive scientist . . the percentage of African countries in cally assess correlations extended over the United Nations). and of individual decision making more gen. the Dow Jones. but exagger. she would likely an- 22 Loren Chapman and Jean Chapman (1967. While this example is somewhat arti- C. Different groups Teresa Amabile. as Jennings. the second. yielding a probability distribution more ality traits of the people who drew the pictures. ham conduct a meta-analysis of the literature-ag- rial. For each quantity. respectively. One of the most widely studied biases like phenomena. More generally. and Ross (1982. as starting points. The subjects were instructed robust shortcomings in human reason. Rabin: Psychology and Economnics 29 unambiguous. 212) put it. when they have a preconceived theory of it. from the given number. 1971) demonstrate that clinicians and therefore. gathered through an unbiased procedure. tity. 65. 1128) provide the probability assessments by stating the following example: likelihood of the Dow Jones exceeding a pre-specified value. point would be to estimate a median mates of uncertain quantities. predictions. can countries in the United Nations were estimate correlation when they have no 25 and 45 for groups that received 10 and theory of the correlation.22 Dennis Jennings. For example. Other Biases ficial. This value would likely then serve ments in assessments away from as an anchor for her further probability (possibly arbitrary) initial values are assessments. are likely to lead to different laypeople often perceive entirely illusory correla. if she were typically insufficient. chor on this value. a time." sight bias. Tversky and asked by somebody to construct the Kahneman (1974. The two procedures. Slovic probability distribution for the level of and Sarah Lichtenstein (1971) demon. in forming numerical esti. have had little that was flattering to say about the layperson's han. Tversky and Kahnemnan point out that anchoring can occur as a natural I briefly outline a few more biases part of the assessment process itself. . sory correlation in the context of confirmatory. and Tversky Willham (1991). Charles Stangor (1988) and David Hamilton and concentrated around the median than Terrence Rose (1980) also discuss the role of illu. gregating the findings of 122 different studies. to test This content downloaded on Sun.

the literature on the hind. As economists. 288) first proposed this bias by they would have thought without that observing that "(a) Reporting an information.") chs. it is hard to control experimentally for the fact that fought to a stalemate without reaching a people have different information. wveight salient. when compared to a control others would have believed absent certain infor- mation. fects are "small. I feel. In general. ment is that people disproportionately and (b) people who have received out. 1990. ties with a brand of car are likely to be people label it as inevitable-and be. and hard to iso- peace settlement). ness. 26 In Tversky and Kahneman's (1973) formula- tract" information they currently have tion: "[A] person is said to employ the availability about an outcome in imagining what heuristic whenever he estimates frequency or probability by the ease with which instances or as- sociations could be brought to mind. overly influential even if we are famil- lieve that they always thought it was in. however.30 Journal of Economic Literature. 319). statistics of the reliability of different One example of Fischhoff s (1975) brands. tions [along the lines of (a)]. tion should have virtually no influence garding British intrusion into India and on our beliefs in the face of much more military interaction with the Gurkas of pertinent statistical information. (They also argue that the ef. We tend to eral statistics.g. you). People don't sufficiently "sub. our assessment of a given city's crime ing these. They conclude that general reviews of the ro1e of salience and vivid- the bias is very real. not about herself. This content downloaded on Sun. via Consumer Reports. Tver- Nepal. Four other sets of subjects ple's perceptions of how they themselves would have answered a particular question absent infor- were each told a different one of the mation they now have.25 outcome's occurrence increases its A pervasive fact about human judg- perceived probability of occurrence. how salience may distort clini- asked to predict the likelihood of each cians' assessments of the relationship of four possible outcomes: 1) British between severe depression and suicide. victory. or vivid evi- come knowledge are largely unaware dence even when they have better of its having changed their percep. we are four outcomes was the true one (the likely to care mostly about a person's beliefs about real true outcome is that the two sides other people. rate is likely to be too influenced by sight bias shows that people exaggerate whether we personally know somebody the degree to which their beliefs before who has been assaulted. 2) Gurka victory. for of this interaction. Likewise. could believe that other people are not as smart as thetical ex ante estimates were 15 per. Without being told the outcome sky and Kahneman (1973) discuss. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions .26 For instance." Combin. you average ex post guesses of their hypo. iar. 25 The definition of hindsight bias regards peo- tlement. even if we are an informative event would be similar familiar with much more relevant gen- to their current beliefs. with general evitable. that the evidence suggests that we have a tendency to think that other people cent higher than those of the control "should have known" as well (Hawkins and Hastie group. dramatic sto- think we "knew it would happen all ries by people we know about difficul- along. In both these cases.7)." For more for the existence of the bias. and in original demonstration of this effect was many others. the more salient informa- to give subjects a historical passage re. Subjects may believe that others have dif- group not told any outcome. For each reported late the hindsight bias when asking subjects what outcome. 3) military Incidents in which patients commit sui- stalemate with a peace settlement. 4) military stalemate without a peace set. some subjects were example. XXXVI (March 1998) p. p. memorable. subjects' ferent beliefs for a variety of reasons (e. 5. Vol. sources of information. see Susan Fiske and Shelley Taylor (1991." After a politician wins election..

claims: 'How could I have missed tors probably do on average moderate that?'" Even if people learn the rele- biases.g. Do Learning and Expertise ber. Rabin: Pst. economists may sloppily interpret such ments with subjects who vary in their head-clutching as evidence for the ra- level of statistical sophistication.choloLt and Economnics 31 cide are much more likely to be remem. This is likely to More generally. No decrease in overconfidence was found relative human potential. Griffin and Tversky (1992) and Andrea Baumann. p. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . or consists of tasks ate confidence in individual cases: done repeatedly by the same individu. and learn. It is abilities to predict events accurately. clutches his head and ex- reasonable conjectures. An early paper arguing this is economists use it. they tend not to apply this general nomic activity is performed by special. As was demonstrated in the context This content downloaded on Sun. Slovic. there is a mass of psychologi. Raisa De- D. expertise. bered than are instances where patients The results are surprisingly negative. but very much will commit suicide. for instance. they may continue to make errors imagine. knowledge in calibrating the appropri- ists and experts. fares much better than some of the psy. the assumption of full rationality call such errors errors of applications. person. Our models use the Fischhoff. most convincingly demonstrated when a Do experience. spontaneously or with minimal ing virtually eliminate biases? These are prompting. people understand the limits in their dence from inexperienced subjects. reduces or eliminates observed biases. for instance. 495) als. Stuart Oskamp (1965). Research also suggests we should use ments. to test tionality hypothesis. and Lichtenstein (1977). toward overconfidence in their judg. Kahneman and Tversky (1982b. and such fac. do not commit suicide. The vast majority of researchers extreme caution in defining the relevant argue that such overconfidence is per. Kahneman and Tversky in their judgnmentsand decision making (1982a) and Tversky and Kahneman in every single case. present experi. to the no-money-stakes condition. e. ple who do learn general principles do cerns possible explanations (of which not apply those principles in particular confirmatory bias discussed above is situations. and Gail Thompson (1991) con- Eliminate Biases? clude that people who are aware of The conjecture that experience helps their own accuracy overall are overcon- overcome biases often leads economists fident on a case-by-case basis. notion of learning. But the conjectures do not ap. who rationality assumption as a realized fea- also tested the robustness of overconfidence with ture of human behavior. commonly argued that if important eco. 27 dence. the experts-get-things-right and in-the- cal research that finds people are prone real-world-people-learn hypotheses.. jayashree not boost the rationality assumption as Mahajan (1992). rather than against whether general knowledge of statistics it. vant statistical truths of their environ- pear to be nearly as valid as economists ment. One fears that (1982). and Paul Paese and Maryellen Kinnaly (1993). and note that "An error of application is chological evidence indicates. When to doubt the relevance of laboratory evi. not merely a monetary stakes rather than reported judgments. because many peo- vasive. does not support the strong versions of Finally. the research leads to lead to an exaggerated assessment of mixed conclusions about when and how the probability that depressed patients learning takes place. But evidence that people see their errors when confronted with them does 27 See. and most of the research con. In the context of overconfi- one).

Wilson and Suzanne LaFleur (1995. curate than the control group in their matory bias discussed above. Yates 1990) are results from this experiment showed consistent with this hypothesis. Each subject was asked to pre- and Tversky (1992). Oskamp 1965) and stock market analysts (e. The varied material of this section sity of Virginia were asked at the begin. p.g. but are more real.. would be accurate 80 percent of the perts who have rich models of the system time. dict "yes" or "no" whether she would en- tionship between expertise and over. while the control group predicted in question. pared to 79 percent for the control Ross et al. experts page on which to list their reasons for not only know more. e. that the act of reasoning increased sub- jects' overconfidence regarding their While a reasonable conjecture is that predictions of their own behavior. and Ross 1980. In such cases. When certain forms of pre. but not Russian economy. greater thoughtfulness and intelligently While those who reasoned about their searching for patterns in the world would predictions were roughly as confident help douse biases.. ning of the semester to predict their own "learning" can even sometimes tend to future behaviors toward fellow sorority exacerbate errors.g. the quote specifically as those who did not reason (reasoners targets (economists take note . bers were asked to list "why they might cal evidence. which in predictions. be- pretty good sense of how accurate their haviors . Iyour reasons will be discarded. experts tend to have a or might not perform each of the . each behavior.32 Journal of Economic Literature." Other subjects were asked to If the future state of a mental patient. Relatedly. and to assess her confidence in her dictability are high and when feedback prediction. experts are often more susceptible read what you have written. then experts asked to think of reasons for their behav- who have rich models of the system in ques. were urged to 'list as many reasons as vide illustrations: you can think of.) as sus. com- Craig Anderson.g. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . Is "Maximnizing Utility" the Right duct an experiment on the role of "rea. . Griffin members. XXXVI (March 1998) of confirmation bias discussed above. They were told that the istic than laypersons about how much purpose of this task was to 'organize they know. and Timothy Wilson group. Studies of clini.. Lepper. the make the same six predictions. formed each of the six activities. 430) pro.' They Griffin and Tversky (1992. 4. or the stock market cannot be predicted from present data. The cal psychologists (e. People were given a separate predictions are. Vol. tion are more likely to exhibit overconfidence At the end of the semester. pp. filling up this page if you can'. predicted their own Yes/No predictions ceptible to overconfidence those "ex. accurate 71 percent of the time. Randomly. subjects than lay people who have a very limited un. suggests that it may be wrong to con- This content downloaded on Sun. many authors have their accuracy at 82 percent). were asked if they had actually per- derstanding of these systems..' that 'no one will actually low. But when predictability is their thoughts." Indeed. the rea- hypothesized the role of the reasoning soners were in fact significantly less ac- process itself in exacerbating the confir. some of the mem- takes the form of unambiguous statisti. reasoners' predictions were turn leads to overconfidence (see.. ior. Model? soning" in strengthening confidence: Members of six sororities at the Univer. gage in each of six different behaviors- confidence. and Jonathan Schooler 1991). address the rela. 23-24) con. .' and that to overconfidence than are laypersons. 1977. .

. some of the material here also signed to that outcome in a decision. through given in Section 2." calls into question some of the interpre. eventually the main carriers man 1994. . change. It also cuts to the core of our people misperceive their own long-run methods of research. While such interview evidence The research on biases reviewed in is inconclusive. man. but departures from man (1994. The decision util- mizes a stable. Dan Coates. preference" method to attempt to infer maximization interpretation of behavior people's hedonic experiences. p. even when they correctly seemed to explain why lottery winners perceive the physical consequences of would be less happy than the winners their decisions. preferences that go beyond a "revealed By calling into question the utility. people systematically had presumably anticipated. Coates. . is the weight as- Indeed. On the other hand. Rabin: Psychology and Economics 33 ceptualize some types of economic be. coherent utility function. they portant economic consequences. and janoff-Bulman (1978) tinction between two notions of utility. also found more equivocal evidence for these ef- The experienced utility of an outcome is fects by interviewing 29 paraplegics and quadri- This content downloaded on Sun. winning the lottery. For instance. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . rather than a modified util. fully we will adjust to changes. Do We Know What Makes Us Happy? winners. such methods as self reports of satisfac- gests greater difficulty in improving the tion and even psychological measure- behavioral realism of formal economics. As Kahne. ity of an outcome . the measure of the hedonic experience havior in terms of an agent who maxi. Peter Wak. of utility become not the absolute levels ker. The realization that decision and expe- tations presented earlier. of consumption. "These our (new) reference level. tation by interviewers). and Rakesh Sarin 1997). requiring us to well-being. such material sug. the material at the How do people misperceive their end of the section on self-control prob. But other research sug. underestimate how quickly and how prove the realism of economics: Re. by contrast to the "peak" experience of atically mispredict our future experi. even when those predic. In a classic study. habituated to our circumstances: Along tions rely only on accurate assessments the lines of the material presented in of our past experienced utility (Kahne. formulate ways of inferring and eliciting ity function as suggested in Section 2. trolled for alternative explanations judge the probabilistic consequences of (such as selection bias or biased presen- their decisions. and Kahneman. First. the researchers con- Section 3 indicates that people mis. . we become enced utility. rienced utility may be systematically loss-averse behavior may often reflect a different cuts to the core of our models flawed rule of thumb employed because of choice. Section 2. not fore- searchers have shown that a (relatively) seeing that our reference points will simple multiple-self model of time-in. $479. of that outcome. found virtually no difference in rated happiness of lottery non-winners and A. ments. Two effects gests that. mun- misperceive the well-being they derive dane experiences become less satisfying from such outcomes. Philip Brick- consistent discounting tractably modi.28 considerations suggest an explicit dis. We often system. .545) and a control group. Second. 21) puts it. 28 Brickman. and Ronnie Janoff- fies our familiar exponential model to Bulman (1978) interviewed both lottery yield a model that is manifestly more winners (with average winnings of about realistic behaviorally and surely has im. utilities? One pattern is that we tend to lems provides a great opportunity to im.

and took a more posi. Subjects often required an or- any event be substantial relative to the der of magnitude more money to expose long-termn utility consequences of own. they argue that people tend to make plegics about their happiness before their acci. current choices according to which dents. your utility each evening is as fol- timate the parameter cc. . (1997) argue that New by changes in their lives. In. be." This realiza. lows: This content downloaded on Sun. In tion. themselves to the disease than they ing the mug.29 This sug. jects' willingness to pay for a cure for a then loss-averse behavior is rational. they did not currently choices. and hence exagger. Thaler (1980) compared sub- tive to a status quo as quite unpleasant.001 versus and avoiding unpleasant sensations. thumb than as a rational utility func. in turn. the minimum price you would accept to And. would pay for a cure. either Blon- the lottery winners or the control group. York taxi drivers decide when to quit gests that the "decision-utility" aversion driving for the day by a rule of thumb people have to losses is not consonant that says they should make sure to with "experienced utility. XXXVI (March 1998) People do not anticipate the degree even though they will not be spending of such adaptation. to long-term utility consequences- deed. Another example of how people tion. more. Vol.34 Journal of Economic Literature. choice has on the utilities of later tive view of. without taking into account the choice's piness as lower than did lottery winners or the effect on the utilities from future control group. their status quo. "internalities"-the effects a current tims put more emphasis on. Paraplegics felt less well off on average than they felt before. even when it is hard nificant long-run consequences. mundane pleasures-they rated both choices. match their usual take for the day. calls for a reexamination some more extreme examples of loss of the first topic of Section 2: Are loss aversion it is hard to believe that the aversion. the endowment effect. this can be trans- lated as saying that people systematically underes. accident vic. Say you eat at one of two past pleasure and anticipated future pleasure from such mundane activities slightly higher than either restaurants every night. ety. some researchers invoke loss here. You enjoy Fat Slice 29 In the simple model of reference-point ad.hrI rrn f i r'n il 1 Nccpc tion. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . Shlomo Benartzi and Thaler misperceive utility consequences of (1995) argue that the equity-premium their choices is Richard Herrnstein and puzzle can be explained by investors' Prelec's (1992b) theory of meliora- 111741frcir%n c-. whether or not you live beyond a aversion more as an irrational rule of week. Moreover. but because you also enjoy vari- justment discussed in Section 2. or in disease. their current happiness. people often ignore enjoy mundane activities more than lottery win- ners or the control group. instance. future happiness. high relative to long-term utility. people to imagine that any experienced "tran- should put less weight than they do on sition utility" is significant relative their initial experience of losses. die's or Fat Slice. For tional? If people experience losses rela. their investment in the short term. and rated their hap. However. Based on a mass of evidence gath- ered from people and other animals. That is. the remembered "loss" of an voluntarily subject yourself to the same owned mug may carry over time. and "transition utility" can rationally rank other reference effects rational or irra. disease that leads to a quick and pain- cause people are correctly anticipating less death with probability . ate expected changes in utility caused Camerer et al. People charge Yet loss aversion often seems to be a heavy premiums for losses relative to judgmental bias: In decisions with sig. and their expected choice directly yields the highest utility.

decreases overall well-being. you get higher util- utility to experienced utility for epi- ity from eating at Fat Slice than at sodes extended over time. Kahneman (1994) posits payoff of 5 each period). we do often train our- adding episodes of pleasure increases selves. by collecting Blondie's.. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . for instance.5) rather than eating teria for adding up flows of experienced all the time at Fat Slice (thus getting a well-being. p. Of the long-run consequences of giving up course. but the evidence argues that experiments suggest biases suggests that we take too little account in how people's own retrospective of the global utility effects of individual evaluations of episodes compare to choices. one must formulate cri- for an average of 5. the last night of the vacation) in they will derive from future experiences assessing their overall experience of the is to recollect utility from comparable episode. pain. minor consumer items such as mugs. when an "episode" is well-defined because they take an overly "piecemeal" (e. Kahneman (1994) account internalities. ant medical procedure (colonoscopy).g.30 much weight on the end of the episode A major way people predict utility (e. we tend to neglect the past experiences. we die's last night may not have learned to assess correctly Utility from Fat Slice = 5 if you ate at Fat the utility consequences of even our Slice last night Utility from Blondie's = 4 if you ate at Fat everyday choices. Yet your utility-maximizing periodic hedonic reports by subjects of consumption program is to alternate be- their current well-being. First.. In evaluating tween Fat Slice and Blondie's (thus al- the overall utility from such an ex- ternating between payoffs of 7 and 4. research on the endowment effect hints for instance. people tend to put too approach. While we might pre- duration of an episode. Additional research Slice last night even more dramatically demonstrates Utility from Blondie's = 3 if you ate at Blon. tended episode. and that Of course. a vacation). patients seem to all but ne- that this presumption may not be accu- glect the duration of the procedure- rate: If we systematically misperceive which ranged from 4 to 69 minutes. because at that an uncontroversial criterion for each moment we tend to ask.g. Rabin: Psychology and Economics 35 Utility from Fat Slice = 7 if you ate at Blon. or learn over time. to take into overall well-being. systematic differences between people's die's last night experienced utility of episodes and their recollections of those episodes. they may not pleasure more than the average. Herrnstein and Prelec (1992b. Finally. in pp. Sec- properly maximize those preferences ond. In assessing the sume that people accurately recollect dissatisfaction of an extremely unpleas- their utility from familiar experiences. 236) for a pain and pleasure associated with an nice discussion of how economists glide over the episode before and after the actual epi- distinction between global and piecemeal maximi- zation. "Which comparing episodes is temnporal mono- will yield me more pleasure-Fat Slice tonicity-that adding moments of pain or Blondie's?." we may eat too often at to an otherwise unchanged experience Fat Slice. people tend to ple do seem aware of the shape of their remember the extremes of pain and global utility functions. are clearly important This content downloaded on Sun. anticipation and recollection of experimental exploration of this distinction. See also Fehr and Peter Zych (1994) for an sode. 257-58) argue that even when peo- evaluating past episodes. no matter your re- recent experiments compare recollected cent eating pattern. one must carefully consider the 30 See Herrnstein and Prelec (1992. their experienced well-being. Several On any given day. Yet.

alive at the end of the first year and 34 are dicted about themselves moments ear.) 31 The hypersensitivity of "preferences" to the C. subjects on av.36 Journal of Economic Literature. Be. Thaler (1991) discussed in Section 2. above. 77 are alive at the end of one year and 22 are cause people don't like to contradict re. involved makes that choice more attrac- ments of Kahneman. e. their actual minimal follows. XXXVI (March 1998) influences on long-run utility. see. equivalent) statements of a problem however. Similarly. This content downloaded on Sun. S254-55) give the following example of Some subjects were first asked to framing effects. pp. Knetsch.g.62. highlights the losses associated with a plications of a related phenomenon choice makes that choice less attractive. The respondents then indicated their erage predicted their own minimal sell. through the post-operative period. and tive. and it prescribes sensitivity.. Vol. alive at the end of five years. (Such a procedure underestimates Radiation Therapy: Of 100 people having ra- diation therapy all live through the treatment. selling price averaged $4. Such an interpretation of cally equivalent (but not transparently most of the experimental evidence. cently expressed predictions of their Problem 1 (Mortality frame) own behavior. price of $5. Indeed. But people more than gains. Diamond and Jerry Hausman that are robust to different ways of elic. alive at the end of five years. lead decision makers to choose differ- The fact that we don't always cor.for welfare implica. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . lier." All sub.73. tion aboutthe outcomesof two treatmentsof jects were then given a mug. Problem 1 (Survival frame) subjects systematically underestimated Surgery: Of 100 people having surgery 90 live the endowment effect. able influence of framing on choice re- viously important. and that al. be. a frame that exploits dimin- ture behavior. and their lung cancer. ent options. Loewenstein and Daniel ishing sensitivity by making losses Adler (1995) performed an experiment appear small relative to the scales based on the endowment-effect experi. taken from a study of "imagine that we gave you a mug ex. the true degree of misperception. and behaved sig. prominent set of research that points to tion are very significant in evaluating such an interpretation of choice behav- the overall well-being associated with ior concerns framing effects: Two logi- vacations. (1994). (1982): we gave you the opportunity to keep it Respondents were given statistical informa- or trade it for some money. tality rates and to others in terms of survival rates. The same statistics were pre- minimal selling prices were elicited. That is.89. 68 are nificantly differently than they had pre. whereby people misperceive their fu.3' The most anticipation and recollection of a vaca. preferred treatment. as outlined in Section 2 caution in reliance on revealed-prefer. An important and predict- rectly predict experienced utility is ob. seems tenuous. Elicitation Effects method of eliciting those preferences is a key is- sue in the emerging debate on "contingent valu- People often lack stable preferences ation". Because losses resonate with ence-based welfare economics. a frame that there may be important behavioral im. sented to some respondents in terms of mor- fore receiving the mugs. medical decisions by Barbara McNeil et actly like the one you can see. however. Once they had the The information was presented [exactly] as mugs. ing price at $3. subjects who had Surgery: Of 100 people having surgery 10 die made no prediction averaged a selling during surgery or the post-operative period. Tversky and Kahneman (1986. just as iting those preferences. lates to loss aversion and diminishing tions of choice.

A nominal wage increase of 5 More generally. people react differently to firms been studied widely by economists and charging different prices for different psychologists over the years: When services (or the same service at differ. but put a higher price on bets less than a 7 percent decrease in a time with a low chance of winning big of no inflation. Related phenomena even more tary stakes. The framing effect was not smaller fects cut more deeply to economists' for experienced physicians or for statistically sophisticated business students than for a model of choice: More than confusing group of clinic patients. with a high chance of winning small tion offends people's sense of fairness amounts. well-defined examples of framing effects. the "frames" may in fact This question is hypothetical. economic theory predicts react more to decreases in real wages these two different elicitation proce- This content downloaded on Sun. Money illusion provides yields $0. the end of five years. For in. and an L bet with a 1/9 perhaps the best example of the impor. More generally. most sub- prices in assessing the fairness of firm jects put a higher price on the L bet. people in pursuit of stable underlying preferences. The overall as heuristic errors people are bound- percentage of respondents who favored radia. and Thaler L bet when asked to choose between (1986a) provide survey evidence that the two. tance of framing effects for economics. Rabin: Pstchologat and Economnics 37 32 die by the end of the first year and 66 die when they are also nominal decreases. people often choose one of the higher price is called a surcharge. The advantage of radiation therapy over surgery evidently looms larger make mistakes in pursuing our true. people choose bets percent in a period of 12 percent infla. behavior. while pricing the larly. Preference reversals have stance. and the presentation of a tion therapy rose from 18% in the survival choice may draw our attention to differ- frame (N = 247) to 44% in the mortality ent aspects of a problem. chance to win $40 and 8/9 chance of $0. from Tversky and Thaler (1990). But sometimes framing ef- survival. As such. tudes toward tax deductions for chil. framing mediate death from 10% to 0% rather than as effects to some extent are a topic for an increase from 90% to 100% in the rate of Section 3. and Tversky and Kahneman strongly call into doubt the view that (1986) cite some important real-world choices reflect stable. The inconsequential difference in formula. and Tversky (1997). Simi. none die during treatment. derlying preferences. preferences. confronted with certain pairs of gam- ent times) depending on whether the bles with roughly the same expected lower price is called a discount or the value. people amounts. but partially determine a person's prefer- similar framing effects were found in ences. Framing effects can often be viewed tion produced a marked effect. Knetsch. and react negatively to nominal price Radiation Therapy: Of 100 people having ra- increases even if they represent no in- diation therapy. un- when stated as a reduction of the risk of im. by the end of five years. edly rational. pair over the other. But when asked to state the people are very attentive to nominal lowest price at which they would be rather than real changes in wages and willing to sell each gamble. To use an example huge differences in his students' atti. consider an H bet that with 8/9 dren depending on how the deductions chance yields $4 and with 1/9 chance were framed. 23 die by the end of one year and 78 die by crease in real prices (Shafir. Thomas Schelling (1981) noticed other more highly. Diamond. Most subjects choose the H bet over the Kahneman. leading us to frame (N = 336). choices over lotteries with small mone. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions .

Indeed. XXXVI (March 1998) dures should yield the same prefer. While today we feel that it pen chose the Cross pen.) time-consistent: A person feels the As another example. such. and context effects: People may from the smaller. plemented. people may state explicitly that a given earlier reward and a larger.38 Journal of Economic Literature. Vol. Casual observation. son's intertemporal preferences are formation revealed by the choice sets. D. Our short term Cross pen and the $6 chose the Cross tendency to pursue immediate gratifica- pen. qualitative feature of exponential dis- tual choice sets were drawn. (Subjects were first tionally model such tastes by assuming asked to look at a catalogue containing that people discount streams of utility the prices and descriptions of all the over time exponentially. In both these is best that we not overeat tomorrow. Time-Variant Preferences where the addition of a new option to a menu of choices may actually increase People have a taste for immediate the proportion of consumers who gratification. introspection. While only 36 percent of that the assumption of time-consistency subjects choosing only between the is importantly wrong. the addition of an option that tomorrow we tend to overeat. for at other times decision makers explicitly instance. movie that involve immediate rewards more expensive model was added to and delayed costs. while to- compared unfavorably (as more expen. Itamar Simonson and Tversky (1992) Simonson. so the re. selves whether they have a "reason" to ences. cisions. we give stronger relative weight the menu of choices influences their de. and Tversky 1993). put it off. For instance. ence for an elegant Cross pen versus re. the proportion of consumers immediate costs and delayed rewards who chose a particular model of micro. An important relevant choices from which their even. report tomorrow. and psychological research all suggest ceiving $6. preferences among a series of pairs. findings that one of their choices would be im- suggest an alternative to the utility. choose one option over another (Shafir. in ences to their choice sets. larger reward as the delay to both This content downloaded on Sun. examples. each case choosing between a smaller. provide examples of context effects. Simonson and same about a given intertemporal trade- Tversky (1992) ran an experiment that off no matter when she is asked. when consid- ness of the existing option. and do soon things such as seeing a wave oven increased when a second. 23 of 24 subjects explain framing effects. tomorrow we tend to tion enhanced the perceived attractive. later re- choice is a compromise between two ward. illustrates that elicited subjects' prefer. to the earlier moment as it gets closer. For such as mowing the lawn that involve example. earlier reward to the make choices in part by asking them. Economists tradi- their choice set. "consistently reversed their choices versals. We procrastinate on tasks choose one of the existing options. preference re. counting is that it implies that a per- sults seem unlikely to be due to any in. ering tradeoffs between two future mo- While people are often unaware that ments. day we feel we should write a referee sive or lower quality) to an existing op. later. asked subjects to state their rationalize their choices with refer. More generally. Simonson and Tversky note that Kris Kirby and Herrnstein (1995). 46 percent of subjects who were tion is inconsistent with our long term also given the choice of a less attractive preferences. Subjects were (truthfully) told other choices. In two experiments with maximization framework that may help monetary rewards. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions .

You can experience a disutility of ture the taste for immediate gratifica.X(8)t U. p.ut + 3.Ut) (8)t." Both the monetary April 14.8 for a one-day delay: different than her future preferences You are willing to suffer a given loss in over those same delays. so that prefer. ences. This how these preferences capture the pref- example seems well-calibrated: On erence for immediate gratification. -10 by working today. From the February 1 t=t+ 1 point of view. Schelling (1978). 1980).32 ber of hours of work. delaying the work until tomorrow. and Loewenstein and Prelec (1992). sup- April 14. then these preferences are simply on April 14. Then this with what your decision would be her intertemporal preferences at time t. Absent a substantive 32 These numbers are calculated from the data difference between the two dates. Formal day that is 80 percent as large.g. For the "time-consistently patient" a person is. prediction. versus spending eleven hours stakes and the delays were substantial. ally no one would choose the delay if 86). where both f and 6 lie you must decide on February 1. you will choose to work For all t. To see choice on February 1 or April 14.. Suppose that April 14 has arrived and ences have been developed. you find procrastinating The parameter 6 determines how in April an undesirable thing.6 < 1.8. Irrespective of its specific exponential discounting. hours on April 15.. if. see. to complete the same task on April 15. even if it means ing ten hours of an unpleasant task on a little more work.. who chooses her current behavior to Thaler and Hersh Shefrin (1981). 85. Ainslie and Herrnstein (1981). e. utility tomorrow for a gain in utility to- ences are not time consistent.(-11) = -8. most of us are apt to put off pose that you had a choice between do- the work until April 15.. with an average delay of about ity from doing work is simply the num- 21/2 weeks. whereas each of her future This content downloaded on Sun. a discounting. therefore. can be represented by the following April 14. maximize her current long-run prefer- 1997b).8 by that slightly modifies exponential dis. But for . a person's preferences today ut( 1) = -11 for all t. and O'Donoghue and Rabin (1997a. You counting. person is modeled as a separate "agent" Steven Goldman (1979. models of such time-variant prefer. George Ainslie To examine dynamic choice given (1991).50.. Chung and Herrnstein (1967).ut(I0) = -10 and Hence. 1997). your choice on just as in exponential discounting. 33 For economics papers on time-inconsistent preferences. work. David Laibson (1994. or experience a tion with a simple two-parameter model discounted utility of . but that f = . Other psychological research showing prefer- ences are not time-consistent includes Shin-Ho asked on February 1. you are told by your boss that utility function. Suppose that 6 = over her future delays in rewards are 1. Be- between 0 and 1: cause from February 1 you discount both dates by . Let ut be the instantaneous will. subjects received an average of about Assume that your instantaneous disutil- $21. virtu- presented by Kirby and Herrnstein (1995. exact same problem. Contrast utility a person gets in period t. instead of choosing when to work on Ut. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . delay work.33 Edmund you are considering whether or not to Phelps and Robert Pollak (1968) cap. If February 1 is different than your choice 3 = 1. T 10 hours on April 14 rather than 11 Ut(utput + 1. for each point in time. Thaler time-variant preferences given these (1981). exponential discounting these preferences capture in a parsimo- would predict that your choice would nious way the type of time-inconsistent be the same whether you made that preferences so widely observed. Robert Strotz (1955). Rabin: Psucholo-u and Economics 39 rewards increased.B.

implied by the existence of some of the times engage in behavior precisely to self-commitment devices illustrated restrict our own future flexibility. you commit to do 1 you prefer less work on April 14 to the task on April 15. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . or buying only small pack- are stable over time-is a radical de. ages of enticing foods so that you won't parture from the utility-maximization overeat when you get home. not choose her future behavior to maximize owning a television. you may you that you must choose on February 1 naively believe that you will feel the when to work. Which would you Strotz (1955) labels people who are choose? The advantage of waiting is fully aware of their future self-control manifest: By not precluding either of problems as sophisticated. If above. You may have expectations about self control: Because you may not like your propensity to misbehave. Attempts to control our own future The behavior predicted by models of behavior indicate an awareness that we time-variant preferences often differs may not behave as we would wish to be- dramatically from the behavior pre. this idea "Christmas Club" from which you are of multiple selves-that a single human not allowed to withdraw money until does not have unified preferences that Christmas. researchers rectly predict their own future have explored many self-commitment preferences: As with predicting the ef- devices we employ to limit our future fects of changes in reference points. even if you is ready-made for adoption by econo. suppose now she gives same way when facing an enticing bowl you three options: You commit to do of ice cream tomorrow. contributing to a her preferences. If on February the task on April 14. Instead of your boss telling not to overeat tomorrow. you may believe April 14 and then choose on which day you'll feel the same way in April. the flexibility you have re. This raises the question of how dicted by the exponential model. havioral realism of our models. Yet we some. if there are any uncertain. choices. ences in the future will match your cur- ture options. While some degree of sophistication is tained may be valuable. will from which you cannot check out. cussed earlier.g. This accords with the evidence dis- to restrict your future self from procras. and people your options. More sub- framework. have no external mechanisms of self- mists interested in improving the be. it does appear that people un- there were few uncertainties. who are fully unaware that they will ties that may be resolved between now have a self-control problem as naive. If today you prefer example. current preferences over future behav- erence to do the task earlier. tly. Such self-commitment devices here too knowing your future prefer- include alcohol clinics and fat farms ences means that you know your prefer- This content downloaded on Sun. may naively believe that your prefer- you may scheme to manipulate your fu. But because this conceptu.. The aware people are of their time-inconsis- most notorious examples are efforts at tency. to do the task. or you the way you will behave in the future. control.40 Journal of Economic Literature. Given your current pref. Consider again the work rent preferences. or you wait until more work on April 15. XXXVI (March 1998) selves. you might derestimate the degree to which their want to commit on February 1 to the future behavior will not match their April 14 date. More generally. and April. you wish ior. with her own preferences. you may try to control yourself alization of intertemporal choice uses a through a variety of internal "rules" familiar tool-dynamic game theory-it (e. Vol. On one level. have. never drink alcohol). that people often incor- tinating.

Similarly. it is of sophistication seems sparse. people's time-inconsistent pro. Loewen.. we can then begin to man behavior can be neglected because treat claims that (say) investors irration- the evidence derives from observations ally infer too much from short-term of people insufficiently motivated to be. 30 Dec 2012 19:24:15 PM All use subject to JSTOR Terms and Conditions . 281-82) reaches the findings to discuss broad methodologi- conclusion that people may be naive in. Self-control While none of the broad-stroke argu- problems are also clearly important in ments for inattention to psychological the demand for addictive goods and research are compelling. whereas diminish. applies else- where. deed. implications. For example. potheses about human behavior with fered many reasons for downplaying the both healthy skepticism and genuine cu- relevance of behavioral research chal. riosity. Rabin: Psychology and Economics 41 ences won't accord with your current assumptions. economists have prof. and carefully draw out their economic Claims abound that evidence inconsis. common when presenting psychological stein (1996. such prefer. In- (Stephen Hoch and Loewenstein 1991). we can look forward to focus- the increased future consumption that ing entirely on its substance. empirically test their validity. arguments will dissipate. relevance of behavioral research derive pensity for immediate gratification is from unfamiliarity with the details of important in a variety of economic this research. obviously not fatty foods. tions are methodologically illicit can consumption. such 1981. and Laibson 1997). orous standards. pp. gressive uncuriosity shown in the past havior because the benefits of current toward behavioral research continues to consumption are immediate. people may sufficiently great burdens of proof. strong impression that many of the ar- Whether they are sophisticated or guments invoked against the reality or naive. And as the ag- ences may be important to savings be. as presump- This content downloaded on Sun. as we apply these rig- tent with our traditional model of hu. cause behavioral research is so often as- ioral evidence that calibrates the degree sessed in light of such arguments. Conclusion our discipline. saving allows is delayed. ages because people tend to avoid large self-interest. While behav. potheses departing from rationality. lenging our habitual assumptions. It is my dicting changes in utility. Hence. my hope and realms.g. or other habitual assump- packages of such goods to prevent over. or that employees feel re- have themselves according to economic sentful when mistreated. free us to evaluate these hypotheses with the same rigorous standards that 5. such as the evidence of people mispre. Thaler and Shefrin more familiar with this research. performance. or because it fails to bear preferences. As investigated by several re. the role of self. Be- will have this will power. And. We can confront plausible hy- Over the years. e. abandoning the view that hy- Naughty goods are sold in small pack. at its best. or repeatedly not have the "will power" to because the implied behavior is unlikely forego tempting foods or quit smoking to matter in the types of (market) set- while predicting that tomorrow they tings that economists care about. cal objections and attempt to rebut directly from psychological findings them. guess is that as economists become searchers (see. all psychological research will be both control in purchasing decisions is well confirmed by field data and proven to known among marketing experts be of great economic importance. I refrain from doing so.

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