Lecture of experiments

*Lecture 5: Public GoodsDr. Ghazala AzmatMonday 9th February 2015

ECN374: Behavioural Economics

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*Todays LecturePublic Goods

Cooperation

*Social DilemmaYou want to build a park in your locality that would be open to everyone

You decide to approach the families in the area and ask them to donate a certain amount

*Social DilemmaNot everyone has to contribute for the park to get built

As long as some of the families contribute you will have enough money for the park

What are the chances that you will be able to raise enough money?

*Social DilemmaLet us assume that, by and large, people are self-interested and care (mostly) about their own welfare

Think about an individual trying to decide whether to contribute or not

If she does not contribute and the park does not get built then she is neither better nor worse off

But suppose she does NOT contribute but enough money is raised to build the park

*Social DilemmaThis person cannot be prevented from going to the park once it is built

She has not contributed anything but still gets to enjoy a walk in the park

This person is then strictly better off

*Social DilemmaWhether the park gets built or not for an individual who cares primarily about her own self-interest the thing to do is not to contribute any money

We call this free-riding

But if everyone reasoned along the same lines then no one will contribute!

*Public Park Public GoodA public park is a public good non-rival in consumption benefits are non-excludable.

A good is non-rival in consumption when As consumption of it does not interfere with Bs consumption of it. The benefits of the good are collectivethey accrue to everyone.

A good is non-excludable if, once produced, no one can be excluded from enjoying its benefits. The good cannot be withheld from those that did not pay for it.

*Examples of Public GoodsFire ServicePoliceNational DefenseHighwaysEnvironmentHospitalsPublic LibrariesPublic Parks

*Why are Public Goods Important?Some of the most fundamental questions about the organization of society centre around public goods:

Can markets provide optimal allocation such as public health?

How well do current political institutions perform in the production and funding of public goods such as space exploration or national defence?

How far can volunteerism take us in attempts to solve world environmental problems?

*Why are Public Goods Important?If existing institutions do not produce desirable results in the presence of public goods, can we discover other organizational arrangements that would better serve the interest of society?At an even more basic level, public goods raises issues about the very nature of humansAre people cooperative or selfish?Do they behave differently when confronting public goods decisions than when making private goods decisions?Are altruism or fairness concepts that a social scientist must come to terms with before solving organizational problems or can these phenomena be ignored?

**Typically:

Taxation

Voluntary contributions (US: over 100 billion dollars of philanthropic contributions)How are Public Goods Provided?

**Descrite public good: bridgePPM: if not enough contribution then no provision, multiple equilibria

Public Good Experiment

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*A Public Goods GameGroup of 4 playersThey are each given an endowment of $5They are then told that each can choose to invest some or all of their $5 in a group projectIn particular, each will simultaneously and without discussion put an amount between $0 and $5 in an envelopeThe experimenter will collect the contributions, total them up, double the amount, and then divide this money among the groupThe private benefit from the public good, in this case, is one half of the total contributions

*PredictionsWhat should one expect to happen this public goods experiment?

There are many theories:

One, the economic/game-theoretic prediction, is that no one will ever contribute anything

Each potential contributor will try to free ride on the others

*PredictionsBecause each $1 contributed yields only $0.50 to its contributor, no matter what the others do

This is called a public goods problem or a social dilemma because the group would be best off in some sense (taking home $10 each) if all contributed.

Each $1 contributed yields $1.50 to the others at no cost to themFrom this point of view of this theory, individual self-interest is at odds with group interest

*PredictionsAnother theory, call it sociologic-psychologic prediction, is that each subject will contribute something

Although it is hard to find precise statements, it is sometimes claimed that altruism, social norms or group identification will lead each to contribute $5, the group optimal outcome

From the point of view of this theory, there is no conflict between individual and group interests

*ResultsWhat does happen in a public goods experiment?

Examination of the data reveals that neither theory is right

In many cases, some contribute $0, some contribute $5 and some choose a middle course and contribute something less than $

Generally, total contributions can be expected to lie between 40 percent to 60 percent of the group optimum

*ResultsThere seem to be a full range of behaviour from fully selfish to fully altruistic

So outcomes in public goods environments can be almost anything depending on which subjects walk into a room

[More likely, the imprecision of the results is due to the fact that we have simply not yet achieved sufficient control in the public goods experiments to be able to identify what is really happening.]

ImplicationsWhy should we care about public goods experiments?

Both economists and sociologists recognize that the desired outcome is for all to contribute $5

The experimental evidence suggests that voluntary contributions will not produce that desired outcome

Economic theory suggests that it may be possible to change the institutions by which group choices are made in a way that makes the outcome to be closer to the group optimum

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*ImplicationsTo know what to do requires anticipating how individual choice will change as the institution changes

Since both the economic/game-theoretic and socio-psychologic theoretical predictions are wrong, we need to discover more about behaviour Not only in the context of voluntary contributions but also in the presence of many institutional design

Experiments are best way to do so

Your Results Group 1 Round 1*

Your Results Group 2Round 1*

InterpretationWho is the winner?

Do we see the efficient level of public good provided?

Why play this over several rounds? What happens over the rounds?

*Cooperation

*Cooperation and Public Goods ProvisionDeterminants of voluntary cooperationMarginal private benefitsGroup sizeCommunicationWhy do people cooperate?Strategic cooperationCooperation as a mistakeConditional CooperationTesting an incentive compatible mechanism for the private provision of public goodsCooperation and private punishment

*Cooperation ProblemsCooperative hunting and warfare (important during human evolution)

Exploitation of common pool resources

Clean environment

Teamwork in organizations

Collective action (demonstrations, fighting a dictatorship)

Voting

*Basic economic problemCooperative behaviour has a positive externality.

Hence, the benefit to society exceeds the benefit to the private person providing it.

Therefore private individuals are willing to incur the cost of providing this if and only if enough others do so.

*Determinants of Voluntary CooperationIsaac, Walker, Thomas (1984)Aim: Isolate effects of group size and the MPCR (Marginal Per Capita Return).

pi=y-ci+aSci a measures the private marginal benefit, na the social marginal benefit. Income from private account y-ci was private information; income from group account (aSci) was public information. 10 periods, public informationInformation feedback at the end of each period: sum of contributions and private income.

*Determinants of Voluntary CooperationIsaac, Walker, Thomas (1984)A-C, B-D: MPCR-effectA-B, C-D: Group size effect with constant MPCRB-C: Group size effect with constant group benefit na

A: n=4, MPCR=.3, na=1.2C: n=4, MPCR=.75, na =3B: n=10, MPCR=.3, na =3D: n=10, MPCR=.75, na =7.5

*ResultsCooperation increases with MPCR for both n. (A-C, B-D)Cooperation increases with n if MPCR is low (not when it is high). (A-B, C-D)Cooperation decreases with n if group benefit constant (B-C)Cooperation decreases over time, in particular in treatments with low MPCR. (over 10 periods)MPCR-effect is present in all periods.Group size effect at low MPCR vanishes over time.

Table shows average contributions in percent:

MPCR=.3MPCR=.75n=4A: 19C: 57n=10B: 33D: 59

*Further ResultsExperiments with larger groups (40 and 100):If MPCR = .3 and n = 40 cooperation does not decline over time If MPCR = .03 and n = 40 cooperation rapidly declines. Conjecture: If n increases at a constant MPCR the probability of beneficial coalitions rises.Assumes that subjects earnings at zero cooperation are a reference point. If sufficiently many cooperate they earn more although they also cooperate.

*Communication & Voluntary Cooperation(Isaac & Walker 1988)n = 4, a = .3, two sequences with 10 periods each, partner design.

Communication opportunities (C=communication, NC=no-communication): Players can discuss what they want to do in the experiment. Yet, no revelation of endowments, no threat and no side payments allowed.

Treatments

C NC, players have the same endowment. NC C, players have the same endowmentC NC, asymmetric endowments.

*ResultsStart with C: High cooperation rates; also in the second NC-phase.

Start with NC: Unraveling of cooperation in NC but after C rapid increase in cooperation.

Asymmetric endowments partly undermine positive communication effects.

InterpretationIf selfishness and rationality is common knowledge communication should play no role

Suggests that subjects have motives beyond self-interestKeeping promises, sympathy, social approvalConditional cooperation*

Cooperation, Punishment & Social Norms

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*Cooperation, Punishment & Social Norms A social norm is a behavioral regularity that rests on a common belief of how one should behave and is enforced by informal sanctions.

Remark: In the case that there is no conflict between privately optimal behavior and the behavior prescribed by the norm there is nothing to enforce.

Example: The no-smoking norm emerged after it became clear that passive smoking is detrimental for health.

Other examples

*Examples of Social NormsDont lieKeep promises.Wear similar cloth as your peers.Norms with regard to club membership, union membership and preferences for political parties. Norms against the overexploitation of common resources

Many of these examples indicate a public good aspect of social norms.

*Economic Approach of Modeling Social NormsStandard approach is incomplete in important respects.Little predictive content because of too many equilibria. Does not deal with the normative component of a social norm, i.e. it does not makes prediction about what individuals should do. Emotions are typically left out of the picture although they are likely to be a driving force of norm enforcement.Idea: violations of social norms trigger negative emotions which in turn trigger a willingness to punish the violators.This contributes to the enforcement of the norm.

* A Cooperation and Punishment Experiment (Fehr & Gchter, 2000)Stage 1: typical linear public goods design: n = 4, = 0.4.Stage 2: Punishment opportunitySubjects are informed about each members contribution. Subjects can punish other group members at a cost to themselves.A punished subject could not lose more than the first-stage income.

Punishment0%10%20%30%40%50%60%70%80%90%100%Costs (Guilders)0124691216202530

*TreatmentsTwo partner sessions: no pun pun and pun no pun.

Each part of the sequence lasted 10 periods.

Subjects in the first part of the sequence did not know that there is a second part.

3 Stranger-Session: two times pun no pun. Once no pun pun.

*PredictionsIt is common knowledge that each subject is a money maximizer and rational:No punishmentNo contribution regardless of whether there is a punishment opportunity.BUT may be that subjects in the partner treatment are able to build up a group reputation (There are punishers in the group, hence it is better to cooperate) Partner: Cooperate and punish in early periods but stop cooperating and punishing at least in the final period. Stranger: no punishment and no cooperation.

*Alternative ViewsPart of the subjects have a preference for reciprocity. They reward nice and punish hostile behavior. The relevant reference point for the definition of kindness is conditional cooperation. Two variants:If I cooperate the other members should cooperate as well.The other group members average cooperation as a reference point.Conditional cooperation is perceived as nice. Free-riding relative to the reference point is perceived as hostile and is, hence, punished. Punishment stabilizes cooperation in the group.

Cooperation with and without Punishment (Fehr & Gchter AER 2000)*

*ImplicationPunishment opportunity allows enforcement of cooperative norms.

Subjects whose contributions are below a relevant reference points are punished by those who cooperate

This also enhances cooperation in a perfect stranger design.

Why Cooperate?

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*Why do people cooperate?Mistakes, initially they dont understand that zero cooperation is a dominant strategy. Strategic cooperation There are strategic (rational) and tit-for-tat players.Strategic players cooperate (except in the final period) if they believe they are matched with tit-for-tat players. Strategic players mimic tit-for-tat players (i.e. they cooperate) to induce other strategic players to cooperate. Social preferencesAltruism, warm glow, Conditional cooperation, ReciprocityNorms

*Why does cooperation decline over time?MistakesIt takes time to learn to play the dominant strategy.

Strategic cooperation if group composition is constant.

Social preferencesSubjects are conditionally cooperative and learn that there are free-riders in the group.As a response they punish other group members by choosing lower cooperation levels.

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**Descrite public good: bridgePPM: if not enough contribution then no provision, multiple equilibria

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Lecture of experiments