Intermediate microeconomics
• Before Monday: read the literature (available on blackboard)
• Monday: online lecture 11.00-12.45
• With a problem set you can test your knowledge. On Monday morning will be
announced on blackboard which problems will be discussed in class.
• Wednesday: tutorial 13.15-15.00 to discuss some problems. Wednesday evening all
the answers to the problem set will be available online
Week 40: midterm covering all the material of the previous weeks
Week 44: endterm covering all the material
Week 8
Fehr and Schmidt (1999) – A theory of fairness, competition and cooperation
Economic models assume that people only look to their self-interest and not care about
social goals, but this is not true. People can increase utility from fairness/social goals. There
is one long formula for U, with alfa, beta and x.
If alfa is greater than or equals beta, the player suffers more from inequality that is to his
disadvantage, so the person is loss averse in social comparisons.
If beta if between one and zero or equals zero, the existence of people who like to be better
off tan others is ruled out.
Akerlof and Kranton (2000) – Economics and identity
This paper looks to identity and how it can affect economic outcomes. Identity is categorized
with different social categories and the behavior of people in those categories. Identity can,
according to this paper, be a motivation for behavior.
Utility depends on:
• Your own actions à self-mutilation = you can change your own bodie as an
expression of identity (tattooing for example)
• Others’ actions à a woman working in a ‘man’s’ job may make male colleagues feel
less like men. The men can act against the female co-workers or change their own
identity a bit.
• Identity or self-image, which depends on your own actions, others’ actions, the social
status of the social categories your in and the extent to which your own
characteristics match the ideal of your category à people choose their own identity
by choosing for example where to live.
• Manipulating your social categories, for example by schools.
The paper gives a prototype model of economics and identity, explained through an
example. Suppose there are two persons from different social categories, student 1
suggesting continuing hazing (=ontgroening) (activity A) and student 2 wants to stop hazing
(activity B). First student 1 chooses and then student 2 and student 1 can choose to
intimidate student 2 after both have chosen.
Conclusion: identity can explain behavior and the choice of identity may be the most
important economic decision people make.
,Levitt and List (2007) – What do laboratory experiments measuring social preferences reveal
about the real world?
In this paper, a model is developed in which utility-maximization is influenced by both
wealth-maximization and morality. It can be used to test the accuracy of laboratory
experiments.
A utility-maximizing individual can choose a single action a, which affects the agent’s wealth
W and the moral cost or benefit M associated with the action.
M is affected by the financial externality that an action imposes on others (the more
negative the impact on others, the more negative the moral payoff), social norms n and the
nature and the effect of scrutiny s.
U(a,L,n,s) = M(a,L,n,s) + W(a,L)
Conclusion: combining the model with laboratory analysis expands the role of those
experiments. And you can test the potential weaknesses of the lab and the usefulness of
experiments.
, Week 7
There are five types of games with assymetric information:
• Moral hazard with hidden actions (to be followed)
• Adverse selection à nature chooses Smith’s type (payoff, strategies, etc.),
unobserved by Jones. Smith and Jones then agree to a contract. Information is
incomplete.
• Mechanism design in adverse selection and in moral hazard with hidden information
à Jones designs a contract for Smith designed to elicit Smith’s private information.
This may happen in both adverse selection (Smith knows the information prior to
contracting) and moral hazard (Smith will learn it after contracting).
• Signalling and screening à nature chooses Smith’s type, not observed by Jonas. Then
Smith takes actions that Jones can observe, which demonstrate his type. If Smith
takes the action before contracting, he is signalling, if he takes afterwards, he is being
screened. Information is incomplete.
In the production game, the principal offers the agent a wage w, the agent decides whether
to accept or reject the contract, if he accepts, he exerts effort e leading to output q(e).
If the agent rejects, the payoff of the principal is zero and of the agent the reservation utility.
If the agent accepts, the payoff of the principal is V(q-w) and of the agent U(e,w).
Usually, either the principal or the agent is one of many perfect competitors.
There are five versions of the production game:
• I: Full information à every move is common knowledge, and the contract is a
function w(e). The equilibrium is the best possible contract for the principal, given
that it must be acceptable for the agent.
• II: Full information, agent moves first à every move is common knowledge, and the
contract is a function w(e). This time the agents offers the contract, and the principal
accepts or rejects. If he accepts, the agent exerts effort e. The agent will maximize his
payoff by driving the principal to exactly zero profits, so w(e) = q(e). But the effort
level will stay the same as for I, so is doesn’t matter for the effort who has the
bargaining power.
• III: A flat wage under certainty à the principal can condition the wage neither on
effort nor on output. This leads to an inefficient outcome, with the agent accepting
the job if the wage is not negative, so the principal offers a wage of zero and the
effort will be zero.
• IV: An output-based wage under certainty à the principal cannot observe effort but
can observe output. Now the principal picks a wage out of function w(q). This shows
that unobservability of effort is not a problem, as long as the contract can be
conditioned on something which is observable and perfectly correlated with effort.
• V: Output-based wage under uncertainty à the principal cannot observe effort but
can observe output and specify the contract to be w(q). But the output is not only
based on effort, but also the depends on the state of the world, chosen by Nature,
which will be done as a move after all the other moves.
Frey (1993) – motivation as a limit to pricing
Pricing = a monetary reward in the principal-agent relationship.
• Before Monday: read the literature (available on blackboard)
• Monday: online lecture 11.00-12.45
• With a problem set you can test your knowledge. On Monday morning will be
announced on blackboard which problems will be discussed in class.
• Wednesday: tutorial 13.15-15.00 to discuss some problems. Wednesday evening all
the answers to the problem set will be available online
Week 40: midterm covering all the material of the previous weeks
Week 44: endterm covering all the material
Week 8
Fehr and Schmidt (1999) – A theory of fairness, competition and cooperation
Economic models assume that people only look to their self-interest and not care about
social goals, but this is not true. People can increase utility from fairness/social goals. There
is one long formula for U, with alfa, beta and x.
If alfa is greater than or equals beta, the player suffers more from inequality that is to his
disadvantage, so the person is loss averse in social comparisons.
If beta if between one and zero or equals zero, the existence of people who like to be better
off tan others is ruled out.
Akerlof and Kranton (2000) – Economics and identity
This paper looks to identity and how it can affect economic outcomes. Identity is categorized
with different social categories and the behavior of people in those categories. Identity can,
according to this paper, be a motivation for behavior.
Utility depends on:
• Your own actions à self-mutilation = you can change your own bodie as an
expression of identity (tattooing for example)
• Others’ actions à a woman working in a ‘man’s’ job may make male colleagues feel
less like men. The men can act against the female co-workers or change their own
identity a bit.
• Identity or self-image, which depends on your own actions, others’ actions, the social
status of the social categories your in and the extent to which your own
characteristics match the ideal of your category à people choose their own identity
by choosing for example where to live.
• Manipulating your social categories, for example by schools.
The paper gives a prototype model of economics and identity, explained through an
example. Suppose there are two persons from different social categories, student 1
suggesting continuing hazing (=ontgroening) (activity A) and student 2 wants to stop hazing
(activity B). First student 1 chooses and then student 2 and student 1 can choose to
intimidate student 2 after both have chosen.
Conclusion: identity can explain behavior and the choice of identity may be the most
important economic decision people make.
,Levitt and List (2007) – What do laboratory experiments measuring social preferences reveal
about the real world?
In this paper, a model is developed in which utility-maximization is influenced by both
wealth-maximization and morality. It can be used to test the accuracy of laboratory
experiments.
A utility-maximizing individual can choose a single action a, which affects the agent’s wealth
W and the moral cost or benefit M associated with the action.
M is affected by the financial externality that an action imposes on others (the more
negative the impact on others, the more negative the moral payoff), social norms n and the
nature and the effect of scrutiny s.
U(a,L,n,s) = M(a,L,n,s) + W(a,L)
Conclusion: combining the model with laboratory analysis expands the role of those
experiments. And you can test the potential weaknesses of the lab and the usefulness of
experiments.
, Week 7
There are five types of games with assymetric information:
• Moral hazard with hidden actions (to be followed)
• Adverse selection à nature chooses Smith’s type (payoff, strategies, etc.),
unobserved by Jones. Smith and Jones then agree to a contract. Information is
incomplete.
• Mechanism design in adverse selection and in moral hazard with hidden information
à Jones designs a contract for Smith designed to elicit Smith’s private information.
This may happen in both adverse selection (Smith knows the information prior to
contracting) and moral hazard (Smith will learn it after contracting).
• Signalling and screening à nature chooses Smith’s type, not observed by Jonas. Then
Smith takes actions that Jones can observe, which demonstrate his type. If Smith
takes the action before contracting, he is signalling, if he takes afterwards, he is being
screened. Information is incomplete.
In the production game, the principal offers the agent a wage w, the agent decides whether
to accept or reject the contract, if he accepts, he exerts effort e leading to output q(e).
If the agent rejects, the payoff of the principal is zero and of the agent the reservation utility.
If the agent accepts, the payoff of the principal is V(q-w) and of the agent U(e,w).
Usually, either the principal or the agent is one of many perfect competitors.
There are five versions of the production game:
• I: Full information à every move is common knowledge, and the contract is a
function w(e). The equilibrium is the best possible contract for the principal, given
that it must be acceptable for the agent.
• II: Full information, agent moves first à every move is common knowledge, and the
contract is a function w(e). This time the agents offers the contract, and the principal
accepts or rejects. If he accepts, the agent exerts effort e. The agent will maximize his
payoff by driving the principal to exactly zero profits, so w(e) = q(e). But the effort
level will stay the same as for I, so is doesn’t matter for the effort who has the
bargaining power.
• III: A flat wage under certainty à the principal can condition the wage neither on
effort nor on output. This leads to an inefficient outcome, with the agent accepting
the job if the wage is not negative, so the principal offers a wage of zero and the
effort will be zero.
• IV: An output-based wage under certainty à the principal cannot observe effort but
can observe output. Now the principal picks a wage out of function w(q). This shows
that unobservability of effort is not a problem, as long as the contract can be
conditioned on something which is observable and perfectly correlated with effort.
• V: Output-based wage under uncertainty à the principal cannot observe effort but
can observe output and specify the contract to be w(q). But the output is not only
based on effort, but also the depends on the state of the world, chosen by Nature,
which will be done as a move after all the other moves.
Frey (1993) – motivation as a limit to pricing
Pricing = a monetary reward in the principal-agent relationship.
