INTRODUCTION TO DECISION THEORY

(ECN 203C, Fall 2008)

Klaus Nehring

1110 SSHB

752-3379

Course Organization

Homework: weekly problem sets.

Evaluation:

• regular handing in of homework 20%.

• take-home midterm (probably around Veterans day) 40%,

• final paper 40%.

• The paper could consist of various things:

1. A literature review identifying an interesting open and possibly doable research question

2. A (possibly small) new result (I may be able to give you some projects)

3. A fairly thorough discussion of the normativity of some axiom / the validity of some type

of normative argument

4. A simple application of some decision-theoretic model in an economic context.

A written proposal is due on Monday, November 10; it counts 10% out of the 40%. The final

version is due on Tuesday, December 9.

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Weeks 1 through 3:

Rational Choice and Revealed Preference

The Standard Model

• Kreps, David M. (1988)∗. Notes on the Theory of Choice, Westview Press, Boulder, ch. 2.1

• see also: Mas-Colell, A. , Whinston, M. and J. Green (1995), Microeconomic Theory, OxfordUP, ch. 1.

Rationality and Revealed Preference

• Elster, J. (1983), “Rationality,” in: Sour Grapes- Studies in the Subversion of Rationality,Cambridge University Press, ch. 1, 1-26.

• Sen, A. (1973), ”Behavior and the Concept of Preference,” Economica 40, p. 241-259

• Bar-Hillel, M. and A. Margalit (1988)∗, “How Vicious are Cycles of Intransitive Choice,”

Theory and Decision 24, 119-145.

Choice under Incompleteness

• Moulin, H. (1985)∗, ”Choice Functions over a Finite Set: A Summary,” Social Choice and

Welfare 2, p. 147-160.

• Nehring, K. (1997)∗, ”Rational Choice and Revealed Preference without Binariness,” SocialChoice and Welfare 14, 403-425.

• Manzini, P. and M. Mariotti (2007), “Sequentially Rationalizable Choice,” American EconomicReview, forthcoming.

• Masatlioglu, Y. and E. Ok (2005), “Rational Choice with Status Quo Bias,” Journal of Eco-nomic Theory 121, 1-29.

Ordinal Utility

• Kreps∗, Notes, ch. 3

1*-ed readings are required.

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Weeks 4 and 5: Temptation and Self-Control

Modeling Temptation

• Gul, F. and W. Pesendorfer (2001)∗: “Temptation and Self-Control,” Econometrica 69, 1403-1435.

• Gul, F. and W. Pesendorfer (2006): “The Simple Theory of Temptation,” mimeo.

• Nehring, K. (2006)∗: “Resisting Temptation,” mimeo.

General Models of Self-Control

• Nehring, K. (2006)∗: “Self-Control through Second-Order Preferences,” mimeo.

• Dekel, A., B. Lipman and A. Rustichini (2006): “Temptation-Driven Preferences,” mimeo.

Related non-axiomatic models

• Bernheim, D. and A. Rangel (2005): “Behavioral Public Economics: Welfare and Policy Analy-sis with Non-Standard Decision-Makers,” forthcoming in Economic Institutions and Behavioral

Economics, edited by Peter Diamond and Hannu Vartiainen, Princeton University Press

• Fudenberg, D. and D. Levine (2005): “A Dual Self Model of Impulse Control”, Harvard Uni-versity Working Paper, forthcoming in the American Economic Review.

• Loewenstein, G. and O’Donoghue, E. (2005): “Animal Spirits: Affective and DeliberativeProcesses in Economic Behavior”, mimeo.

Weeks 6 through 8:

Decision Making Under Uncertainty: Expected Utility Theory

Expected Utility Theory under Risk (Known Probabilities).–

The von-Neumann Morgenstern Representation Theorem; Characterizing Risk-Attitudes

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• Kreps∗, Notes, ch. 5 and 6

• Mas-Colell, A. , Whinston, M. and J. Green (1995), Microeconomic Theory, Oxford UP, ch.6∗.

Expected Utility with Subjective Probabilities.–

The Fundamental Representation Theorem

• Kreps, David M. (1988)∗. Notes on the Theory of Choice, Westview Press, Boulder, ch. 8 and9.

• Savage, L. (1954, 19722), The Foundations of Statistics, Dover N.Y., ch. 1-5.

• Fishburn, P. (1970), Utility Theory for Decision Making, John Wiley, NY, ch. 14: Savage’sExpected Utility Theory.

Mixing Subjective and Objective Probabilities: The Anscombe-Aumann Approach

• Kreps, Notes, ch. 7.

Probabilistic Sophistication: Non-Expected Utility Decisions based on Subjective Probabilities

• Machina, M. and D. Schmeidler (1992)∗, “A More Robust Definition of Subjective Probability”,Econometrica 60, 745-780.

Normative Issues:

• Broome, John (1991, pb. 1995).∗ Weighing Goods, Basil Blackwell, Oxford, ch. 5.

On the notion of Subjective Probability:

• Kreps, Notes, ch. 11.

• Fitelson, B., A. Hajek and N. Hall, “Probability,” in: J. Pfeifer and S. Sarkar (eds.), Philosophyof Science: An Encyclopedia, Routledge Press, forthcoming.

Framing

• Ahn, D. and H. Ergin (2007), “Framing Contingencies,” mimeo.

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Weeks 9 and 10: Non-Expected Utility Theory under Risk

Overview

• Wu, G., J. Zhang and R. Gonzalez (2004)∗, “Decision under Risk” in, Blackwell Handbook ofJudgment and Decision Making, N. Harvey and D. Koehler (Eds.).

Expected Utility implies Almost-Risk Neutrality for Moderate Stakes

• Rabin, M. (2000)∗, Risk Aversion and Expected-Utility Theory: A Calibration Theorem,

Econometrica 68, 1281-1292.

Quasi-Expected Utility Theory with Loss Aversion and Endogeneous Status Quo Point

• Dekel, E (1986), “An Axiomatic Characterization of Preferences under Uncertainty: Weaken-ing the Independence Axiom,” Journal of Economic Theory 40, 309-318.

• Gul, F. (1991)∗, “A Theory of Disappointment Aversion in Decision-Making under Uncer-

tainty,” Econometrica 59, 667-686.

• Nehring, K. (2005)∗, “Expected Utility with Psychological Consequences: On the Logic ofBetweenness-Based Preferences,” mimeo.

Rank-Dependent Expected Utility and Prospect Theory

• Kahneman, D. and A. Tversky (1979)∗: “Prospect Theory: An Analysis of Decision underRisk,” Econometrica 47, p. 263-291.

• Diecidue, E. and P. Wakker (2001): “On the Intuition of Rank-Dependent Utility,” The Journalof Risk and Uncertainty, 23:3; 281—298.

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Week 11: Decision Making under Ambiguity

Representation of Incomplete Beliefs and Preferences

• Bewley, T. F. (1986):∗ “Knightian Decision Theory, Part I,” Cowles Foundation DiscussionPaper No. 807. Reprinted in: Decisions in Economics and Finance 25 (2002), 79-110.

Decision Making under Complete Ignorance

• Luce, R. D. and H. Raiffa (1957)∗: Games and Decisions. New York, John Wiley, ch. 13.

• Nehring, K. (2000): “Rational Choice under Ignorance”, Theory and Decision 48, 205-240.

A Classical Experiment

• Ellsberg, D. (1961)∗: “Risk, Ambiguity, and the Savage Axioms”, Quarterly Journal of Eco-nomics 75, 643-669.

Models of Decision Making under Ambiguity

• Camerer, Colin and Weber, Martin (1992): “Recent Developments in Modelling Preferences:Uncertainty and Ambiguity”. Journal of Risk and Uncertainty, 325-370.

• Gilboa, I. and D. Schmeidler (1989)∗: “Maxmin Expected Utility with a Non-Unique Prior”,Journal of Mathematical Economics 18, 141-153.

• Schmeidler, D. (1989)∗: “Subjective Probability and Expected Utility without Additivity”,Econometrica 57, 571-587.

• Tversky, A. and D. Kahneman (1992): “Advances in Prospect Theory: Cumulative Represen-tation of Uncertainty,” Journal of Risk and Uncertainty 5, 297-323.

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Weeks 12: Dynamic Choice

Preference for Flexibility

• Kreps, D. (1979)∗: “A Representation Theorem for ‘Preference for Flexibility’,” Econometrica47, p. 565-577.

• Nehring, K. (1999), “Preference for Flexibility in a Savage Framework”’, Econometrica 67,101-120.

• Dekel, E., B. Lipman and A. Rustichinni (2001): “Representing Preferences with a UniqueSubjective State Space,” Econometrica 69, 891-934.

• Ergin, H. and T. Sarver (2005), “A Unique Costly Contemplation Representation,” mimeo

MIT.

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