From subjective expected utility theory to bounded rationality [Elektronische Ressource] : an experimental investigation on categorization processes in integrative negotiation, in committees

From subjective expected utility theory to bounded rationality [Elektronische Ressource] : an experimental investigation on categorization processes in integrative negotiation, in committees', decision making and in decisions under risk / vorgelegt von Livia Reina

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Technische Universität Dresden - Fakultät Wirtschaftswissenschaften - From Subjective Expected Utility Theory to Bounded Rationality: An Experimental Investigation on Categorization Processes in Integrative Negotiation, in Committees’ Decision Making and in Decisions under Risk Dissertationsschrift Zur Erlangung des akademischen Grades eines Dr. rer. pol. der Wirtschaftswissenschaften Vorgelegt von Livia Reina, Dottoressa in Scienze Politiche e in Economia betreut durch Herrn Prof. Dr. Lehmann-Waffenschmidt Dresden, im April 2005 To my parents Acknowledgment I would like to thank Prof. Luigi Mittone for his supervision of the experimental part of this work, and for giving me the chance to carry out my experiments at the CEEL (Computable and Experimental Economics Laboratory) of the University of Trento, with the financial support of TECS (Technologies for Experimental and Computational Economics). Index pp. Introduction 1 Section 1 Normative and descriptive approaches to decision making 11 Introduction 11 1.1 From Subjective Expected Utility Theory (SEUT) to Bounded Rationality 12 1.2 Bringing psychology into economics 24 1.3 Experimental Economics 46 1.3.1 The experimental method 46 1.3.2 Experimental evidence on bounded rationality 50 Section 2 Categorization 67 Introduction 67 2.

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Technische Universität Dresden
- Fakultät Wirtschaftswissenschaften -


From Subjective Expected Utility Theory to
Bounded Rationality:
An Experimental Investigation on Categorization
Processes in Integrative Negotiation, in Committees’
Decision Making and in Decisions under Risk


Dissertationsschrift

Zur Erlangung des akademischen Grades eines
Dr. rer. pol. der Wirtschaftswissenschaften



Vorgelegt von

Livia Reina, Dottoressa in Scienze Politiche e in Economia



betreut durch

Herrn Prof. Dr. Lehmann-Waffenschmidt





Dresden, im April 2005

To my parents



Acknowledgment

I would like to thank Prof. Luigi Mittone for his supervision of the experimental part of
this work, and for giving me the chance to carry out my experiments at the CEEL
(Computable and Experimental Economics Laboratory) of the University of Trento,
with the financial support of TECS (Technologies for Experimental and Computational
Economics).

Index




pp.

Introduction 1


Section 1 Normative and descriptive approaches to
decision making 11

Introduction 11

1.1 From Subjective Expected Utility Theory (SEUT) to
Bounded Rationality 12

1.2 Bringing psychology into economics 24

1.3 Experimental Economics 46

1.3.1 The experimental method 46

1.3.2 Experimental evidence on bounded rationality 50


Section 2 Categorization 67

Introduction 67

2.1 The concepts of category and categorization 68

2.2 The cognitive and the psychophysical approaches to
categorization 77

2.2.1 General knowledge (GK) categories 78

2.2.2 Sensory perception (SP) Categories 81

2.3 Categorical Perception (CP) 84



Section 3 An experimental study on categorization
processes in bilateral integrative negotiation 95

Introduction 95

3.1 Integrative negotiation 96

3.2 Experiment 102

Appendix A 119
B 121


Section 4 An experimental study on categorization processes
in committees’ decision making with logrolling 123

Introduction 123

4.1 Logrolling in the public choice 124

4.2 Experiment 1 130

4.3 2 140

4.4 Experiment 3 145

Appendix A 151
B 153

Appendix C 155


Section 5 An experimental study on categorization
processes in decisions under risk 157

Introduction 157


5.1 Bounded rationality and probabilistic decision making 158

5.2 Experiment 184

Appendix A 204
B 206


Conclusions 217


References 219

Tables and figures index


Tables:
pp.
Tab. 1.1 Normative theories of decision making 15
Tab. 1.2 Example of a payoff matrix 16
Tab. 1.3 Costs and benefits of subscribing the insurance 32
Tab. 1.4 Payoffs and regret matrixes 32
Tab. 3.1 Experimental results of the policy makers 113
Tab. 3.2 Experimental results of the students 114
Tab. 4.1 Example of logrolling 126
Tab. 4.2 Logrolling and government spending 127
Tab. 4.3 Results experiment 1 137
Tab. 4.4 Reexperime2 142
Tab. 4.5 Results experiment 3 with majority rule 148
Tab. 4.6 Reent 3 with unanimity rule 149
Tab. 5.1 Payoffs in the speed problem 189
Tab. 5.2 Expected payoffs in the speed problem 190
Tab. 5.3 Payoffs in the taxes problem 191
Tab. 5.4 Expected payoffs in the taxes problem 191
Tab. 5.5 Number of steps above the sure option (positive frame) 202
Tab. 5.6 Number of steps above the sure option (negative frame) 203


Figures:

Fig. 1.1 The utility function 14
Fig. 1.2 mini-ultimatum games 54
Fig. 1.3 The attraction effect 60
Fig. 1.4 Extremeness aversion 63
Fig. 2.1 Stimulus configurations 71
Fig. 2.2 The five steps of categorization 75

Fig. 2.3 Categorical Perception 85
Fig. 2.4 Predictions of Prototype and CP models 92
Fig. 3.1 2-issues bilateral negotiation 98
Fig. 3.2 Logrolling 99
Fig. 3.3 Satisficing 104
Fig. 3.4 Treatment A and B 108
Fig. 3.5 Treatment A – Space of agreements 111
Fig. 3.6 Treatment B – Space of agreements 111
Fig. 3.7 Experimental results of the policy makers: treatment A 115
Fig. 3.8 Experimental results of the policy maent B 115
Fig. 3.9ental results of the students: treatment A 116
Fig. 3.10 Experimeent B 116
Fig. 4.1 3 issues and 3 parties logrolling 133
Fig. 4.2 Results exp. 1 138
Fig. 4.3 exp.2 142
Fig. 4.4 Synthesis of the results of exp. 1 and 2 144
Fig. 4.5 4 issues and 4 parties logrolling 146
Fig. 4.6 Resultes exp. 3 – Majority rule 148
Fig. 4.7 – Unanimity 149
Fig. 4.8 Synthesis results exp. 3 150
Fig. 5.1 The value function 175
Fig. 5.2 Weighting 178
Fig. 5.3 The speed problem 185
Fig. 5.4 taxes 186
Fig. 5.5 Example for a speed limit of 25 193
Fig. 5.6 Categorization of the options 194
Fig. 5.7 Binary choices in the third session 197
Fig. 5.8 Results 200


Introduction

The objective of this work is to provide experimental evidence in relation to the topic of
bounded rationality in economic decision making. I report three experimental studies,
one on integrative negotiation, one on committees’ decision making with logrolling, and
one on the perception of risk, that I carried out with the aim to analyse the implications
of categorization processes in human decision making. The purpose of the experiments
is to test the hypothesis that people do not behave according to the perfect rationality
and maximization assumptions of Subjective Expected Utility Theory (SEUT), which
underlie many economic models, but rather as satisficers who try to simplify complex
decision problems through the process of categorization.
Particular importance throughout this work has been given to the adoption of an
interdisciplinary approach by integrating psychological and economic perspectives, and
by transferring the concept of categorization from the psychological research to the
study of economic decision making.

For a long time decision making has been the object of study almost exclusively of
economists and mathematicians. As a consequence it is originally of a normative nature,
concerned with prescribing the course of action that most fully conforms to a decision
maker’s own goals, expectations and values.
Subjective Expected Utility Theory (SEUT) represents the most actual and widely
accepted normative theory of decision making, and bases its architecture on the
fundamental principles of perfect rationality and of utility maximization.
Much debate and empirical research has centred around the question of whether this
theory can actually describe both the goals that motivate real decision makers and the
process they employ when making their decisions.
The moment one moves beyond simple constrained settings, as those treated by SEUT,
to real-world situations, the time, knowledge, and computational capabilities that SEUT
demands in order to make decisions grow unfeasibly large.
1
Many experimental studies, indeed, have rigorously tested the foundations of SEUT,
and have given a solid proof that several axioms and principles underlying it are
systematically violated by individuals.

As an alternative to SEUT, in the 1950’s Herbert Simon introduced the theory of
bounded rationality which provides a new key for understanding how actual people
make decisions. This theory postulates that decision-makers avoid the problem of
evaluating utilities and comparing incommensurable features. Fundamental is the idea
that humans are constrained by limitations of time, knowledge, perception and
computational abilities, and that these limitations force individuals to construct
simplified and partial models of the world in order to deal with complexity.
In opposition to the concept of optimization, the key principle of bounded rationality is
that of “satisficing”, whereby individuals strive to attain some satisfactory, though not
necessarily maximal, level of achievement.
The exponents of the bounded rationality framework sustain that much of human
decision making cab be understood by examining the cognitive limitations that
constrain our ability to cope with complexity, and thus by taking into consideration the
evidence coming from the psychological research. The attempt to incorporate
psychological aspects into economic models of decision making has given birth to a
new discipline, Experimental Economics, which has the purpose to test the actual
correspondence between economic theories of human behavior and empirical data, and
to generate new theoretical models or corrections to the original ones.
One of the most consistent conclusions drawn from economic-psychological
experiments is that human decision making is guided by heuristics which are
simplifying strategies, or rules of action, that allow to take decisions with limited time
and knowledge and do not require to compute probabilities and utilities.

An example of simplifying strategy is represented by the process of categorization.
Economics, with the exception of the research on consumer behavior, has paid very
little attention to this topic. The reasons for that probably have to do, among other
things, with the particular nature of the research. It is rare to derive in this vein simple
2