Bestiary of Behavioral Economics/Self-Interest

Definition and Use in Classical Economics

The concept of self-interest and its application in classical economics is distinct from that of the related notion of selfishness. Although often used interchangeably in everyday speech, within economics these terms can mean very different things. In The Theory of Moral Sentiments, intellectual father of capitalism Adam Smith explains the difference between the two words in terms of their effect on society. Smith argues that society benefits when an individual acts in one’s own self-interest, while selfish actions result in the creation of one individual’s happiness at the cost of another’s.

In order to grasp the idea of self-interest, one could examine the actions of homo economicus, a hypothetical figure within classical economics whose actions are completely rational. Homo economicus is said to operate according to the self-interest axiom, which is “the assumption that individuals seek to maximize their own material gains in
interactions and expect others to do the same”. Thus , according to the axiom of self-interest, a rational man will always behave in ways that maximize his own well-being .

Self-Interest in Behavioral Economics

As a field of study, behavioral economics developed out of the inability of classical economics to adequately predict the actions of individuals. The discipline integrates psychology, sociology, and pure economic theory with the intention of creating a more accurate understanding of how humans make economic decisions. Behavioral economics challenges the axiom of self-interest by investigating circumstances in which individuals are motivated by factors other than self-betterment. The following sections will explore instances of human behavior that differ from the predicted rational decisions of homo economicus.

The Extent of Self-Interest

While classic economic theory describes individuals as being primarily motivated by self-interest, behavioral economics argues that psychological and societal influences hinder one’s ability to pursue their own self-interest. In his thought-provoking work Predictably Irrational, Duke University professor of psychology and behavioral economics Dan Ariely discusses the results of his research into the limitations of self-serving behavior. Intrigued by the large gap between financial losses due to robberies and losses caused by employer fraud, Ariely conducted a series of experiments at large universities across the United States. One experiment, originally performed at the Harvard School of Business, was designed to investigate how the opportunity to act in one’s own self-interest influences behavior.

The study tested four groups, the first of which was asked to complete a fifty question multiple choice test, transfer their answers to a bubble sheet, and report their score to the administrator, who would give the subject ten cents for each correct answer. Each successive group encountered the same multiple choice exam, but was tempted to cheat in some way. Group Two was given a bubble sheet that had the correct answers pre-bubbled in, Group Three was able to shred their test and just hand in the pre-answered bubble sheet, and Group Four was given the opportunity to destroy both their bubble sheet and their exam and then remove the appropriate amount of money from a jar at the front of the testing room.

The results from the above experiment were as follows: Group One averaged a score of 32.6 questions out of 50, Group Two reported 36.2 correct answers, Group Three averaged 35.9, and Group Four claimed to answer 36.1 correctly. Perhaps what is most intriguing about this data is that it suggests that individuals, when given the opportunity, will act in their own self-interest, but only to a certain extent. Subjects in Group Four could have easily reported perfect scores and collected $5.00 from the jar, yet they only boosted their earnings by an average of $.35. Ariely’s research suggests that there is some factor other than self-interest that influences the decision-making process.

Reputation and Conscience

Within social situations, perhaps two of the greatest influences on behavior are peer judgment and the desire to maintain a reputation. According to professor of moral philosophy Francis Hutcheson, self-interest is counter-acted by the need to be accepted by others. In addition to his above-mentioned work on the extent to which individuals will pursue their own self-interest, Dan Ariely conducted an experiment at the University of California in Los Angeles to investigate how imposed value systems affect behavior.

Ariely’s study was simple in its design: three groups, each subject to different testing conditions, took a ten question multiple-choice exam. Group One served as a control group and was not given the opportunity to cheat on the test, while groups Two and Three received a pre-bubbled answer sheet. Members of Group Two were given the additional instructions to construct a list of ten books they read over the summer before attempting the questions. Similarly, subjects in Group Three were prompted to list the Ten Commandments before beginning the test

The results of this investigation suggest that humans do respond to external judgment, or at the very least perceived social judgment. Group One, the control group, established an average score on the exam of 3.1. Group Two, likely because of their access to the correct answers, obtained a slightly higher score of 4.1. One may have postulated that Group Three would also achieve an above-average score, as they had been given the pre-bubbled answer sheet as well. However, this group only managed to answer 3 out of the ten questions correctly. In his work Predictably Irrational, Dan Ariely postulates that being forced to recall socially constructed systems of morality effectively strengthens one’s conscience. In other words, reminding individuals of appropriate ethical conduct increases the probability that they will adhere to these behaviors, despite the fact that they may conflict with their own self-interest.

Cross-Cultural Evidence Against Self-Interest

Thus far, our discussion of the self-interest axiom has relied entirely upon experiments which took place within the United States. Although there is certainly value in investigating the behavior of individuals within a capitalist society, failing to consider other societies would result in an extremely narrow understanding of human nature. This section will seek to explore how self-interest manifests itself in societies whose economic and social structures differ from those of the United States.

In the mid 1990s, a group of curious behavioral economists designed and conducted a cross-cultural experiment that investigated the degree to which members of other societies pursue their own self-interest. The experiment consisted of three simulations in fifteen small-scale societies around the world. The societies chosen spanned four continents and represented a wide variety of economic systems, ranging from nomadic herding to slash-and-burn horticulture .

The first simulation is more commonly referred to as the Ultimatum Game. The game is played with two players, the first of which is given the ability to divide a sum of money and offer a portion to player two. Player two can then either accept player one’s offer, in which case both players receive their money, or player two can reject the offer, in which case both players leave empty-handed. Game theorists argue that, if a completely rational individual were to play the Ultimatum Game, as player one they would offer the lowest portion of the money and as player two they would accept any non-zero offer. From the point of view of this rational player, simply leaving the game with more than they entered makes them better off. When the Ultimatum Game is played in the United States, the average offer made by player one is between 43% and 48%. In this study, the mean offer ranged from 26% to 58%. Several societies also had curious reactions to certain offers. For example, the Machiguenga, a hunter-gatherer society, rejected only one offer, even though three-quarters of all offers made were below 30%. Also interesting is the way in which the Au and Gnau of Papau New Guinea rejected both extremely low and extremely high offers, perhaps suggesting that the latter divisions were too fair .

The next simulation used is similar to the Ultimatum Game, but player two is not able to reject the offer. This game is often used to remove the possibility that players are making offers out of fear of rejection. American subjects playing this game have a modal offer of 0%, which is consistent with the predicted “rational” division. Of the fifteen societies studied, only two exhibited behavior similar to that of Americans . These results indicate that something other than self-interest is affecting the way in which members of other societies make economic decisions.

The last simulation explores how individuals behave when their own interests interfere with those of society. These interactions are known as Public Goods Games, and the primary simulation used in this study was the Voluntary Contributions Game. In the Voluntary Contributions Game, each player receives an endowment at the beginning of the round. Players must then choose how much of this sum they wish to contribute to a communal pot, the contents of which are doubled and then redistributed at the end of the round. Completely rational players would choose to donate nothing to the community and earn money off the generosity of other players. Some societies, such as the Orma and Huinca, defy this behavior with modal contributions at 100% and 40%-50%, and with no instances of defection . Such evidence suggests that the axiom of self-interest cannot adequately predict the general behavior of all cultures.