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Behavioral Economics

Arthur O'Sullivan

Available: June 2022

ISBN: 9780197515952

Online Resource


The text is designed as the main text for an undergraduate course in Behavioral Economics, which is a growing course for students of economics at the undergraduate level. The presentation is grounded in microeconomics and traditional economic models to discuss observed human behavior. The book presents models that show the trade-offs between material benefits and social concerns. The models incorporate social concerns such as altruism, guilt, exploitation, fairness, and cognitive dissonance. Unlike many other books on behavioral economics, the text is not a catalog of human quirks. Although the book highlights all sorts of observed behavior that appears irrational and misguided, it doesn't stop there. It examines the possible motives for the puzzling behavior. For many misguided and regrettable choices, we highlight actions taken to control the behavior and mitigate the damage. We use the insights of anthropologists and economists to explore the role of natural selection in shaping human thinking and behavior. A decision that appears irrational today may be understandable in the context of millions of years of natural selection. Recent work explores the role of natural selection in (i) loss aversion, (ii) the endowment effect, (iii) time preferences, and (iv) responses to the free-rider problem.


  • Presents models that show the tradeoffs between material benefits and social concerns
  • Uses the insights of anthropologists and economists to explore the role of natural selection in shaping human thinking and behavior
  • Includes digital widgets that encourages interaction with the text

About the Author(s)

Arthur O'Sullivan is Dr. Robert B. Pamplin Jr. Professor of Economics at Lewis & Clark College. He is the author of Urban Economics, Ninth Edition (2019), the best-selling urban economics text, and co-author, with Steven Sheffrin and Stephen Perez, of Economics: Principles, Applications, and Tools, Tenth Edition (2020).

Table of Contents

    Part 1: Introduction

    Chapter 1. Introduction & Key Concepts of Microeconomics

    1. What is Behavioral Economics?
    2. Key Concepts of Microeconomics
    Opportunity Cost
    The Marginal Principle
    The Equimarginal Principle
    Nash Equilibrium
    Comparative Statics
    Pareto Efficiency
    Lotteries and Certainty Equivalent

    Chapter 2. Insights from Behavioral Science
    1. Social Preferences and Norms
    Adam Smith and the Impartial Spectator
    Rule Following Task: Avatar Pedestrian
    Sharing the Rewards of Collaboration
    Incurring a Cost to Enforce a Social Norm
    The 50-50 Norm
    2. Mental Shortcuts
    Mental Accounting
    Default Options
    3. Cognitive Bias
    The Decoy Effect
    Present Bias
    4. Problems with Probabilities
    Rare Events
    Gambler's Fallacy
    5. Instincts and Deliberation
    Apple versus Cupcake
    Hunting Practices of the Ju/'hoansi
    Why Do We Do That?
    Appendix to Chapter 2
    1. Anchors
    2. Confirmation Bias
    3. Overconfidence Effect
    4. Availability Heuristic

    Part 2: Social Preferences

    Chapter 3. Social Norms: Sharing and Enforcement

    1. Utility Maximization with a Social Norm
    2. Sharing Behavior: The Dictator Game
    Game Structure and Results
    Variation in Sharing Behavior
    3. Norm Enforcement: Ultimatum Game
    Game Structure
    Norm-Sensitive Responder
    Equilibrium Responder Share
    Norm-Sensitive Proposer
    4. Results from Ultimatum-Game Experiments
    Meta Analysis of Ultimatum Experiments
    Crosswalk Rules and the Ultimatum Game
    Competition Between Responders
    Widget 3.1: Equilibrium in the Ultimatum Game

    Chapter 4. Trust
    1. The Trust Game: Investment & Production
    Game Structure
    Outcome in the Absence of a Sharing Norm
    2. Sharing Norm for the Producer
    Producer's Tradeoff
    Varying Norm Sensitivity and Return Fractions
    Investor Decision
    3. Sharing Norm for the Investor
    Investor's Tradeoff
    Relative Norm Sensitivity and Equilibrium
    Social Norms, Efficiency, and Social Capital
    4. Experiments and Implications
    Experimental Results
    Trust Game and Social Capital
    Trust Game and Oxytocin

    Chapter 5. Public Goods
    1. Free Riding and Experiments
    The Free-Rider Problem
    Results from Voluntary-Contribution Experiments
    2. Social Norms and Voluntary Contributions
    Norm: Efficient Choice
    Norm: Equal Contribution
    Explaining a Path of Decreasing Contributions
    3. Punish Free Riders?
    Punishing Norm Violators
    Summary of Experimental Results

    Chapter 6. Reciprocity in the Workplace
    1. Worker Reciprocity and Social Capital
    Perfect or Imperfect Information in the Workplace?
    Social Norms and Pareto Improvements
    2. Worker Identity and Effort
    Utility-Maximizing Effort
    Insiders versus Outsiders
    Norm Sensitivity and Effort
    Producer Investment in Identity Management
    3. Response to a Higher Wage
    Wages and a Sharing Norm
    Wages and the Work-Effort Norm
    Wages and Profit
    4. Evidence of Worker Reciprocity
    Field Experiments
    A Gift-Exchange Experiment

    Chapter 7. Voluntary Prices
    1. Voluntary Prices: Pay What You Want
    The Equal-Sharing Price and Norm-Violation Cost
    Variation in Norm Sensitivity
    Sustainability of PWW Systems
    Economic Experiment: Pay What You Want versus Pay it Forward
    Widget 7.1 PWW Price and Social Norms
    2. Public Broadcasting: Free Riders and Punishing Pledge Drives
    Payoffs to Members and Free Riders
    Choosing the Length of a Pledge Drive

    Chapter 8. Imitation and Cultural Learning
    1. Imitation and Conformity
    Over-Imitation by Humans
    Over-Imitation: Humans versus Chimpanzees
    Conformity and Matching Pennies
    2. Faithful Imitation and Cultural Learning
    Manioc and Obscure Production Processes
    Social Learning: Humans versus Chimpanzees

    Part 3: Time Preferences

    Chapter 9. Discounting and Present Bias

    1. Conventional Discounting and Present Bias
    The Quasi-Hyperbolic Discount Function
    Widget 9.1 Conventional Discounting and Present Bias
    Present Bias & Doubling Your Apples
    Time Inconsistency
    Time Inconsistency and the Relative Values of Bundles
    Present Bias and Regret
    2. Estimates of Discounting Parameters
    Estimates of Conventional Discounting and Present Bias
    Economic Experiment: Patience Among Mothers and Children
    Widget 9.2 Roll Your Own Current Value
    3. Illustrations: Cupcake, Weed, Bucket List
    Cupcake versus Apple
    Homeowner versus Weed
    The Bucket List

    Chapter 10. Time Preferences and Saving
    1. Discounting and Intertemporal Choice
    Saving and the Equimarginal Principle
    Widget 10.1 Discounting, Present Bias, and Saving
    Present Bias and Regret
    2. Saving Mandates and Nudges
    Response to Mandate: Active Saver
    Response to Mandate: Non-Saver
    Nudges: Defaults, Save More Tomorrow, and Saving Lotteries
    3. Clueless versus Savvy Consumers
    Three-Period Model of Intertemporal Choice
    Consumption Path of the Clueless (Naive)
    Widget 10.2: Three-Period Consumption Program
    Regret of the Clueless
    Consumption Path of a Savvy Consumer
    Commitment Devices and Saving
    4. Present Bias and Pre-Commitment by Pigeons

    Chapter 11. When to Act
    1. Procrastination: Waiting Too Long
    Present Bias and a Clueless Decision Maker
    Conditions for Procrastination
    Widget 11.1 Present Bias and Procrastination
    Self Awareness and Procrastination
    Clueless versus Self-Aware: How to Tell the Difference
    2. Preproperation: Acting Too Soon
    Present Bias and a Clueless Decision Maker
    Conditions for Preproperation
    Self Awareness and Preproperation

    Chapter 12. Application of Present Bias--Sin Taxes and Fertilizer
    1. Personally Harmful Products & Sin Taxes
    A Model of a Personally Harmful Good
    Present Bias and a Personally Harmful Good
    Price and Consumer Choice
    Savvy Consumers and Hobbling
    Support for Sin Taxes
    Widget 12.1 Present Bias and a Sin Tax
    2. Present Bias and Fertilizer Investment
    Review of Intertemporal Choice Model
    Present Bias and the Fertilizer Investment
    Policy Options

    Part 4: Mental Accounting and the Endowment Effect

    Chapter 13. Mental Accounting for Consumers

    1. Mental Accounting and Fungibility
    Consumer Budgets and Fungibility
    Mental Accounting and Coupons
    2. Other Implications of Mental Accounting
    Mental Accounting and Sunk Cost
    Decoupling Cost and Benefit: Credit Cards and Ride-Hailing Services
    Regular versus Premium Gasoline

    Chapter 14. Loss Aversion and the Endowment Effect
    1. Painful Loss and Loss Aversion
    Conventional Benefits and Costs of Exchange
    The Pain of Loss Exceeds the Joy of Gain
    Loss Aversion Parameter
    Loss Aversion and Reappraisal
    2. The Endowment Effect
    Classic Endowment Experiment
    Evidence for the Endowment Effect
    Endowment Effect for Chimpanzees and Capuchin Monkeys
    The Endowment Effect and Asset Exchange

    Part 5: Risk Preferences

    Chapter 15. Risk Preferences and Prospect Theory

    1. Three (of Four) Features of Prospect Theory
    Utility Function for Prospect Theory
    Widget 15.1 The Shape of the Utility Curve
    Utility Value and Certainty Equivalent
    Widget 15.2 Utility Value & Certainty Equivalent
    2. Risk Aversion and Risk Neutrality
    Risk Aversion and the Risk Premium
    Risk Neutrality: Linear Utility and No Loss Aversion
    Sources of Risk Aversion
    3. The Values of Key Parameters
    Loss Aversion
    Decreasing Sensitivity to Gain and Loss
    Widget 15.3: Compute Your for Gain and Loss
    Measuring Sensitivity to Stimulus
    Experiment: Risk Preferences and Cognitive Ability
    4. Risk Preferences of Rats

    Chapter 16. Problems with Probability
    1. Probability in Prospect Theory
    Prelec Probability Weighting
    Psychological Foundations
    Widget 16.1 The Graphics of Probability Weighting
    A Closer Look at Rare Events
    2. Learning by Description versus Learning by Experience
    3. Solving Puzzles with Probability Weighting
    The Numbers Game Puzzle
    The Longshot Puzzle

    Chapter 17. Prospect Theory & Asset Markets
    1. Decreasing Sensitivity and Attitudes Toward Risk
    Decreasing Sensitivity to Gain and Risk Aversion
    Decreasing Sensitivity to Loss and Risk Seeking
    Constant Sensitivity and Risk Neutrality
    Widget 17.1 Reservation Prices for Gain & Loss Lotteries
    2. Disposition Puzzle
    Reservation Price in a Winner Market
    Reservation Price in a Loser Market
    Reservation Prices and Time on the Market
    Evidence for the Disposition Puzzle
    3. Disposition Puzzle Disappears?
    Let Bygones be Bygones
    Constant Sensitivity to Gain and Loss
    4. The Equity Premium Puzzle
    Loss Aversion and Utility Values
    Professional Traders: Too Much Information?
    Widget 17.2 Equity Premium Puzzle

    Chapter 18. Prospect Theory and Insurance
    1. Willingness to Pay for Insurance
    Decreasing Marginal Disutility of Loss
    Certainty Equivalent & Willingness to Pay for Insurance
    Willingness to Pay for Insurance versus Break-Even Price
    Economic Experiment: Willingness to Pay for Insurance
    Widget 18.1: WTP versus Price of Insurance
    2. Probability Weighting and Insurance Puzzles
    Decreasing Sensitivity and Probability Weighting
    Widget 18.1 Hazard Insurance
    The Hazard Insurance Puzzle
    3. Insurance Deductible Puzzle
    Insurance Deductibles
    Surprise Loss Aversion

    Chapter 19. Reference Points and Goals
    1. Goals and the Marginal Principle
    Goal-Related Marginal Benefit
    Full Marginal Benefit and Choice
    Goals on the Golf Course
    2. Applications: Rainy Day Taxis and Abstinence
    Rainy Day Taxi
    Widget 19.1 Regular versus Goal-Oriented Taxi Drivers

    Part 6: Natural Selection and Human Behavior

    Chapter 20. Natural Selection & Behavioral Economics

    1. Background Concepts from Evolutionary Biology
    DNA, Genetic Mutations, and Natural Selection
    Illustration: A Fire-Building Manual
    2. A Closer Look at Fitness and Evolution
    Fitness, Natural Selection, and Evolution
    Fitness Contests and Geometric Mean Fitness
    Economics versus Biology: Spider Somersaults
    3. Genes, Environment, Norms, Culture, and Cognition
    Genes and the Environment
    Genes and Culture
    Genes and Social Norms
    Instinctive Urges versus Deliberation
    Chapter 21 Natural Selection and Cooperation
    1. Humans versus Chimpanzees
    Cooperation: Skills and Motivation
    Willingness to Enforce Norms
    Natural Selection and Cooperation
    2. Consumption and Production Benefits of Cooperation
    Benefits from Consumption Smoothing
    Benefits from Economies of Scale
    3. The Co-Evolution of Genes and Culture
    Genes and Culture
    Cultural Learning

    Chapter 22. Natural Selection, Loss Aversion, and Time Preferences
    1. Natural Selection and Loss Aversion
    Steady versus Fluctuating Reproduction
    Gain Equals the Loss
    Gain Exceeds the Loss
    Fitness Equivalence
    Environmental Conditions and Genetic Mixes
    Widget 22.1: Fitness and Loss Aversion
    2. Natural Selection & Time Preferences
    Tradeoffs from Investment
    Low Investment Productivity
    High Investment Productivity
    Lessons from Historical Data

    Chapter 23. Natural Selection and Risk Aversion
    1. Small Reward and Risk Aversion
    Geometric Mean Fitness
    Natural Selection and Risk Aversion
    2. Large Reward and Risk Neutrality
    Greater Fitness for Risk Takers
    Natural Selection Favors Risk Taking
    Fitness Equivalence
    Risk Aversion in Bonobos, Shrews, and Other Creatures
    Widget 23.1: Fitness and Risk Aversion
    3. Subsistence and Risk Seeking
    Subsistence and Risk Preferences
    The Flexible Risk Preferences of Juncos

    Chapter 24. Bargaining and the Endowment Effect
    1. A Hunter-Gatherer Exchange Economy
    Hunter-Gatherer Fitness
    Edgeworth Box and Gains from Exchange
    Bargaining and Equilibrium
    2. Natural Selection: Bargaining Outcomes
    Endowment Effect and Nash Equilibrium
    Disagreement Value and the Nash Bargaining Solution
    Endowment Effect and Group Fitness
    Widget 24.1: Nash Bargaining, Fitness, and the Endowment Effect
    Egalitarian Economy and the Endowment Effect

Related Title

Behavioral Economics