In the ultimatum game, a proposer offers a split of $10 and a responder can accept (both get their shares) or reject (both get nothing). Standard game theory predicts the proposer will offer the minimum and the responder will accept any positive amount. In practice, what happens?
AProposers offer the minimum and responders always accept, consistent with theory
BProposers typically offer 40-50% of the total, and responders frequently reject offers below 20-30%, even though rejection is costly
CProposers always offer exactly 50% to avoid any risk of rejection
DResponders always reject because they prefer getting nothing over accepting an unfair offer
The modal offer is 40-50% of the total, and offers below 20% are rejected roughly half the time. This pattern is remarkably stable across cultures and stakes (replicated with several months' wages in developing countries). Proposers offer generously partly from fairness motives and partly from strategic fear of rejection. Responders reject low offers at a material cost to themselves, revealing a willingness to sacrifice money to punish unfairness. This behavior is incompatible with pure self-interest but consistent with models incorporating fairness or inequality aversion.
Question 2 True / False
Social preferences only appear in laboratory experiments and do not affect real economic behavior outside the lab.
TTrue
FFalse
Answer: False
Social preferences have been documented in numerous field settings. Workers reciprocate higher wages with greater effort (gift exchange), taxpayers comply at rates far exceeding what audit probabilities alone would justify (conditional cooperation), consumers pay premium prices for fair-trade products, and individuals contribute to public goods and charities at rates incompatible with pure self-interest. While laboratory and field magnitudes may differ, the fundamental pattern — that people care about fairness, reciprocity, and others' outcomes — is robust across contexts.
Question 3 Short Answer
How does the Fehr-Schmidt model of inequality aversion formalize social preferences?
Think about your answer, then reveal below.
Model answer: The Fehr-Schmidt model adds disutility from inequality to the standard utility function. An individual suffers from 'disadvantageous inequality' (when others earn more, weighted by alpha) and 'advantageous inequality' (when they earn more than others, weighted by beta), with alpha > beta (people dislike being behind more than being ahead). This parsimoniously explains ultimatum game rejections (reducing disadvantageous inequality), dictator game giving (reducing advantageous inequality), and conditional cooperation in public goods games.
The model's elegance lies in explaining a wide range of experimental results with just two parameters. It captures the asymmetry between envy (disliking being behind) and guilt (disliking being ahead), with envy being the stronger motive. It also explains heterogeneity: people differ in their alpha and beta parameters, and the distribution of types in a population determines equilibrium outcomes in strategic settings. This allows the model to accommodate both selfish and fair-minded behavior within a single framework.