From the ultimatum game
when a recipient rejects the offer it highlights that their utility function has non-monetary values
ie they value fairness more
Researchers on valuing fairness
wanted to check whether allocators of the rewards would be fair even if their offers could not be rejected
and whether recipients would punish an allocator who had been unfair to someone else
participants divided into pairs and split between allocators and receivers
allocators told they could split $20 dollars in 2 ways
either $18 for themselves or $10 equally
76% split money evenly
likely because they could have a taste for fairness
worried that unfair offers would be rejected
roles reversed in this game
played with 1 allocator and 2 potential receivers
the receivers were labelled either U - meaning they allocated money unfairly last round
or E - they did it evenly
the allocator then asked to split either $6 for himself and $6 for U or $5 for himself and $5 for E
would someone rather benefit themselves by giving to someone greedy or sacrifice $1 to reward someone who was fair?
74% rewarded the fair people
The insula
part of brain associated with system 1 and processes emotional responses like anger pain and disgust
when studying the ultimatum game, the more unfair the offer the greater response in the insulation
insula activations also had strong predictive powers
those with stronger insula reactions went on to reject a much greater proportion of unfair offers
participants pre-frontal cortex (system 2) were more strongly activated with unfair offers that were actually accepted
why is this?
because the unfair offers are more difficult to accept and so needs the more logical and rational and cognitive part of the brain to work harder to reject the more impulsive and emotional response of rejection -neoclassical way
“it appears that maintaining the social order and the rules of fairness in this fashion has its own rewards…our brains are not designed to reward generosity as reliably as they punish meanness” - TF&S
what can business learn from this tendency to fairness?
against neoclassical
should be wary of fairness:
imposing what is seen as unfair losses on people can be risky if victims are in a position to retaliate
e. g in South America
- coke machine raised prices from $1.25-$1.75 when it got hotter
- makes sense due to supply and demand but many people thought it was unfair and causes a lot of damage
“homo economicus is usually assumed to care about wealth more than such issues as fairness and justice…the research on ultimatum games belies such easy characterisations” - Richard Thaler
lesson about fairness
in general, we’re unwilling to participate in an exchange where one party gets too large a share of profits. We consider that unfair
e.g if you give friend money for a beer without knowing what it costs and he keeps the change, its unfair even though you get the same utility from the beer
e.g fairness
employee works for 6 months on $9 an hour
business is satisfactory but is in area with high levels of unemployment. Other shops can now hire workers for $7 an hour
the owner of the shop reduces the workers wages
83% of people thought this to be unfair
73% thought it would be fair if employee leaves and owner hires a replacement for $7 an hour
why the difference in fairness
- because of the existence of a reference point
the $9 originally was a reference point of fairness for his wages. But not for a replacement worker
disagreements about fairness can occur when parties to an agreement have different reference points leading to a different view on the assessment of outcomes
Lesson about fairness - reference points
reference points are starting points for decisions on fairness
e.g company making small profit. In area with large unemployment but NO inflation. A lot of workers want to come and work so firm cuts wages by 7%
62% think this is unfair
what about when inflation at 12%
- company decides to increase wages by only 5% (still reduction in wages by 7%)
- 78% say this is fair
why the difference here?
money illusion - don’t understand inflation
coding of outcomes:
- a firms action is judged as unfair if it comes across as a loss compared to if it comes across as a reduction of a possible gain
- a wage cut that is coded as a loss seems unfair
- a nominal wage increase which doesn’t compensate for inflation is more acceptable as its coded as a gain to the employee relative to the reference wage
e. g workers see it more unfair to have their wages cut by 10% than have their 10% yearly bonus’ taken away
Framing
the framing of outcomes/framing of it as either a gain or loss affects our beliefs on fairness
we perceive it to be fair when a company is protecting itself from a loss much more than if they’re doing something to make a profit
determining if something is fair
we look at effort:
“assessing the level of effort is a common shortcut of heuristic to assess the fairness of the price” - Ariely
- when we see words like “hand-made” or “artisan” this signals more effort so we view a higher price as fair
- using a heuristic of effort for value we are actually paying for incompetence (use locksmith example)
Ariely fairness experiment
if data recovery on a computer by a technician took a few minutes, willingness to pay was low, but if it took a weak, willingness to pay was higher for the same result
You won’t find the concept of fairness in neoclassical economics
existing economics models are parsimonious and neat and tidy; they assume consumers want to maximise their utility and pursue that assuming rationality within legal and budgetary constraints
- these assumptions are simple and allows for decisions to be predictable
- adding complexity to the model around fairness makes it much more difficult to be unequivocally precise as to how we will act
“perhaps behaviour assumptions should only be introduced to identify conditions under which observations deviate significantly from the basic model and only if they predict the direction of those deviations” - Thaler
- people care about being treated fairly
- willing to resist unfair offers even at a cost
- have implicit rules to what they deem fair
