Introduction to Behavioral



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An 

Introduction 

to Behavioral 

Economics

2nd EDITION

Nick Wilkinson

 and 

Matthias Klaes




© Nick Wilkinson & Matthias Klaes 2012

All rights reserved. No reproduction, copy or transmission of this

publication may be made without written permission.

No portion of this publication may be reproduced, copied or transmitted

save with written permission or in accordance with the provisions of the 

Copyright, Designs and Patents Act 1988, or under the terms of any licence 

permitting limited copying issued by the Copyright Licensing Agency, 

Saffron House, 6-10 Kirby Street, London EC1N 8TS.

Any person who does any unauthorized act in relation to this publication

may be liable to criminal prosecution and civil claims for damages.

The authors have asserted their rights to be identifi ed as the authors of this work 

in accordance with the Copyright, Designs and Patents Act 1988.

First published 2012 by

PALGRAVE MACMILLAN

Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, 

registered in England, company number 785998, of Houndmills, Basingstoke, 

Hampshire RG21 6XS.

Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 

175 Fifth Avenue, New York, NY 10010.

Palgrave Macmillan is the global academic imprint of the above companies 

and has companies and representatives throughout the world.

Palgrave® and Macmillan® are registered trademarks in the United States, 

the United Kingdom, Europe and other countries

ISBN-13:  978-0-230-29146-1 

This book is printed on paper suitable for recycling and made from fully

managed and sustained forest sources. Logging, pulping and manufacturing 

processes are expected to conform to the environmental regulations of the 

country of origin.

A catalogue record for this book is available from the British Library.

A catalog record for this book is available from the Library of Congress.

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Printed and bound in China




iii

 

Brief Contents



Detailed Table of Contents

 iv


List of Figures

 viii


List of Tables

 ix


Preface

 

x



Acknowledgments 

xiii


PART I   INTRODUCTION 

CHAPTER 1   Nature of Behavioral Economics

 

1

CHAPTER 2   Methodology



 28

PART II   FOUNDATIONS

CHAPTER 3   Values, Preferences and Choices

 62


  

CHAPTER 4   Beliefs, Heuristics and Biases

 115

CHAPTER 5   Decision-making under Risk and Uncertainty



 146

CHAPTER 6   Mental Accounting

 218

PART  III   INTERTEMPORAL CHOICE 



CHAPTER 7   The Discounted Utility Model

 260


CHAPTER 8   Alternative Intertemporal Choice Models

 283


 

PART IV   STRATEGIC INTERACTION 

CHAPTER 9   Behavioral Game Theory

 334


CHAPTER 10   Social Preferences

 391


PART V   CONCLUSION 

CHAPTER 11   Behavioral Economics: Summary and Outlook

 459

Bibliography



 504

Index


 

559



iv

Detailed Table of Contents

List of Figures

 viii


List of Tables

 ix


Preface

 

x



Acknowledgments 

xiii


PART I   INTRODUCTION 

CHAPTER 1   Nature of Behavioral Economics

1.1  

Behavioral economics and the standard model 



2

1.2  


History and evolution of behavioral economics 

12

1.3  



Relationship with other disciplines 

15

1.4 



Objectives, scope and structure 

19

1.5 Summary  



20

1.6 Review 

questions 

20

1.7 Applications 



20

 

Case 1.1 



Loss aversion in monkeys 

21

 



Case 1.2 Money 

illusion 

23

 Case 


1.3 

Altruism – the joy of giving 

26

CHAPTER 2   Methodology



2.1  

Theories 

29

2.2  Evidence 



36

2.3  Consilience 

45

2.4 Summary 



52

2.5 Review 

questions 

53

2.6 Applications 



53

 

Case 2.1 



Do economists need brains? 

53

 



Case 2.2 

Riots in the UK 

57

PART II   FOUNDATIONS



CHAPTER 3   Values, Preferences and Choices   

3.1  


The standard model  

64

3.2 



Axioms, assumptions and defi nitions 

68

3.3 



The evolutionary biology of utility 

71

3.4 Broadening 



rationality 

74

3.5 



Types of utility 

86

3.6 



The neuroscientifi c basis of utility 

93



v

 

3.7 Policy 



implications 

97

3.8 Summary 



102

3.9 Review 

questions 

103


3.10 Applications 

104


 

Case 3.1 Drug 

addiction 

104


 

Case 3.2 

When abstention is better than moderate consumption  

105


 Case 

3.3 


Environmental protection  

109


 Case 

3.4 


The way the brain buys 

109


CHAPTER 4   Beliefs, Heuristics and Biases

4.1 


The standard model 

117


4.2 Probability 

estimation 

119

4.3 Self-evaluation 



bias 

124


4.4 Projection 

bias 


129

4.5 Magical 

beliefs 

 

130



4.6 

Causes of irrationality 

132

4.7 Summary 



140

4.8 Review 

questions 

140


4.9 Review 

problems 

141

4.10 Applications 



141

 Case 


4.1 

Fakes and honesty 

141

 

Case 4.2 



Trading on testosterone 

143


 

Case 4.3 

Celebrity contagion and imitative magic 

143


CHAPTER 5   Decision-making under Risk and Uncertainty

5.1 Background 

 

148


5.2 

Conventional approaches to modifying EUT 

155

5.3 Prospect 



theory 

160


5.4 

Reference points  

164

5.5 Loss-aversion 



167

5.6 


Shape of the utility function  

171


5.7 Decision-weighting 

176


5.8  

Criticisms of prospect theory 

188

5.9  


Recent theories and conclusions 

197


5.10 

Summary 207

5.11 Review 

questions 

208

5.12 Review 



problems 

209


5.13 Applications 

210


 Case 

5.1 


The endowment effect 

210


 Case 

5.2 


Insensitivity to bad income news   

213


 Case 

5.3 


Loss-aversion in golf 

215


CHAPTER 6   Mental Accounting

6.1 


Nature and components of mental accounting 

219


6.2 

Framing and editing 

220

6.3 


Budgeting and fungibility 

225


6.4 

Choice bracketing and dynamics 

233

6.5 Policy 



implications 

239



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