“If I had a dollar for every time an economist claimed that raising stakes would drive the ultimatum behaviour towards self-interest, I’d have a private jet on standby all day.”

This is an interesting read.

Excerpt from:

The empirical evidence against neoclassical utility theory: a review of the literature

"Economics is the queen of the social sciences because unlike any of the others, it offers a sharp and unambiguous analysis of this game. The proposer seeks to maximise his own monetary payoff. He will offer the responder $1, and keep $9 for himself. He is secure in the knowledge that the rational responder will not reject his offer – a rejection will give both $0, and the responder will prefer to get the $1 he has been offered. This is the unique utility maximising offer for the proposer. If he tries to keep all ten dollars and offers zero, he runs a risk of rejection, while there is no reason to go for less. This then is a Nash equilibrium of the game: The proposer offers the split ($9, $1), and the responder accepts all positive offers. Unfortunately, this prediction based on economic rationality bears no resemblance to the actual outcomes. A substantial number of proposers (though still a minority) offer a 50-50 split ($5, $5) based on considerations of equity and fair play2, even though this is not their best move in the economic sense. A majority of proposers offer 30% or more to the responders. They are aware that there is a risk of rejection if they offer less. Proposers who behave according to economic theory and offer only a small amount (less than 30%) are frequently rejected. This means that the responders act against their own best interests and refuse low percentage shares of money to punish the proposer for making an unfair offer – even when this ‘unjust’ percentage is large in absolute terms. In fields which have more contact with actual human behaviour, these ultimatum results cause no surprise. Ordinary human beings have trouble understanding what the fuss is all about; these results seem perfectly clear and natural. Only economists, conditioned to look at reality using wrong theories of human behaviour, are shocked and surprised by these results. In fact, these results run so strongly against the grain of economic thinking that no major economic journal would publish these results for a long time. There were standard objections to these clear results about actual human behaviour from orthodox economics (Fehr, 2003; Lewitt and List, 2007):

• results from a lab experiment would not generalise to the field of actual decisions in real economic environments
• monetary stakes in experiments were too low to induce people to think carefully about their decisions
• new and unfamiliar game conditions led people to make mistakes.

Camerer (2003, p.60) describes the skepticism of economists about ultimatum results as follows: “If I had a dollar for every time an economist claimed that raising stakes would drive the ultimatum behaviour towards self-interest, I’d have a private jet on standby all day.” Replication of these results in a wide variety of different context, with high stakes (equivalent to a month’s salary or more), with experienced players in realistic field experiments has led to the conclusion that these results are robust (Fehr and Schimdt, 2006). Economists have reluctantly accepted the validity of these results. Nonetheless, there has been no progress towards integrating these results into the body of economic theory; the flat contradiction between the assumptions of microeconomics and these observations of human behaviour make it unlikely that a resolution can be found which fits into the framework of orthodox theory.

The assumption of economists that people only care about their own share and not about fair and equitable distributions, leads economists to propose drastically wrong policies in the domains of taxation and income re-distribution. Norton and Ariely (2011) document substantial consensus in the US population abouth thedesire for a more equitable distribution of wealth. People think the distribution of wealth is more equal than it actually is; and they think it should be much more equal than their already unrealistically-equal notion of its current state. For example, the top 20% of the US wealth distribution actually controls nearly 85% of total wealth; people think the top 20% controls under 60%; and they think it should control just over 30%. Since concern for fairness is not currently part of economic theories, these issues get swept under the rug, to the detriment of all."

The paper concludes with a refreshing yet somber but also encouraging note.

"Today’s economists do not bother to check whether their theories are actually aligned with real world behaviour. All conventional economic textbooks use the axiomatic method to derive theoretical results which are never cross-checked against observations of the real world. The straitjacket of a wrong, pre-scientific, methodology can lead even the best minds to theories grossly in conflict with observations. Most of the current efforts at reform do not go far enough in challenging methodology. They seek to achieve conformity with observations while retaining existing economic methodology. We feel is that this is not sufficient. Radical methodological changes are required for progress. The world of economics awaits its Copernicus."

Asad Zaman and Mehmet Karacuka