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ED 8 - IIM C Topic 2 Incentives Aug 2022

The document discusses the role of monetary and non-monetary incentives in promoting pro-environmental behavior, highlighting various experimental games such as the Ultimatum and Dictator games to illustrate concepts of fairness, altruism, and social preferences. It explores how visibility and reputation influence individual behavior, suggesting that people often sacrifice personal gain to appear fair or altruistic. Additionally, it examines the implications of these findings for environmental policy and the design of mechanisms that leverage reputation to encourage conservation efforts.

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0% found this document useful (0 votes)
2 views52 pages

ED 8 - IIM C Topic 2 Incentives Aug 2022

The document discusses the role of monetary and non-monetary incentives in promoting pro-environmental behavior, highlighting various experimental games such as the Ultimatum and Dictator games to illustrate concepts of fairness, altruism, and social preferences. It explores how visibility and reputation influence individual behavior, suggesting that people often sacrifice personal gain to appear fair or altruistic. Additionally, it examines the implications of these findings for environmental policy and the design of mechanisms that leverage reputation to encourage conservation efforts.

Uploaded by

pinjariss
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Environmental economics

Topic 2: Incentives
Theory and evidence of monetary and non-monetary incentives for pro-environmental
behaviour change

Dr Prasenjit Banerjee
University of Manchester
IIM C

Environmental Economics
Positive contribution to PG—altruism?
Direct evidence?
Well functioning
market
Homo Social
Economicus Efficiency

Market Economic
Failure Nash Incentives
Equilibrium

Conditional
Cooperation
 Social preferences
Behavioural
Failure
Crowding-Out
3
Ultimatum game
A Proposer is given $10. He is asked how
much of this he wants to give to a receiver.
The receiver either accepts or rejects the
offer. If she accepts both receiver and
proposer get their share. If she rejects both
get nothing.

Behavioral Economics (3rd Edition) b 4


y Edward Cartwright
Ultimatum Game
• Ultimatum Bargaining Game with a pie of $c
• Player 1 (Dictator) offers:
– (c-x, x); x => the amount offered to Player 2
(Recipient).
• Player 2 is informed and can accept or reject
– Rejects: both players earn zero.
– Accepts: (c-x, x) is implemented.
• Prediction
– (c-,), with   0, is proposed and accepted, as is
every offer x > .

5
Dictator game

A Proposer is given $10. He is asked how


much of this he wants to give to a receiver.
The receiver gets whatever she is given. And
the proposer keeps the rest.

6
Dictator Game
• Like the ultimatum game but player 2 (Recipient) has
no choice

Þthe proposed allocation by 1 (Dictator) always


implemented.

• Self-interest prediction: (c -,) where   0 is


proposed.

7
Do subjects punish unfair behaviour?
(KAHNEMAN, KNETSCH,THALER (1986).
• 2 stages
• Stage 1:
– subjects could divide a $20 pie only one of two ways,
• (1) (20 – 10, 10); or (2) (20 – 2, 2)
– The counterpart was passive => Dictator game
– Results: 76% split it equally.
• Stage 2:
– subjects were matched with two recipients
– could divide $10 (evenly) with someone who had previously
kept $10, or $12 with someone who had previously kept $18.
– Results: 74% chose the smaller pie, sacrificing $1 in payoffs to
reward the fair counterpart.
• Clearly fairness plays a role, and subjects are willing to sacrifice
small amounts of money to punish unfair behaviour.
Is anonymity a factor?
• Agents are anonymous -- no individual or social identities
– agents do not care if they are observed
• But in the experiments, subjects are not anonymous.
– subjects are fair because they are observed?
• To test this: use double-blind or double anonymous protocol
Hoffman, et al (1994, AER)
– subjects know that their actions are not observed, and they
are anonymous to each other.
• Their experiment is a dictator game
• Result: A notable increase in selfish play, with about 70% of
subjects keeping the full endowment.
Does the unearned endowment play a
role?
• Subjects received monetary endowment from the experimenter
for free
• What if they earned it, as in reality people do
• The assets in a bargain must be legitimate to produce rational
behaviour in the lab
• To test this add the following to the dictator game (Cherry et
al. 2002):
– subjects had to earn the endowment by putting real effort
(solving a GMAT quiz) – if at least 10 correct answers, they
received $40, otherwise $10
– Then decides how much to give to a recipient from the earned
endowment
Design (Cherry et al. 2002, AER)
• Subjects unfamiliar with bargaining/dictator game
• Randomly divided into 2 groups, A & B, split into 2 rooms
• 2 stages: earnings and bargaining/giving
• Bargaining: A1 (who earns $40) & A2 split into different
rooms and randomly matched with B
• A: decides a split from their earning and game ends
• 3 treatments
– Baseline: endowment given ($40 or $10) and D decides a
split
– Earnings: D earns the endowment ($40 or $10) and R knows
that D earns it (common knowledge)
– Double blind: same as ‘Earnings’ with zero visibility
Results
• Social preferences diminished with earned
wealth
• This nearly eliminated with earned wealth +
anonymity.

Treatment Zero offers


Baseline 19% ($10) and 15% ($40)
Earnings 79% ($10) and 70% ($40)
Double Blind 95% ($10) and 97% ($40)
Does the framing of D-game cause the ‘norm’ of
positive giving?
• Traditional action set: “demand” a positive gift
– such norms causes positive giving—away from the SPNE
• Allowing action set in the non-positive domain, norms change
– “moral authority” to give nothing
– dictator now has many choices to signal she is not selfish
• Do subjects have preferences over the other agent’s outcomes?
or
• Do they want to signal (or self-signal) motives to avoid
appearing completely selfish?
Design (List, 2007, JPE)
• Treatment Take ($1)
– Action set: (-$1–$5) => dictators can now take $1 from room B subjects
– Whether simply allowing taking can yield differences in behaviour?
• Treatment Take ($5)
– Makes the choice set symmetric for the dictator, a take of up to $5
– Use of two take treatments: two points on the “moral cost function.”
• Treatment Earnings
– Identical to Treatment Take ($5), except subjects now earn their monies
– All subjects (rooms A and B) participated in the earnings session.
– Subjects were also told that room A (B) agents earned $10 ($5) for
completing the task
Results

Treatment Rate of Median offers Mean offers


positive
offers
Baseline 71% $1.00 $1.33
Take $1 35% $0.00 $0.33
Take $5 10% -$4.50 -$2.48
Earnings 6% $0.00 -$1.00
Dictator Game: Share offered by proposers
Experiment

standard, $5
standard, $10
replication, $10 The nice side of
variation, $10 social preferences
exchange, $10 – people giving to
single blind 2, $10 others.
single blind 1, $10
double blind 2, $10
double blind 1, $10

-0.1 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Share offered by proposers
Source: Forsythe et al. (1994), Hoffman et al. (1994), Hoffman et al (1996), Camerer (2003) 16
Reputation: a formal model
(Bénabou, R. and Tirole, J., 2006. Incentives and prosocial behavior. American economic review, 96(5), pp.1652-
1678.)

• Three motives:
extrinsic + intrinsic + reputational
– Their interaction and how incentives affect them


• f(v) with mean (). Its realization is private information.
Motivation and motivational crowding out
• Economists suggest that people respond to monetary incentive even if
they have other motivations (e.g. altruism, reputation)
• Evidence suggests possibility of crowding out effect
– Voluntary blood donations decreases after introducing monetary payment to
blood donation—because people unable to indulge the altruistic satisfaction
from ‘good deed’ or they have doubts about the true motives of the work
(Titmus 1970)
– A majority of Swiss residents were willing to accept repositories of nuclear
waste in their communities when no payment was offered compared to
different level of monetary payments and this willingness actually went
down when a monetary payment was offered (Frey and Oberholzer-Gee
1997)
– On the other hand, imposing fine to parents for late pick-ups of toddlers did
not change behaviour—extrinsic incentives crowd-out intrinsic motives
(Gneezy and Rustichini 2000)
Test: whether people care about
moral reputation
– People donate more when visibility increases
– Exert more effort in workplace to gain a good
reputation
– Tend to keep self-chosen savings commitment if
observed by other person
• Andreoni and Bernheim (2009)(Andreoni, J. and Bernheim,
B.D., 2009. Social image and the 50–50 norm: A theoretical and experimental
analysis of audience effects. Econometrica, 77(5), pp.1607-1636.)
– In private setting behave selfishly but in public setting
inequity averse
Altruism or 50-50 norm? Concerns for self-image?

• Altruism or concerns for fairness ?


– the utility function is kinked, or that dictators are
boundedly rational.
• But, neither altruism nor a preference for fairness explains
why visibility and, hence, audiences play an important role in
determining the norm’s strength.
• Test:
– the fairness hypothesis
+
– Whether people like to be perceived as fair
Design
Andreoni and Bernheim 2009, Econometrica
• With probability 1 – p, D chooses x
• With probability p, nature sets it equal to x0, a fixed amount
• Then the game ends
• Parameter p and x0 – common knowledge
• But R cannot observe whether nature intervened
• Identities of D & R, and outcomes are publicly identified to
heighten the effects of social image
• Question: With increasing p, should increase the mass of D
who choose any given x0 (close to 0) and reduce the mass of D
who split the payoff equally?
Results
• A significant fraction of the population elects
precisely 50– 50 division even when it is possible to
give slightly less or slightly more
• Subjects rarely cede more than 50 percent of the
aggregate payoff
• In addition, choices depend on observability: greater
anonymity for the dictator leads him to behave more
selfishly and weakens the => ‘audience effect’
Reputation Concern: Application
• Energy usage in the US, OPOWER (Allcott 2011,
JPubE)
– In energy bill, information about neighbours’ energy
usage
– If more than average, a smiley face 
– People who were using more than the average
significantly decreased their consumptions—comply
with the norm (avoid bad psychological reputation)
• Incentive mechanism: reputation seekers give
economic gain to gain a good reputation
Behavioral Economics; Nudging Effects
(taken from: Allcott, H., 2011. Social norms and energy conservation. Journal of public
Economics, 95(9-10), pp.1082-1095. )

• Change in household electricity consumption behaviour


• OPOWER (one US utility company) started sending
information about the average electricity consumption in the
locality to each household with their monthly electricity bill
• Control (those who did receive such info) vs treatment
groups
• Within Treatment group: two variations: (i) a smiley face if
one HH’s consumption was less than the average; (ii) a sad
face if HH’s consumption was less than the average
• HH’s electricity consumption significantly reduced for those
who got a sad face
Behavioral Economics; Nudging Effects
Behavioral Economics; Nudging Effects
Why save endangered species?

“endangered and threatened species of wildlife and


plants are of esthetic, ecological, educational,
historical, recreational, and scientific value to the
Nation and its people.” –ESA 1973

fundamental economic conflict

As 1000+ endangered species on private land


Economic Policy rational and self-
The ESA 1973 Incentives and regarding agents
CONFLICT: Private mechanism design act in the common
Vs Social Interest Innes et al. 1998; Shogren et al. 2001 interest

Warm-Glow/
Crowding-Out Altruism
∂a/∂T<0 Andreoni 1995; Frey 1994;
Becker 1974; Fehr and
Titmuss 1970; Frey 1997; Frey and
Rockenbach 2004
Benabou andBowles
Jegen 2001; Tirole2008
2006

∂a/∂T>0
Participation in •at least compensate loss
pro-social action of rents
Moral •Information Rent
for reputation?
Benabou and Tirole 2006; Dana Reputation Smith and Shogren 2002; Laffont 1995; Baliga
and Maskin 2003
et al. 2003 Smith 1759; Milgrom and
Roberts 1982; Sen 1994;
Nowak & Sigmund 1998

29
Research Questions

Can we incorporate reputation to motivate


people?

Can we redesign mechanism using


reputational concern behavior?

Can the regulator save public fund by


exploiting reputation?
Regulator’s challenge
• Regulator knows two types of landowners—social preference
and reputation seeker—but doesn’t know who is who
• Social preference
– shelter species even though privately costly
– money might crowd out
– Regulator doesn't want to chase away these folks
• Reputation seeker
– uninterested in paying a private cost to protect species
– might want to “buy” a good reputation
– Not reward them as extra money could be spent elsewhere
• Design a menu of monetary transfer-to-effort that gets the best
out of different types of landowners

31
Reputation: how we see it
• Perception others have about an individual’s type,
nature, or value
• People care because -- feel good ; other selfish
motive
• Here -- based on the landowners’ intrinsic valuation
for money (vT)– a high vT ,a low reputation and vice-
versa

R= x [γa E(va|a,T) – γT E (vT|a,T)]


Visibility of Warm Intrinsic valuation
landowner’s action Glow for money
Model
Landowner’s utility,
U = vT π(A - a) + va a + vT T a + R

Crowding-out
∂a/∂T <0 if RaT > vT
=> if care more about reputational gain than monetary gain

Design under full information


Max W = B(a)+vT π(A - a)+ va a + vTTa + R – λTa

s.t. vT π(A - a) + va a + vT T a + R ≥ θ

Optimality requires
∂π(A - a)/∂a = ∂B/∂a + λ/ vT (1 + ∂R/∂a)
vTT* a* = θ – π(A - a*) – a* - R
Mechanism under Asymmetric Information about Reputation and land quality

Participate IF, Results

GH U (in) ≥ U (out) at least optimal acres;


Participation Const. no info. rents

T ≥ T of H-Land more than optimal acres;


T GL Incentive Compatibility (Milinski et al. 2002; Nowak and Sigmund 1998)
Y (IC)
P
info. rent
E

BH R ≥ R of Green buy reputation


(IC)

T ≥ T of H-Land a trade-off – buy


BL R ≥ R of Green reputation and capture
(IC)
info. rent
34
Concluding Remark

Address crowding-out, prescribe optimal monetary transfer

Two sources of asymmetric information

more wide-spread publicity for land retirement decisions

over-protect species to “shelter” own good reputation

save public resources as brown landowner buys reputation

35
EFFECT OF INCENTIVES
Effect of fine on late pick-up of pupils from
day-care centers (Gneezy and Rustichini)
• Standard economic theory predicts: attaching a fine to an activity
will reduce the amount of that activity, all else equal (the
principle of deterrence)
• This paper provides an example where that principle fails.
• A group of private Israeli day-care centers were troubled by the
frequency at which parents arrived after the 4pm closing time to
pick up their children (despite the contracted pickup time of
4pm).
• Although day-care staff frowned on this behavior, there was no
specific sanction for tardiness.
• The experimental manipulation was, at 6 of 10 day-care centers,
to fine parents for being late.
Effect of fine on late pick-up of pupils from
day-care centers (Gneezy and Rustichini)
• The procedure was:
– In the first 4 weeks, collect baseline data. no
manipulation
– In weeks 5 through 16, a fine was announced and
parents were charged approximately $3:50 for a
delay of 10 minutes or more.
– In weeks 17 through 20, the fine was removed
without explanation.
Effect of fine on late pick-up of pupils from
day-care centers (Gneezy and Rustichini)
• Results:
– In the first 5 weeks in which the fine was in place,
late arrivals approximately doubled at the
treatment centers. that is, the fine induced more
late arrivals.
– In week seven forward, late arrivals equilibrate at
slightly less than twice the initial level.
– After week 17, when the fine was removed, late
arrivals did not return to normal.
Effect of fine on late pick-up of pupils from
day-care centers (Gneezy and Rustichini)
• Interpretation:
– Incomplete contracts.
• The formal day-care contract did not specify penalties for
coming late, but it was implicitly understood that this was an
imposition on the staff and should only occur in emergencies.
• Because the consequences for violating the contract were not
specified, parents did not know how much they stood to be
punished for tardiness (i.e., would there children be asked to
leave the day-care?).
• The fine revealed to parents these consequences were very
mild. Once the consequences were known, many parents
decided they were happy to bear them.
Effect of fine on late pick-up of pupils from
day-care centers (Gneezy and Rustichini)
• Interpretation:
– Social norm.
• Prior to the fine, parents implicitly understood that arriving
late was taking advantage of teachers’ generosity, and so
refrained from doing so in compliance with a social norm.
• The fine turned this informal social interaction into a
market transaction. The fine conveyed to the parents that
they could buy the right to be late.
• Why did behavior not return to normal when the fine was
removed? Perhaps the perception of the social norm was
altered by the experience of the fine. Parents continued to
think of lateness as an additional service rather than a
violation of terms.
Effect of fine on late pick-up of pupils from
day-care centers (Gneezy and Rustichini)
• Interpretation:
– The authors state: “The conclusion seems to be that the
absence of a price is not just the limit of very low prices.
Mentioning a payment is enough to change the perception
of the contract: from a service, which is due from them as
subjects in the experiment, to a market exchange. In a
similar manner, in the day-care study a fine is enough to
change the perception of the obligation to arrive on time.”
– explicit incentives exist against a backdrop of implicit rules
and incentives (typically called social norms). By
introducing explicit incentives one may inadvertently
‘crowd-out’ or undermine implicit incentives.
Crowding out of monetary incentive
(Frey and Oberholzer-Gee 1997)

• Question asked: if respondents were willing to permit the


construction of a nuclear waste repository for short-lived, low-
and mid- level radioactive waste on the grounds of their
community
• More than half of the respondents (50.8 %) would have voted in
favor of having the nuclear waste repository built in their
community, 44.9% percent opposed the facility
• This NIMBY project received widespread support
• It was mostly viewed as a heavy burden for the residents of the
host community:
– Nearly 40% percent of all respondents believed the risk of serious
accidents in the facility and ground- water contamination to be
considerable and nearly 80% believed that many local residents would
suffer long-term effects should any accident occur.
Crowding out of monetary incentive
(Frey and Oberholzer-Gee 1997)

• To test the effect of external compensation:


• The exact same question was repeated—asking respondents whether
they were willing to accept the construction of a nuclear waste
repository when the Swiss parliament had decided to compensate all
residents of the host community
• The amount offered varied from $2,175 per individual and year (N =
117) to $4,350 (N = 102) and $6,525 (N= 86).
• While 50.8% of the respondents agreed to accept the nuclear waste
repository without compensation, the level of acceptance dropped to
24.6 percent when compensation was offered.
• About one-quarter of the respondents seem to reject the facility
simply because of financial compensation. The amount of
compensation had no significant effect on the level of acceptance
Crowding out of monetary incentive
(Frey and Oberholzer-Gee 1997)
• To test the effect of external compensation:
• Everyone who rejected the first compensation was then made
a better offer, raising the amount of compensation from $2,175
to $3,263, from $4,350 to $6,525, and from $6,525 to $8,700.
• Only a single respondent changed his/her mind.
• To further test the crowding-out effect:
• An identical survey conducted in northeastern Switzerland
• 41% of these respondents stated they would vote for the high-
level radioactive waste facility, 56.4 per- cent would have
voted against it.
• When offered compensation, the level of acceptance dropped
to 27.4%. Again, variations of the financial incentives did not
result in significant changes of the supportive votes.
Effect of Social Reward (Kosfeld and
Neckermann 2011)
• Awards are abundant in social and economic life.
• For examples in corporate sector: "Employee ofthe Month" at
McDonald's, the "Bravo Award" at IBM, or the "Spotlight" employee
recognition program of the software company Intuit.
• While all these awards differ in different aspects, they have the common
features:
– they are visible: everyone in the particular environment knows that the
award exists and that winners are typically honored in a public
ceremony.
– they create a competitive environment by setting up a tournament with
ex-post winners and losers.
– they are based on broad and vague criteria that typically make them
contractually unenforceable.
– they yield a number of material and non-material benefits.
Effect of Social Reward (Kosfeld and
Neckermann 2011)
• Awards offers indirect material benefits for the future if the award improves
the career perspectives of the winner in the organization or if it generates a
positive signal to the environment, which leads to later financial advantage.
• Probably most people would also agree that awards yield non-material
benefits. These benefits come in the form of social recognition from the
award-giving institution from peers and colleagues, or from an
external audience.
• This recognition is related to the status of the winner of an award
within a group (e.g., the department, the overall workforce, or
society).
• A further source may be the winner's improved self-esteem, either with
regard to the particular achievement or with regard to general ability.
• How important are these non-material benefits of awards? Do
they create anyincentive
Effect of Social Reward (Kosfeld and
Neckermann 2011)
• How important are these non-material benefits of awards?
• Do they create any incentive themselves to win the award?
• or are they just enjoyable but irrelevant social facets of an
achievement that is driven by pure material aspects?
• Almost always awards include material and non-material benefits in
parallel: impossible to disentangle the different aspects of these
incentives in the field.
• Nevertheless, the answer to this question is important.
– from a practical viewpoint the role of social recognition, vis-à-vis
monetary incentives, is clearly of great relevance and has major
implications for optimal reward policies.
– Important to test theory: status and social recognition important the
pure status dimension of awards and employee recognition
Effect of Social Reward (Kosfeld and
Neckermann 2011)
• collaborate with an international NGO to hire students to
work on a database project for a fixed wage.
• randomly assigned students to one of two treatments
(award, control).
• In the award treatment, students were promised an award
for the best performance. The award was purely symbolic
consisting of a personalized congratulatory card that was
signed by the president and the managing director of the
organization.
• In the control treatment, students worked under exactly the
same conditions except that they were not offered an award.
Effect of Social Reward (Kosfeld and
Neckermann 2011)
Results:
• symbolic award significantly increases performance by about
12 percent on average.
• The award increases not only the average performance but also
the variance of performance. Both observations are in line with
the theoretical prediction of pure social status preferences.
• the award has a particularly strong effect on individuals who
are more likely to win the award.
• the increase in performance has no negative influence on
quality. This is of particular importance, as it shows awards can
be effective instruments that have no quantity-quality trade-off
Wrap up
• There are already many constraints on human
behavior operative that do not look like individual
maximization.
• Many agents appear to be complying with norms of
fairness and cooperation in the absence of explicit
incentives
• Or perhaps these norms provide strong incentives but
we don’t know how to adequately account for them
Wrap up
• The insertion of economic incentives in such an
environment may work exactly as neoclassical theory
predicts or it may instead generate perverse
consequences (or, as in the public goods experiment,
unexpected positive consequences) by interacting
strongly with the implicit constraints and incentives
already in place.
• Understanding these implicit incentives and constraints
may help to interpret much human behavior that
economic models do not seem to accommodate.

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