1. Foundations

Regularities may arise when individuals faced with information scarcity follow the crowd (see Appendix 2).

The development of the field ‘behavioral economics’ accelerated when The Russell Sage Foundation offered a grant designed to bring the fields of economics and psychology together to study decision-making processes. The first grant was received by the economist, Richard Thaler, who spent one year (1984–1985) with the psychologist, Daniel Kahneman (2002).

The ABC group is often associated with the field of research known as ‘evolutionary psychology.’ The label ‘evolutionary psychology’ is not usually used to refer to all of the attempts to provide evolutionary approaches to psychology, but rather to a more specific and demanding paradigm, suggested by Leda Cosmides, John Tooby, and other scholars. In order to avoid confusion as a result of this ambiguous term, Scher and Rauscher (2003) distinguish between the term ‘narrow evolutionary psychology,’ which refers to the paradigm characterized by a narrow range of assumptions, and the term ‘broad evolutionary psychology,’ which refers to any of a set of evolutionary approaches to psychology. The ABC group is an instance of ‘broad evolutionary psychology’ although whether it can be associated with the ‘narrow evolutionary psychology’ is debatable.

Hayek categorized the two books, Hebb (1949) and Hayek (1952), as “complementary rather than covering the same ground” (Hayek 1952, p. viii).

Hayek’s interest in human cognition goes back to the early 1920s when he was still a student. In the winter of 1919–1920 a fuel shortage and forced closure of the University presented Hayek with an opportunity to travel to Zurich, where he, as well as attending lectures in law and philosophy, “worked for a few weeks in the laboratory of the brain anatomist von Monakow, tracing fibre bundles through the different parts of the human brain” (Hayek 1994, p. 64).

See Groenewegen et al. (2010) for a wide-ranging introduction of institutional economics.

Libecap (1989) explores the origins of property rights rules. Individuals and groups engage in bargaining, lobbying, and political action to try to alter the rules for their own benefit.

Williamson (1996) defines a contract as an agreement between a buyer and a supplier in which the terns of exchange are defined by a triple: price, asset specificity, and safeguards.

For example, Fama (1980), and Fama and Jensen (1983a, b).

Williamson (1975) criticizes this conclusion and underlines that there are interactions between the attitudes of workers with regard to transactions.

See Lewin (2001) for a wide-ranging review of critical scrutiny by Liebowitz and Margolis.

Acemoglu and Robinson (2005) argue that after 1500, some European countries experienced a substantial growth in Atlantic trade, and the political power of merchant groups increased. The growing strength of merchant groups constrained the power of monarchs, and, as a result, these countries developed institutions which were more conducive to economic growth compared to countries with lower levels of trade.

Furthermore, there may be ‘meta-constitutional rules’ (rules for choosing constitutional rules).

‘Quasi-hyperbolic’ discount functions are introduced in Phelps and Pollak (1968), using a model of imperfect intergenerational altruism.

As suggested in Loewenstein (1987), this steepness is related to several emotional factors that are involved in decisions over time. Some of our emotions are caused by expectations about outcomes, and people have goals concerning these emotions as well as concerning the outcomes themselves.

In Gul and Pesendorfer (2001), the agent’s preferences do not change between periods (there is no dynamic inconsistency). They propose that ‘temptation’ rather than a preference change may be the cause of a preference for commitment. Their dynamically consistent decision-maker is unambiguously better off when ex ante undesirable temptations are no longer available.

O’Donoghue and Rabin (2001) examine the behavior of a person who is ‘partially naïve.’ A partially naive person is aware that he or she has future self-control problem, but underestimates its magnitude.

Fudenberg and Levine (2006) propose a ‘dual-self’ model in which many sorts of decision problems can be viewed as a game between a sequence of short-run impulsive selves and a long-run patient self. In their model, the patient’s long-run self and a sequence of myopic short-run selves share the same preferences over stage-game outcomes. They differ only in how they regard the future.

A line of research has shown how the combination of self-control and informational concerns can account for forms of ‘motivated cognitions’ documented by psychologists. For example, in Bénabou and Tirole (2004), a person may achieve self-control through the adoption of personal rules based on self-reputation over one’s willpower.

Appendix 2 is based on Teraji (2003).

This terminology may be a close parallel to what Leibenstein (1950) called the ‘bandwagon effect’ and ‘snob effect’ in his classic study on the static market demand curve. By the bandwagon (snob) effect he referred to the extent to which the demand for a commodity is increased (decreased) because others are consuming the same commodity.

Note that the decision may not be optimal from the social point of view since the individual does not take account of the effect of his or her decision on the information of others.

See, for example, the analysis of ‘rumours’ in Banerjee (1993) and ‘fashions’ in Karni and Schmeidler (1990).

See also Kirman (1993) for an explanation of asymmetric aggregate behavior arising from the interaction between identical individuals.

Anderson and Holt (1997) induce the emergence of information cascades in a laboratory setting. Their results seem to support the hypothesis that agents tend to decide by combining their private information with the information conveyed by the previous choices made by other agents, in conformity with Bayesian updating of beliefs.

Akerlof (1980) says that there are multiple equilibria in the sense that different customs, once established, could be followed in equilibrium. In one of these equilibria, a custom is obeyed, and the values underlying the custom are widely subscribed to by members of the community. In the other equilibrium, the custom has disappeared, no one believes in the values underlying it, and it is not obeyed.

The equilibrium dynamics of this kind is used in Matsuyama (1992). However, the interpretation attached to this dynamics here is quite different.

The fundamental argument in the path dependency literature (David 1985; Arthur 1989) is that the free market typically generates sub-optimal equilibrium solutions to a variety of economic problems and the probability of sub-optimal equilibrium outcomes increases where increasing returns prevail. It is even possible for efficient and inefficient (sub-optimal) solutions to prevail simultaneously in the world of path dependency. For this reason, one cannot expect the free market to force the economy to converge to unique equilibrium.

Many studies on evolutionary games also address the question of how a particular equilibrium will emerge in a dynamic context; see, for example, Friedman (1991) and Gilboa and Matsui (1991). These studies do not, however, offer an equilibrium selection criterion, since all strict Nash equilibria share the same dynamic properties in their models.

See, for strategic delays caused by information externalities, Chamley and Gale (1994).