CHAPTER 1

Rationality, Social Preferences, and StrategicDecision-making from a Behavioral Economics Perspective

SIMON GÄCHTER

Introduction

The central assumption of the rational choice approach is that decision-makershave logically consistent goals (whatever they are), and, given thesegoals, choose the best available option. This model, in particular its extension tointeractive decision-making (game theory), has had a tremendous impact in thesocial sciences, in particular economics, and has allowed for great theoreticalprogress in the latter. For instance, the model and its formalization have led toimportant insights into the functioning of economic systems (see Mas-Colell,Whinston, and Green [1995] for a leading textbook account). They have alsoshed new light on numerous nonmarket processes, such as crime, addiction,family behavior, political decision-making, and organizational behavior(Coleman 1990; Becker 1993; Hechter and Kanazawa 1997; Gintis, Bowles,Boyd, and Fehr 2005). Rational choice theory in the form of game theory isnow the core theoretical tool of economics. It is therefore certainly justified tospeak of the rational choice model as a "success story."

Rational choice models often assume that agents are "unboundedly rational"and always know what is best for them. This assumption has long found manycritics (Simon 1982). A further assumption that is not part of the canonicalrational choice model but is frequently invoked in applications is that agentsare primarily self-regarding. This assumption has been challenged in particularin the last decade through the accumulation of empirical, in particularexperimental, evidence that has shown substantial and robust deviations fromwhat selfishness predicts.

In the past the discussions about the fruitfulness of the rational choiceapproach were based largely on philosophical convictions and less on facts. Inthis chapter I will argue on the basis of insights from behavioral economicsthat the usefulness of the rational choice approach is also an empirical questionand not just a philosophical one. My approach is related to that of Hechter andKanazawa (1997), who argue for the fruitfulness of rational choice explanationsby discussing its empirical successes across a large variety of interestingsociological domains. My arguments are based on data from many laboratoryexperiments which all share the feature that the theoretical predictions arederived from rational choice models (typically game-theoretic models) and thatdecisions in the experiments have financial consequences for the participants,which give them an incentive to take decisions seriously. Specifically, I willuse experimental results to argue that one can acknowledge that humansare boundedly rational and nevertheless appreciate the predictions made byrational choice models that at times rest on unrealistically strong assumptions.Moreover, I argue that a rational choice approach does not imply assuming thateveryone is selfish.

I start by giving a short characterization of the canonical rational choicemodel, including the selfishness assumption. With the help of one famousresearch program on the functioning of experimental markets I will illustrateone main point that will recur several times. I argue that one can fruitfullyuse rational choice theory to predict social outcomes even if the assumptionsentering the model are empirically invalid. I will first discuss the success andlimits of the rational choice approach. Then, I focus attention on the empiricalinvestigation of the selfishness assumption. I will present evidence from severaleconomic experiments that have been used as tools to uncover the structureof people's "social preferences." Numerous experiments have shown that theselfishness assumption is invalid as a description of typical behavior, although inall experiments we do find selfish...