Experimental economics and small decision-making problems

Abstract

This thesis aims at pursuing an extensive investigation into decision making in small decision-making problems with the tool of experimental economics. A typical small decision-making problem is characterised by three critical features: first, it involves repeated tasks; the decision maker faces the same choice problem many times in similar situations. Second, each single choice is of little consequence in terms of net payoff; the alternatives tend to have similar expected value that may be fairly small. Finally, in choosing among the possible alternatives, the decision maker will have to rely on the immediate and unbiased feedback obtained in similar situations in the past. The importance of shedding light on the economics of small decisions is twofold. The first is that nowadays many common economic activities can be captured by small decision-making problems. Second, although each small decision conducted by the decision maker is not very important, the aggregate outcomes may be consequential and significant when repeated. In the first place, the author of this thesis deals with the question of propensities for individual decision making in small decision-making problems. To elicit an answer to the question, a series of economics experiments are conducted. The author identifies the ideas behind individual decision making in small decision making problems and assesses the observed outcomes. A substantial work of this thesis is based on the two experiments presented in this thesis: (1) the search experiment, and (2) the choice experiment. Among the results is the demonstration that in the search experiment the tendency to select best reply to the past and mis-estimation of the payoff distribution leads to robust deviations from maximisation. As for the choice experiment, it raises a discussion on appropriateness of the certainty effect in repeated-play decisions. I present the expected utility model, which shows even in small decision-making problems the certainty effect is appropriate. As well as the search and the choice experiment, this thesis conducts the ambiguity treatment experiment. The experiment includes the situation where the decision maker's payoff distribution is limited to either favourable distribution or unfavourable distribution. Results are analysed in the context of Bayesian updating. The first observation reveals loss aversion. The second observation includes the law of small numbers and deviations from maximisation. Finally, imperfect Bayesians are observed in the experiment. . Having finished fundamental analysis on small decision-making problems, I analyse a practical application of small decision-making problems and attempts to explain the observations in terms of the theory and experiments. It deals with the question of why a case of small decision-making problems is significant in our daily life. One practical application of small decision-making problems is concerned with individual officer's petty corrupt behaviour. I experimentally examine that it is caused by subjective underweighting of rare events and its objective probabilities. Results of an experiment reveal that the subjects tend to subjectively underweight rare outcomes in small decision-making problems. It is revealed that petty corrupt behaviour is a consequence of the theoretically-optimal behaviour. This is examined along with the expected utility model. Another practical application of small decision-making problems is concerned with a model of educational efforts in the context of individual learning in small decision-making problems. I will show that an individual student's optimal investment in education is shown to depend on what other students are doing. On the basis of this simple model, I establish how herding can influence the economic decision making into the formation of human capital: these important individual decisions may be predicated upon collective "whims" and "fashions" and not longrun economic consequences. I also offer a model of product quality in a simple duopoly as one of applications of small decision-making problems. I exploit the full-cost pricing models. Based on these two key features, I derive the dynamics that characterise the evolution of product quality. This thesis presents that duopolists retain and invoke a signal of quality of the items. A series of signals are discussed and investigated in the light of small decision-making problems.

Date of Award	2006
Original language	English