DecisionTheoryandEvidence

TopicsinMicroeconomicTheory2090
Spring2015
BrownUniversity
Instructor:MarkDean
Background

Attheheartofalmosteverymoderneconomicmodelliesamodelofhowpeoplemakedecisions.The
studyofhowthesedecisionsaremadeisoneofthemainlinesofenquiryinmicroeconomictheory.
Decisiontheory(andtherelatedfieldofrevealedpreferencetheory)istheuseofformal(andusually
axiomatic)modelingtechniquestocapturetheobservableimplicationsofmodelsofbehavior.These
techniquesarecentraltoattemptstoincorporatebehavioralandpsychologicalinsightsintoeconomics.
Ontheonehand,decisiontheorytellsushowwecantestpsychologicallyinspiredmodelsofeconomic
behavior.Ontheother,ittellsuswhatimplicationsnewbehavioralinsightshaveforourexisting
models,thusprovidingalinkbetweenbehavioraleconomicsandtherestoftheeconomicuniverse.

Inrecentyears,decisiontheoryhasbeenenlivenedbyanexplosionofnewdataonhowpeoplemake
decisions.Muchofthisevidencehascomefromlaboratoryexperiments,butincreasinglyfielddatais
beingusedtounderstandeconomicbehavior.Morerecentlystill,researchershavestartedthinking
abouthownonchoicedata,intheformofeyetracking,brainscanning,decisiontimeandsoon,can
informeconomicmodelsThisnewemphasisondatahassetupexcitingnewinteractionsbetween
theoristsandexperimentaliststheoristsareadaptingtheirmodelstotakeintoaccountthefindings
fromexperiments,whileexperimentersarerunningexperimentstotestthenewtheory.Theresulting
modelsarehavingamajorimpactinmanyareasofeconomicsandpolicy,includingfinance,macro,
developmentandmarketing.

CourseOverview

Theaimofthiscourseistostudybehavioraleconomicsthroughthelensofdecisiontheory.Wewill
studythetoolsthatdecisiontheoristsusetomodelchoicesoverdifferenttypesofobjects(forexample
riskyanduncertainprospects,menus,consumptionstreams,stochasticchoice).Wewillusethesetools
tostudysomeofthekeytopicsinbehavioraleconomics.Thefocuswillbeonmodelsofbounded
rationalityandrationalinattention,butwewillalsocoverotherimportanttopics:temptationandself
control,violationsofexpectedutility,ambiguityaversion,nonexponentialdiscountingandreference
dependence.Wewillstudytheexperimentalevidencethathasbeenbroughttobearonthesetopics,
andshowhowdecisiontheoryactsasanimportantinterfacebetweentheoryanddata.Finallywewill
lookatapplicationsofthesemodelstoquestionsofeconomicinterest.

Thecoursehasfivemainaims.
1. Teachyouthetechnicalskillsnecessarytounderstandandbeginresearchindecision/revealed
preferencetheory

2. Provideaninsightofthemaintopicsthatbehavioraleconomistsanddecisiontheoristsare
currentlyinterestedin
3. Provideanoverviewoftheexperimentalevidencerelatedtothesetopics,andgiveyouthetools
necessarytoconductexperimentalresearchintothevalidityofbehavioraleconomicmodels
4. Showhowbehavioraleconomicmodelshavebeenappliedmorewidelyintheliterature
5. Giveaguidetosomeoftheopenquestionsintheliterature,whereresearchmayfruitfully
undertaken

Assessment
Assessmentforthecoursewillbebasedonthreestrands,eachofwhichwillreceiveroughlyequal
weight:

1. Problemsets:Decisiontheoryisatechnicalsubject,andthereisnowaytoproperlyunderstand
theconceptswithoutworkingthroughsomeproblemsforyourself.Therewillbeuptofour
problemsetsspacedthroughoutthecourse.

2. Presentations:Startingfromweek5,theclasswillbedividedintotwogroupseachweek.Each
groupwillberesponsibleforpreparinga20minutepresentationonanassignedpaper.Thenext
week,onememberofthegroupwillbeselectedatrandomtogivethepresentationinclass.

3. ResearchProposal:Oneofthejobsthroughoutthesemesterwillbetocomeupwitharesearch
proposal.Youwillcomeanddiscussthisproposalwithmeonceortwiceduringthecourseof
thesemester.Inthelastclasseveryonewillpresenttheirresearchproposal,andproducea15
20pagereportidentifyingtheresearchquestion,therelatedliteratureandthestepsthatyou
wouldtaketoanswerthequestion

Whileitisnotpartofyourformalassessment,IwouldalsoSTRONGLYencourageallofyoutocometo
theTheoryseminarthattakesplaceofMondaysat4pm,andthetheorylunchwhichtakesplaceon
Thursdaysat12.00.Infact,ifyouarethinkingofhavingmicrotheoryasoneofyourfields,Iwouldsayit
isprettyvitalforyoutostartattendingtheseassoonaspossible.Theyareagreatwaytostarttosurvey
thetypesofworkthatarecurrentlybeingdoneinmicrotheory,andwhatthestateoftheartcurrently
is.Theyarealso,ingeneral,prettyinteresting.

Prerequisites
Thecourseisprimarilydesignedforgraduatestudentswhohavetakenthe1styearmicroeconomics
sequence.However,itisalsopossibleforotherstotakethecourseiftheyarekeen,andhaveadecent
technicalbackground(particularlyinrealanalysis).
WhileIamhappyforpeopletotakethecourseonanotforcreditbasis,IwillexpectanyonewhoIs
sittinginonthecoursetoalsomakeagoodfaithattemptatthevariousassignments.Thereissimplyno
pointotherwise.

CourseMaterials

Byandlarge,thecoursewillbebasedonacademicpapers(whichareavailableonline)andlecturenotes
(whichIwillmakeavailable).However,therearetwobooksthatyoumayfinduseful.ThefirstisNotes
ontheTheoryofChoicebyDavidKreps,whichisadeceptivelysimplebookthatprovidesafantastic
introductiontoclassicaldecisiontheory.ThesecondisRealAnalysiswithEconomicApplicationsbyEfe
Ok.Thisisprimarilyamathstextbook,buthassomeexcellentdecisiontheoreticapplications.

AdministrativeDetails
TheclasswillmeetonTuesdaysbetween5.30and7.50(possiblylaterifwearestillgoingstrong)in301
RobinsonHall.Officehourswillbe2.004.00onWednesdays,thoughIwillbeavailableoutsidethese
timesifyoucontactmeinadvance.

Mycontactdetailsareasfollow:
Office:303c
Telephone:4018632907
Email:mark_dean@brown.edu
Website:www.econ.brown.edu/fac/Mark_Dean/(lecturenoteswillbepostedhere)

Topics

Thecoursewillbesplitintothreesections.Thefirst(3rdFebto3rdMarch)willcoverthemaintoolsof
decisiontheory.Thesecond(10thMarch31stMarch)willcoverboundedrationalityandrational
inattention.Thethird(7thAprilMay5th)willcoverotherkeyareasofbehavioraleconomics.

3rdFeb:Introduction,MathematicalPreliminaries(OrderTheory):
Readings:
o ElementsofOrderTheoryEfeOk,ChapterA
o RealAnalysiswithEconomicApplications,EfeOk,ChapterB
Assignments
o Problemset

th
10 Feb:Choice,UtilityMaximizationandRevealedPreference:NonParametrictestsforutility
maximizingbehavior,andmeasuresofhowfarpeoplearefromsatisfyingtheserestrictions
Readings
o NotesontheTheoryofChoice,DavidKreps,Chapter13
o RevealedPreferenceVarian,H.InSamuelsonianEconomicsandtheTwentyFirst
Century,2006
o TheMoneyPumpasaMeasureofRevealedPreferenceFedeEchenique,
SangMokLeeandMattShum,JournalofPoliticalEconomy2011
o "WhoIs(More)Rational?,"AmericanEconomicReview,AmericanEconomic
Association,vol.104(6),pages151850,June.SyngjooChoi,ShacharKariv,Wieland
Mueller,DanSilverman,2011

Assignments
o Problemset

24thFeb:MathematicalPreliminaries(MeasureTheory),ExpectedUtilityforRisk,ExpectedUtility
underUncertainty:Coveringthebasicsofmeasuretheory(whichisusefulofmodellinguncertain
events)andtheaxiomaticstructureunderlyingtheexpectedutilitymodelforriskanduncertainty

Readings
o ProbabilityTheorywithEconomicApplications,EfeOkChapterB
o RealAnalysiswithEconomicApplications,EfeOk,ChapterF
o NotesontheTheoryofChoice,DavidKreps,Chapter49
Assignments
o Problemset

3rdMarch:ChoiceoverMenusandStochasticChoice:Extendingtherevealedpreferencemethodtothe
caseofmenupreferences,stochasticchoiceandthelinkbetweenthetwoReadings

o "ARepresentationTheoremforPreferenceforFlexibility,"DavidKreps,
Econometrica,EconometricSociety,vol.47(3),pages56577,May1979
o "RepresentingPreferenceswithaUniqueSubjectiveStateSpace,"EddieDekel,Bart
LipmanandAldoRustichini,Econometrica,July2001.
o RevealedStochasticPreference,McFadden,D.andM.Richter,mimeo,
DepartmentofEconomics,MIT,1970.
o TheChoiceAxiomafterTwentyYears,Luce,R.D.,JournalofMathematical
Psychology,15:2152331977
o RandomExpectedUtilityFarukGulandWolfgangPesendorfer.Econometrica,
74(1):121146,2006.
o PreferenceforFlexibilityandRandomChoiceDavidAhnandToddSarver,
Econometrica,January2013
o PreferenceforFlexibilityandRandomChoice:AnExperimentalAnalysisMark
DeanandJohnMcNeill,Memo,2014

th
10 March:BoundedRationalitywithLimitedAttention:Webeginourstudyofboundedrationalityby
consideringwhatwecansayaboutbehaviorifwedonotknowwhatinformationadecisionmakerhas
processed
Readings
o "RevealedAttention"Y.Masatlioglu,D.NakajimaandE.Ozbay,AmericanEconomic
Review,2012
o Search,ChoiceandRevealedPreferenceAndrewCaplinandMarkDean,
TheoreticalEconomics,January2011,6:1948

SearchandSatisficingAndrewCaplin,MarkDeanandDanielMartin,American
EconomicReview,2011
o ATestableTheoryofImperfectPerceptionAndrewCaplinandDanielMartin,
EconomicJournal,2014
Assignments(presentations)
o "StochasticChoiceandConsiderationSets,"Paola,Manzini&Marco,Mariotti,SIRE
DiscussionPapers201328,2013
o "ConsiderationSetsandCompetitiveMarketing,",KfirEliaz&RanSpieglerReview
ofEconomicStudies,2011
o

17stMarch:RationalInattention:Modelsinwhichdecisionmakerschooseoptimallywhatinformation
togatherinthefaceofcosts
Readings
o RevealedPreference,RationalInattention,andCostlyInformationAcquisition
AndrewCaplinandMarkDean,Mimeo,2014
o Foundationsforoptimalattention.AndrewEllis.Mimeo,BostonUniversity,2012.
o RationallyInattentivePreferences(December20,2014).deOliveira,Henriqueand
Denti,TommasoandMihm,MaximilianandOzbek,KemalAvailableatSSRN

Assignments(presentations)
o SalienceandConsumerChoice",PedroBordalo,NicolaGennaioliandAndrei
Shleifer,Mimeo,2012
o Testingmodelsofconsumersearchusingdataonwebbrowsingandpurchasing
behavior.BaburDeLosSantos,AliHortacsu,andMatthijsR.Wildenbeest.
AmericanEconomicReview,2012

st
31 March:Entropy:Usingentropyasameasureofinformationcosts
Readings
o "RationalInattentiontoDiscreteChoices:ANewFoundationfortheMultinomial
LogitModel."Matjka,Filip,andAlisdairMcKay.2015.AmericanEconomicReview,
105(1):27298.
o RevealedPreference,RationalInattention,andCostlyInformationAcquisition
AndrewCaplinandMarkDean,Mimeo,2014
o Foundationsforoptimalattention.AndrewEllis.Mimeo,BostonUniversity,2012.

Assignments(presentations)
o AnOptimizingNeuroeconomicModelofDiscreteChoice.Woodford,Michael.No.
w19897.NationalBureauofEconomicResearch,2014.
o Rationallyinattentiveseller:Salesanddiscretepricing,FilipMatejka,CERGEEI
WorkingPaperswp408,TheCenterforEconomicResearchandGraduateEducation
EconomicInstitute,Prague,March2010.


7thApril:TemptationandSelfControl:Approachestomodelingdecisionmakerswhosufferfrom
temptationandselfcontrolproblems
Readings
o TemptationandSelfControlFarukGulandWolfgangPesendorfer,Econometrica,
2001
o "ADualSelfModelofImpulseControl,"DavidK.Levine&DrewFudenberg
AmericanEconomicReview,AmericanEconomicAssociation,vol.96(5),pages1449
1476,December2006
Assignments(presentations)
o SelfControlatWork,SupreetKaur,MichaelKremerandSendhilMullainathan,
Mimeo,2013,
o CommitmentvsFlexibilityManuelAmador&IvnWerning&GeorgeMarios
Angeletos,2006.Econometrica,EconometricSociety,vol.74(2),pages365396,03.

14thApril:ViolationsofExpectedUtility:Introducingcommonviolationsofexpectedutilityincasesof
riskanduncertainty

Readings
o "ATheoryofDisappointmentAversion,"Gul,Faruk,Econometrica,EconometricSociety,
vol.59(3),pages66786,May.1991
o AGenuineRankDependentGeneralizationoftheVonNeumannMorgenstern
ExpectedUtilityTheorem,",Abdellaoui,M.,2002,Econometrica,70,717{736.
o "AmbiguityAversion,Robustness,andtheVariationalRepresentationofPreferences,"
Maccheroni&MassimoMarinacci&AldoRustichini,2006.Econometrica,Econometric
Society,vol.74(6),pages14471498,November
o Maxminexpectedutilitywithnonuniqueprior,"Gilboa,I.andD.Schmeidler(1989):
JournalofMathematicalEconomics,18,141{153.

Assignments(presentations)
o "DevelopmentsinNonexpectedUtilityTheory:TheHuntforaDescriptiveTheoryof
ChoiceunderRisk,"ChrisStarmer,JournalofEconomicLiterature,2000
o YHalevy.EllsbergRevisited:AnExperimentalStudy.Econometrica,75(2):503536,
2007.

21stApril:TimePreferences:Modelingthechoicesofdecisionmakersfacedwithchoicesthathavea
temporalelement

Readings

o
o
o
o

"AxiomatizationandMeasurementofQuasihyperbolicDiscounting,"J.L.MontielOlea&
TomaszStrzalecki,WorkingPaper8367,HarvardUniversityOpenScholar.
GoldenEggsandHyperbolicDiscounting,Laibson,David.QuarterlyJournalof
Economics1997
NevermindtheHyperbolicsIanCrawford,Mimeo,2013
CreditConstraintsandtheMeasurementofTimePreference

Assignments(presentations)
o "EstimatingTimePreferencesfromConvexBudgets,"JamesAndreoni&Charles
Sprenger,2012.AmericanEconomicReview,AmericanEconomicAssociation,vol.
102(7),pages333356,December.
o Strotzmeetsallais:Diminishingimpatienceandthecertaintyeffect.YoramHalevy.
AmericanEconomicReview,98(3):114562,2008.

th
28 April:ReferenceDependence:Howdoreferencepointsaffectchoicebehavior?

Readings
o "AModelofReferenceDependentPreferences,"BotondKoszegiandMatthewRabin,
2006;TheQuarterlyJournalofEconomics,MITPress,vol.121(4),pages11331165,
November)
o Advancesinprospecttheory:cumulativerepresentationofuncertainty,"Tversky,A.
andD.Kahneman(1992):JournalofRiskandUncertainty,5,297{323.
o Lossaversioninrisklesschoice:Areferencedependentmodel.AmosTverskyand
DanielKahneman.TheQuarterlyJournalofEconomics,106(4):103961,November
1991.
Assignments(presentations)
o "Rationalchoicewithstatusquobias,"Masatlioglu,Yusufcan&Ok,EfeA,Journalof
EconomicTheory,Elsevier,vol.121(1),pages129,March.
o StochasticReferencePoints,LossAversionandChoiceunderRisk,Masatlioglu,
YusufcanandRaymond,Colin,Mimeo

5thMay:NeuroeconomicsandNonChoiceData:Aquicklookintotheuseofnonchoicedataand
neuroeconomicstotesteconomicmodels

Readings
o "WhatCanNeuroeconomicsTellusAboutEconomicDecisionMaking?Mark
Dean,ChapterinComparativeDecisionMaking,PhilipCrowleyandThomasZentall,
eds,2013

"Neuroeconomics:HowNeuroscienceCanInformEconomics,"Camerer,C.,
Loewenstein,G.,andD.Prelec.,JournalofEconomicLiterature,AmericanEconomic
Association,vol.43(1),pages964,March.
o Dopamine,RewardPredictionError,andEconomics,Caplin,A.andMarkDean,
QuarterlyJournalofEconomics,123:2(2008),663702.
o "MeasuringBeliefsandRewards:ANeuroeconomicApproach,"Caplin.A,&Mark
Dean&PaulW.Glimcher&RobbB.Rutledge,2010.,TheQuarterlyJournalof
Economics,MITPress,vol.125(3),pages923960,August.
o Decisionfieldtheory:adynamiccognitionapproachtodecisionmaking.
Busemeyer,J.R.,Townsend,J.T.,1993.PsychologicalReview100,432459.
o "DetectingFailuresofBackwardInduction:MonitoringInformationSearchin
SequentialBargaining."Johnson,EricJ.;Camerer,Colin;Sen,SankarandRymon,
Talia.JournalofEconomicTheory,2002,104(1),pp.1647
Assignments(presentations)
o Preparepresentationofresearchideas
o

12thMay:PresentationofResearchIdeas