The Nature of Preferences: An essay on the debate over preference theory.

I.????Introduction

“We float between different opinions; we want nothing freely, nothing absolutely, nothing constantly”

?Montaigne ([1580]1999, p. 47)

One of the cornerstones on which the economic theory edifice is built upon is the set of assumptions around consumer preferences. Who hasn't heard in one of their economics courses that preferences are static or that individuals are selfish? Well, it is these statements that are currently causing a stir among those who study economic phenomena.

Preferences are “…the reasons for behavior, that is, attributes of individuals that (accompanied by their beliefs and abilities) are considered by them to act in a given situation” (Bowles, 1998). It is precisely this ability to determine human behavior that gives the greatest importance to the study and determination of the processes that form and influence preferences.

This importance has been considered in the construction of economic theory. However, the Walrasian paradigm, which can be considered as the mainstream of the economic academy, postulates that preferences are exogenous in nature, so they do not change over time, but they remain static and immovable.

These assumptions had been accepted without reservation, which kept preferences and their nature out of the question for a long time. However, in recent times, some less orthodox economists with a reticent attitude towards these claims have dedicated themselves to empirically test their veracity, finding that reality is far from these premises, which reduces the analytical power and credibility of the model.

In the following pages, I will try to briefly describe and analyze some of the contributions and criticisms that these economists make to the conventional model and the methods that they use to do so. For this purpose, I have decided to address three topics: the role of institutions and social norms in the process of formation and modification of preferences, the methods used in empirical studies and finally social preferences and reciprocity. To conclude, a comment will be made about the scope of these facts and ideas within the economic doctrine.

II.????Institutions, Norms and Preferences

The conventional economic school holds a series of assumptions about the behavior of individuals. These, the neoclassicals consider, are axiomatic so there is no need to prove their legitimacy. These axioms, among other things, hold that individuals act out of selfishness and that their preferences do not change.

This vision is a simplification of reality that can be extreme. The formalization of the ideas of Adam Smith by Walras, Arrow and Debreu due to lack of proper tools, resulted from the progressive separation of what seemed strange or excessively complex (Bowles and Gintis, 1993). This kind of selection left aside aspects as important as the influence on the individual of historical and cultural contexts. It could be argued that taking these aspects into account can be complicated, mainly in the cultural field, since there is a risk of vagueness and inconsistency.

However, suggested by P.H. Vries, it does come in handy to analyze the effect of culture on preferences through institutions and social norms, even when “…they are not a direct and unequivocal reflection of culture” but are “strongly intertwined” (Vries, 2001). The institutions and social norms that concern us mainly are those that can affect the economic behavior of individuals, so we will focus on economic institutions.

Bowles (1998) points out that economic institutions have structuring and interpretation effects since "different institutions create different alternatives" and "...the terms in which people are willing to carry out transactions depend on the perception that they have of the existing relationships between the parties involved”. Such perceptions are given by the structure of the market. This means that institutions and norms serve as a framework for human activity and that by determining the ways in which it takes place, they affect the way in which preferences are created.

According to Gintis and Romer, (1998) "there is evidence that preferences are not formed outside the economic system but are formed through the interaction between individuals and the communities to which they belong".

We can find an example of this in “Incentives and Social Norms in Household Behavior”, a study that analyzes the role that incentives and norms have in the formation of preferences through their structuring effect (Amartya Sen calls it delineation [ Sen, 1998]), which is present through the approval or disapproval of the individual's actions by others, which can cause feelings of shame or pride. This research observes, the effects that social norms have over individual preferences about work, savings, consumption, and sanctions against opportunism. (Lindbeck, 1997)

On the other hand, Heinrich and McElreath (2001 in Kuznar) show us in a study carried out with four groups (two from Chile: The Mapuche and the Huinca, the Sangu from Tanzania and students from UCLA), that the two communities that are relatively far apart from markets and their institutions, the Sangu and the Mapuche, are less risk averse than the other two who are fully immersed in market economies. They explain this fact through a culturalist argument, in which people acquire sensitivity to risk as a group value. Therefore, communities that are more immersed in markets are more risk averse.

Bowles (1998) goes further and suggests that preferences are not strictly influenced by economic social institutions and norms, but also include deep psychological aspects that can affect decision making: “Preferences can be strongly mediated by cognitive processes of perception, or they can even be visceral reactions that evoke deep feelings…”

All these studies point to the fact that social pressure and the internalization of institutions and norms have the power to outline and direct our decisions in one direction or another and that many of our preferences are culturally transmitted and structured within economic systems. Therefore, preferences might be endogenous.

III.????Game Theory and Experimental Economics

This alternative view of economic theory has used various research and experimentation techniques to obtain its results. I will now present a brief description of some of its methods and their implications for preference theory.

Game theory is a mathematical language to describe strategic interactions and their outcomes (Camerer & Fehr, 2002). A game consists of a set of players and a set of alternative strategies available to each player, from which results are obtained as a function of the interacting strategies played simultaneously by all players (Binger and Hoffman, 1998).

Experimental economics uses this theory to design situational tests in which it is necessary to use strategic behavior (games). There are four games that are widely used for these studies: the prisoner's dilemma game, the public goods game, the ultimatum game, and the dictator game.

Below I include a description of each of them taken from “Measuring Social Norms and Preferences Using Experimental Games: A Guide for Social Scientists” (Camerer and Fehr, 2002) and “Economic Man' in Cross-cultural Perspective: Behavioral Experiments in 15 Small-scale Societies” (Heinrich et al, 2001):

Prisoner's Dilemma. - In this game there are two players who have the alternatives of cooperating and not doing so. The results of this game are four. Let us call the first individual A and the second individual B. If A and B decide to cooperate, the best of the combinations is reached for both, however if A decides not to cooperate and B does, B does not get anything and A keeps everything, the opposite happens if A cooperates, and B does not. Finally, there is the possibility that both decide not to cooperate, in which both obtain a much lower result than if they cooperated.

?Public Goods. - This game examines people's reaction to a group’s conflict of interest. N players simultaneously decide on their contributions to a group fund. Whatever amount is raised by the fund, it will be increased by 50% and shared equally among all players. Contributions to the fund can range from zero to the full prize pool given to each player at the start of the game.

Ultimatum. - This is a haggling game in which the players are arranged in pairs. One is the "proposer”, and the other is the "respondent". In this case, an amount is granted to the "proposer" that he must share with the "respondent". The “respondent” knows the total amount that is available to be shared and the “proposer” is free to make any offer to the “respondent”. If the “respondent” rejects the offer, they are both left with nothing. In this game, the names of the players remain secret.

Dictator. - This game has a structure like that of the ultimatum, with the only difference that the "respondent" does not have the possibility of rejecting the offer. These games test the assumption that individuals seek to maximize their utility, and that this is maximized by reaching the highest indifference curve according to their preferences, all based on the rationality and selfishness of individuals, two of the main assumptions of the Walrasian economic paradigm.

The evidence that has been collected using these games indicates that in most cases these postulates fail when trying to predict the behavior of individuals. Camerer and Fehr (2002) show that in 50% of the cases in which the prisoner's dilemma game was played, the players decided to cooperate, which clearly contradicts the prediction of the neoclassical model according to which individuals should not cooperate. In the case of public goods, 50% percent of the players contribute if the game is played repeatedly and in the last repetition the majority do not contribute anything to the fund.

In the ultimatum game, offers which were less than 20% were rejected half of the time and most of the offers were between 30% and 50%, which is contradictory in the conventional line of reasoning since according to her, the “respondent” would be willing to accept any offer greater than zero. In the dictator game, the average of the portions shared with the respondent was 20%.

In another study done with 15 small societies at different levels of income, development and market integration, similar results were achieved and in some cases the levels of cooperation exceeded the expectations of the researchers, although in others the cooperation was minimal. (Heinrich et al, 2001).

These types of studies are carried out with increasing frequency and yield results that contradict to a certain extent the axioms of neoclassical theory, among other results, it can be said that the most important thing is that individuals consider the well-being of others when making decisions and that their preferences are not only determined by the satisfaction of personal needs, but also as a function of group action.

?This shows that economic science has left aside certain aspects of human behavior due to a focus error and that is why in some cases it has not been able to offer satisfactory explanations or solutions to various social problems. Some of these problems may be: the role of competition and cooperation in markets and organizations (Fehr and Fischbacher, 2002), risk aversion (Rabow et al, 1966), the labor market, team production, revenue collection, taxes (Bowles, 2001), etc.

IV.????Social Preferences and Reciprocity

As we have pointed out in the previous section, empirical studies show that there is a series of behaviors among human beings in which the level of well-being of others is considered when making economic decisions, “…forms of human behavior that have been inadequately analyzed by behavioral scientists” (Bowles et al, 1997). ?

These same studies show that not only is the well-being of others considered, but the decision-making process is also influenced by what one believes about the intentions of others. Some suggest that these phenomena are related in an important way, so they have been addressed in combination. Bowles et al (1997) call the combination of both “Reciprocal Equity”. Others call it Social Preferences (Camerer and Fehr, 2002) others simply named it “Reciprocity” (Fehr and G?tcher, 1998). It is also Fehr and G?tcher (1998) who provide us with a definition of reciprocity: "In general terms, reciprocity means that people respond to kind acts with kind behavior and if they are treated badly, they simply pay in the same way”.

Bowles (2001) proposes another equally illuminating definition: "Social preferences [or reciprocity] are these reasons for behavior relative to others and to processes" and later clarifies "The key aspect of preferences relative to processes is that the evaluation of the result is conditioned by the way in which it was generated”

These aspects of reciprocity reveal to us that then, the utility of individuals is not only generated by the material results of their interactions, but also derives from the perceptions that they have when carrying them out.

One explanation for this phenomenon is that in the absence of formal mechanisms that guarantee full compliance with agreements and contracts, should emerge to prevent individuals from taking advantage of all the possibilities of opportunistic behavior that this lack gives rise to. Otherwise, individuals would not be willing to carry out any transaction in the absence of complete contracts (Falk et al, 1999).

As a result of this way of approaching the problem of preferences, the concept of aversion to inequality has emerged, which designates the levels of utility that a person obtains in situations that he/she perceives to be more or less fair. Fehr and Fischbacher (2002) address this concept as separate from reciprocity, since they consider that people averse to inequity act altruistically towards others. However, they note that reciprocity appears to have much larger quantitative effects than inequity aversion.

These new characteristics of preferences pose new challenges for the interpretation and modeling of economic problems, one of them is the inclusion of these motivations within utility functions. Creating models able to cope with the different outcomes of game variants is also challenging.

Finally, reaching an understanding of reciprocity can lead economists to be better prepared to make recommendations on public policies that can help solve social problems that the traditional paradigm has been unable to solve due to the inadequate treatment that has been given to these very important aspects of preferences.

?V.????Conclusion

Throughout this work, emphasis has been placed on the deficiencies that the predominant school of economic theory shows while trying to explain reality. It has been said that the extreme simplification it incurs in affects its ability to analyze and predict.

Some of the empirical works of a group of economists who aim to contribute new ideas and approaches to the building of economic theory have also been exposed. Such contributions, in turn, represent complications and challenges for the academic community since it sees the need to adapt and expand the explanatory models to respond to the social need to create efficient economic policies.

On the other hand, it is necessary to continue testing the assumptions on which conventional economic theory is based to continue refining the instruments it uses to answer the questions that have given rise to the discipline. Undoubtedly, the progress made has been of great importance, however there are still many unanswered questions and some answers that are very far from reality. Finally, the only thing left to say is that the social sciences, and especially economics, are still very far from being able to give convincing explanations about human behavior, so a great work still lies ahead of us.

VI.????Bibliografía

?De Montaigne, Michel, (1999), Ensayos, CONACULTA y Océano.

Bowles, Samuel (1998). “Endogenous Preferences: The Cultural Consequences of Markets and other economic Institutions”.?Journal of Economic Literature, volúmen 36 primera edición.

Bowles, Samuel y Gintis, Herbert (1993). The revenge of Homo Economicus: Contested Exchange and the Revival of Political Economy”. Journal of Economic Perspectives, volúmen 7, primera edición.

Vries, P.H.H (2001) “The role of culture and institutions in economic history: can economics be of any help?”

Gintis, Herbert y Romer, Paul (1998). “The Human Side of Economic Analysis: Economic Environments and the Evolution of Norms and Preferences”

Sen, Amartya (1998). La Razón Antes que la Identidad” Letras Libres, Número 23 (2000)

?Lindbeck, Assar (1997).?“Incentives and Social Norms in Household Behavior”. American Economic Review.

Kuznar, Lawrence, “On Risk-Prone Peasants: Cultural Transmission or Sigmoid Utility.

Maximization?”. Universidad de Indiana.

Camerer, Colin F. y Fehr, Ernst. (2002) “Measuring Social Norms and Preferences using

Experimental Games: A Guide for Social Scientists”. Institute for Empirical Research in Economics, University of Zurich.

Binger, Brian y Hoffman, Elizabeth. (1998) “Microeconomics with Calculus”. Addison-Wesley.

Heinrich, Joseph et al. (2001) “Economic Man’ in Cross-cultural Perspective: Behavioral Experiments in 15 Small-scale Societies”. Santa Fe Institute.

Bowles, Samuel (2001). “Preferences and Behavior”.

Rabow, Jerome et al (1966). “The role of Social Norms and Leadership in Risk-taking”. Sociometry, volúmen 29, primera edición.

Fehr Ernst y Firschbacher, Urs (2002). “Why Social Preferences Matter- The Impact of

Non-selfish Motives on Competition, Cooperation, and Incentives”. The Economic Journal.

Falk, Armin et al. (1999) “On Nature of Fair Behavior” Institute for Empirical Research in Economics, University of Zurich.

Bowles, Samuel et al. (1997) “Homo reciprocans: A Research Initiative on the Origins, Dimensions, and Policy Implications of Reciprocal Fairness.