Behavioral game theory explores how real people make decisions in strategic situations. It challenges traditional assumptions by incorporating cognitive biases and social preferences into economic models. Experiments reveal that humans often deviate from purely rational behavior.

Ultimatum and trust games show people value fairness and reciprocity. Meanwhile, cognitive biases like anchoring and overconfidence affect judgment. Understanding these factors helps predict and explain human behavior in various economic contexts.

Experimental Games

Ultimatum and Dictator Games

• Ultimatum game involves a proposer offering a division of a fixed amount of money and a responder accepting or rejecting the offer
  • If the responder accepts, the money is divided as proposed
  • If the responder rejects, neither player receives any money
  • Standard game theory predicts the proposer will offer the smallest possible amount and the responder will accept
  • Experiments show proposers often offer 40-50% of the total and responders frequently reject offers below 20-30% (Güth et al., 1982)
• Dictator game is a variant of the ultimatum game where the responder must accept the proposer's offer
  • Proposers often still offer positive amounts, despite no threat of rejection
  • Suggests fairness considerations and social preferences play a role in decision-making (Kahneman et al., 1986)

Trust and Public Goods Games

• Trust game involves a trustor deciding how much to send to a trustee, which is multiplied by a factor
  • The trustee then decides how much to send back to the trustor
  • Measures trust and reciprocity
  • Experiments show trustors often send positive amounts and trustees frequently reciprocate (Berg et al., 1995)
• Public goods game involves players deciding how much to contribute to a public good
  • Contributions are multiplied by a factor and divided equally among all players
  • Individually rational to free-ride, but socially optimal for all to contribute
  • Experiments show players often contribute positive amounts, especially with communication or punishment (Fehr & Gächter, 2000)

Cognitive Biases

Anchoring and Confirmation Biases

• Anchoring bias occurs when individuals rely too heavily on an initial piece of information (the "anchor") when making decisions
  • Affects numerical estimates and probability judgments
  • Even irrelevant or arbitrary anchors can influence decisions (Tversky & Kahneman, 1974)
  • Anchoring effects have been demonstrated in various contexts (negotiations, real estate prices, legal judgments)
• Confirmation bias is the tendency to search for, interpret, or recall information in a way that confirms one's preexisting beliefs
  • Leads to seeking out information that supports one's views and ignoring contradictory evidence
  • Can lead to overconfidence and poor decision-making (Nickerson, 1998)
  • Examples include selectively reading news articles that align with one's political views or focusing on positive feedback while dismissing criticism

Availability Heuristic and Overconfidence Bias

• Availability heuristic is a mental shortcut where people judge the likelihood of events based on how easily examples come to mind
  • Leads to overestimating the probability of vivid, memorable, or recent events (Tversky & Kahneman, 1973)
  • Media coverage can exacerbate this bias by making certain events more salient (terrorist attacks, plane crashes)
• Overconfidence bias is the tendency to have excessive confidence in one's abilities, knowledge, or predictions
  • Manifests as overestimating the accuracy of one's beliefs or underestimating uncertainty
  • Can lead to poor decision-making and insufficient preparation for potential risks (Fischhoff et al., 1977)
  • Examples include entrepreneurs overestimating their chances of success or students overestimating their performance on exams

Behavioral Preferences

Loss Aversion and Endowment Effect

• Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains
  • Losses are perceived as more significant than corresponding gains (Tversky & Kahneman, 1991)
  • Leads to risk aversion when facing potential gains but risk-seeking when facing potential losses
  • Demonstrated in various contexts (financial decisions, health behaviors)
• Endowment effect is the tendency to value an object more once one owns it
  • Leads to a disparity between willingness to pay for an object and willingness to accept compensation to part with it (Thaler, 1980)
  • Implies a reluctance to trade and can lead to inefficient allocations
  • Examples include valuing a mug more highly after receiving it as a gift or demanding a higher selling price for a house than one would be willing to pay to buy it

Social Preferences

• Social preferences refer to the concern for the well-being of others and the desire for fairness
  • Includes altruism, reciprocity, and inequity aversion
  • Can lead to behavior that deviates from pure self-interest (Fehr & Schmidt, 1999)
  • Experiments show people are often willing to sacrifice personal gains to benefit others or to punish unfair behavior
• Examples of social preferences in action:
  • Charitable giving and volunteering
  • Engaging in costly punishment of free-riders in public goods games
  • Rejecting unfair offers in the ultimatum game, even at a personal cost