30261 - EXPERIMENTAL ECONOMICS AND PSYCHOLOGY

Prior knowledge in Calculus, Statistics or Econometrics, and Microeconomics allow students to benefit more from the course but is not strictly necessary.

Many public discussions, policy decisions by government agencies, as well as many operational and strategic decisions of corporations are based on the assumption of rationality. By contrast, our everyday experience suggests that people may be easily confused and their intuitive decision making isn’t always mathematically perfect. How big is the gap between the rational behavior assumed in models and forecasts and the behavior of real people? We will start with a critical evaluation of the standard theory of economic agents' behavior and a review of the ways that were proposed in the literature to incorporate psychological insights. We will spend about 25% of class time on reviewing the concepts, notation, and main testable predictions of the relevant theories. The majority of class time will be dedicated to discussing experimental papers. Many questions that researches want to investigate cannot be satisfactorily answered by a straightforward yes or no experiment. Experimental papers frequently employ clever designs to shed light on their subject, and we will learn why and what authors do to make their point. Dive deeper into a course that challenges our conventional perception of decision-making and studies the real-world behavior through the lens of cleverly crafted experiments!

The course covers the following topics. (Some topics take more than one lecture.)

1. Introduction. The assumption of rational behavior in Economics and the ways psychological insights can improve economic models.
2. Experimental evidence. Example of a study: the Endowment Effect.
3. Fundamental principles of experiments in Economics: incentivized choice and honesty. Key incentive schemes.
4. Introduction to Choice Theory. Rational choice and the utility function.
5. First departures from the standard theory of choice: limited attention, satisficing behavior, shortlisting.
6. Psychological biases that affect choice: the endowment effect, framing, asymmetric dominance effect. Experiments.
7. Choice under risk. Expected utility theory. Risk aversion.
8. Probabilistic biases and deviations from the expected utility theory. Prospect theory. Rank-Dependent Expected Utility theory. Experiments on choice under risk.
9. Uncertainty vs. risk. Ellsberg’s experiments. Ambiguity.
10. Intertemporal choice. Discounting of the future and the discount factor.
11. Choice in multiple time periods. Dynamic consistency. Present bias and hyperbolic discounting. Naive and sophisticated choice in the absence of dynamic consistency.
12. Experiments on intertemporal and multi-stage choice.
13. Confidence in choice. Over-confidence and under-confidence. Experiments on confidence.
14. Analysis of experimental data. Review of concepts: statistical test, p-value, regression. Multiple hypothesis testing.
15. Introduction to Game Theory. Sequential move games and simultaneous move games. Key concepts: dominance, equilibrium, backward induction.
16. Experiments on rationality in playing games.
17. Psychological aspects of playing games and socially-oriented behavior. Experiments on fairness, trust, and reciprocity.
18. Beliefs about other players and strategic concerns. Level-k theory. Experiments.
19. Experiments on gender differences in choice and social behavior.

At the end of the course students will be able to:

• for contexts discussed in class, explain the procedure that rational people are supposed to use to make decision or choose an action;
• describe a range of psychological effects and biases that affect decisions of real people in economically relevant situations;
• discuss the experimental evidence that we have on the existence, prevalence, magnitude, and determinants of those effects and biases;
• describe a few theories that incorporate psychological insights, such as the Prospect Theory and hyperbolic discounting models, and discuss their strengths and weaknesses;
• explain the way we describe interaction between people by the means of a game and describe concepts that we use to analyze games and make predictions about their outcomes;
• discuss the evidence on psychology-driven and pro-social behavior in situations that can be modeled by simple games;
• summarize key principles of designing an experiment in Economics;
• understand the way experimental data is analyzed and evidence is established and presented.

At the end of the course students will be able to:

• recognize decisions that are driven more by psychological factors than a careful evaluation of the present options and the rational choice of the most beneficial one;
• relate key elements of standard theories of rational behavior, as well as alternative psychology-driven theories, to their representation via mathematical expressions and formulas;
• read an experimental paper and understand why the paper is written and what question it seeks to answer, its results and findings;
• propose a way to resolve a question about people’s behavior or validate a theory by the means of an experiment, including developing an incentive scheme ruling out potential alternative explanations;
• critically assess the design of someone else’s experiment;
• evaluate the arguments and evidence presented in an experimental study and their strength.

• Face-to-face lectures
• Online lectures
• Individual assignments
• Group assignments

Online lectures will consist of the recording and, possibly, the synchronous streaming of face-to-face lectures, or alternative methods, such as recorded presentations of slides, should face-to-lectures become unfeasible.

Individual assignments: optional problem sets and a mandatory report on a research paper.

Group assignments: a project that covers several stages of an experiment.

Individual assignments motivate students to review the material and help to get a better understanding and some hands-on practice with the main theoretical concepts studied in the course, as well as prepare for problems that they will see in the final exam.

Group assignments allow students to get some practice with experimental methods while developing important teamwork skills.

The grade for the course will be given on the basis of the score that is computed as the weighted sum of the points awarded for

• problem sets,
• individual report on an experimental paper (with the weight of 30% together with the problem sets),
• group project (with the weight of 40%),
• written final exam (with the weight of 30%).

Each problem set, the report, the project, and the final exam will be graded on a 100-point scale. The total score, computed as the weighted sum of the points earned for each of the activities, will be converted into the transcript grade using a scale that is approximately linear scale and calibrated to match the typical grade curve of an elective course at Bocconi.

There will be three problem sets in this course. All submitted solutions will receive feedback. Students are allowed to choose the weight between 0% and 20% that they want to allocate to the problem sets, and the zero weight means that the problem sets become optional. In the case of positive weight, best two out of three problem sets will be included in the final score. The weight of 30% minus the weight of problem sets goes to the report.

For the report on an experimental paper, each student needs to choose a published experimental paper to her/his liking. The paper needs to be confirmed with the instructor in advance to ensure that the chosen paper indeed represented experimental study and that two or more students do
not choose the same paper. The report should be about 2 pages long and summarize (in student’s own words) the research question of the paper, its motivation, the methodology of the experiment, and the findings. To get the top grade, a student needs to elaborate what she/he likes in the paper and what she/he perceives as its weaknesses. The deadline for submitting the report will be after the Easter break.

The group project should be devoted to an experimental study of some psychological phenomenon relevant for Economics or experimental evaluation of a model of individual decision making or interaction between people. It needs to cover at least two of the following points:

• proposal of an original question for an experimental study and a review of relevant literature;
• proposal of an original question and design of an experiment (that includes instructions for subjects and design of the incentive scheme);
• analysis of data from a published experiment (that is, doing or replicating statistical analysis and evaluating what we learn from the data);
• making an in-class presentation of the results of your work on one of the above points.

Students taking the course are expected to self-organize into groups. Each group should consist of at least two and at most four people. Everyone in a group gets the same grade; however, the group should submit a short summary of the contribution of each of its members. Before the midterm exam break, a project proposal needs to be submitted. The proposal is expected to be half-page long and list the members of the group, the topic, and the points (from the above list) that the group plans to cover to fulfill the requirements. Failure to submit the proposal on time will result in a penalty. In-class presentation should be scheduled with the instructor in advance. The deadline for the final submission of the project will be agreed upon during the first two weeks of classes.

The final exam will last 60 minutes and will contain a mixture of quantitative (about 80%) and non-quantitative questions that are similar to those given in the problem sets.

The main source of course material is lectures. Lecture slides will be posted on the Bocconi blackboard site before each class.

For the discussion about the way psychological insights contrast to or augment the neoclassical economic theory, the following textbook may be used to supplement lectures:

• Angner, A Course in Behavioral Economics (2021).

For the part of the course devoted to game theory, the best reference is

• Osborne and Rubinstein, A course in Game Theory (any edition; the books is also available online).

The discussion of experiments will be based on original research papers. References to the discussed papers will be provided in the slides. If needed, the following books may be used for an overview of some topics discussed in the course and finding more references:

• Kagel and Roth, The Handbook of Experimental Economics, Vol. I (1995), Chapter 8;
• Kagel and Roth, The Handbook of Experimental Economics, Vol. II (2015), Chapters 1, 2, and 8.