Preference for flexibility in the absence of learning: the risk attitude effect

Individuals’ preferences over opportunity sets may display “preference for flexibility” which prescribes to gradually eliminate alternatives from a given set until a final choice is made. One rationale for this preference for flexibility is individuals’ incentive to postpone the final choice in order to better learn their underlying preferences over basic alternatives. In this paper we show that even in the absence of learning, preference for flexibility arises if individuals are risk-averse or, at least, are not very risk-seeking. Thus, individual’s attitude towards risk provides yet another rationale for preference for flexibility. One of our results is that in the absence of learning, risk-neutral as well as risk-averse individuals display the same, maximal preference for flexibility. We thank Han Bleichrodt, Robert Dur, Chaim Fershtman, Maarten Janssen, Peran van Reeven, Peter Wakker, and Timothy van Zandt for helpful comments to and inspiring discussions. We are very grateful to the anonymous referee for very constructive comments and suggestions.     

The political economy of constitutional restraints

Constitutions are multidimensional objects with non-trivial implications on the structure of the political environment and, therefore, on the policy outcomes. This paper models constitutions as sets of “restraints” on the authority’s choice freedom (absolute and democracy restraints). We argue that even if both kinds of restraints seem to be serving the same purpose (increase social welfare), “democracy restraints” prolong the “life” of a constitution while “absolute restraints” not. We moreover use the proposed way of modelling constitutions in order to explain the dominance of intermediate (in terms of tightness of “democracy restraints”) constitutions in the real world.     

Exploring policy options in joint intertemporal-spatial trade models using an incomplete markets approach

In this paper we discuss the desirability of service trade liberlization in the presence of incompleteness of markets where there is both inter-spatial and intertemporal trade between countries. We use numerical simulation methods for insights and relate our discussion to the General Agreement on Trade in Services (GATS) in the WTO. We interpret the absence of intertemporal trade as an absence of intermediation services provided by both domestic and foreign service providers. For simplicity, we consider extreme cases where intertemporal intermediation services can only be provided by domestic providers, so that when intertemporal trade in services is not allowed, markets are not complete. To our knowledge, this type of models is not used in the trade literature as general comparative statics results are unavailable. We first consider the liberalization of trade in financial services in an inter-spatial and intertemporal model of two countries, and we show how services liberalization can be welfare worsening in the presence of a tariff on spatial trade in goods. We show that this can hold in an artificial world with no domestic financial services provider. We compare financial service trade autarky in which there is no intermediation to financial service trade liberalization which involves costless intertemporal intermediation provided by foreign service providers. We also consider a more complex (and realistic) world where costly intermediation services can be provided by both domestic and foreign providers. This paper draws in part on material of an earlier paper, “Financial Services Trade Liberalization in A Joint Spatial Intertemporal Multi-Country Model” by Huang et al. (2004). We acknowledge the financial support from The Centre for Intentional Governance Innovation (CIGI), Waterloo, Canada and from National Social Science Foundation of China (SSFC Grant 07AJL002), National Natural Science Foundation of China (NSFC Grant 70825003) and “Humanities and Social Science” Major Project, Chinese Ministry of Education (Grant Number 07JJD790145).     

Experts with a conflict of interest: a source of ambiguity?

We present an experimental design where uncertainty is generated from the advice of experts with conflicts of interest. In this experiment clients are faced with a variant of a multi-armed bandit problem with a random end-time. On the known arm (the “task screen”), clients can earn a certain payment per completion of a decoding task. However, clients may also opt for the unknown arm where they earn an uncertain amount if they end the experiment on this “expert screen”. The amount is uncertain to the clients because the value is being communicated through an “expert” with conflicted incentives. A control session provides for direct transmission of the value to the clients. Our results show that ambiguity aversion is alive-and-well in this environment. Also, when we vary the wage rate on the known arm we find that higher opportunity cost clients are less likely to heed the advice of conflicted experts.     

The measurement of income mobility: A partial ordering approach

Summary. Given a set of longitudinal data pertaining to two populations, a question of interest is the following: Which population has experienced a greater extent of income mobility? The aim of the present paper is to develop a systematic way of answering this question. We first put forth four axioms for income movement-mobility indices, and show that a familiar class of measures is characterized by these axioms. An unambiguous (partial) ordering is then defined as the intersection of the (complete) orderings induced by the mobility measures which belong to the characterized class; a transformation of income distributions is “more mobile” than another if, and only if, the former is ranked higher than the latter for all mobility measures which satisfy our axioms. Unfortunately, our mobility ordering depends on a parameter, and therefore, it is not readily apparent how one can apply it to panel data directly. In the second part of the paper, therefore, we derive several sets of parameter-free necessary and sufficient conditions which allow one to use the proposed mobility ordering in making unambiguous income mobility comparisons in practice. Received: July 12, 1995; revised version: May 13, 1997     

Knowledge and economic behaviour. A constructivist approach

The knowledge of human knowledge claims a place of its own in economics. Beyond the walls of our discipline, spectacular progress is taking place in the field of empirical research into human knowledge -the so-called “cognitive sciences”. In the light of such advances, the old and new classicals' axiom that nothing scientific can be said beyond the axioms of substantive rationality now looks very much like the protective belt of a degenerating programme. On the other hand, criticisms and alternative programmes will hardly be effective so long as their arguments are purely negative or are drawn from armchair introspection. In the present study I wish to outline a pattern of human knowledge emerging from cognitive research that may be called “constructivist”, and to point out the restrictions it sets on economic analysis. It is also my argument that such a pattern is consistent with the present non- or post-Walrasian trends in economic theory, and that it may provide them with firmer cognitive foundations.     

A general impossibility result on strategy-proof social choice hyperfunctions

A social choice hyperfunction picks a non-empty set of alternatives at each admissible preference profile over sets of alternatives. We analyze the manipulability of social choice hyperfunctions. We identify a domain D^λ of lexicographic orderings which exhibits an impossibility of the Gibbard–Satterthwaite type. Moreover, this impossibility is inherited by all well-known superdomains of D^λ. As most of the standard extension axioms induce superdomains of D^λ while social choice correspondences are particular social choice hyperfunctions, we are able to generalize many impossibility results in the literature.     

Sustainable recursive social welfare functions

What ethical criterion for intergenerational justice should be adopted, e.g., when faced with the task of managing the global environment? Koopmans’ axiomatization of discounted utilitarianism is based on seemingly compelling conditions, yet this criterion leads to hard-to-justify outcomes. The present analysis considers a class of sustainable recursive social welfare functions within Koopmans’ general framework. This class is axiomatized by means of a weak equity condition (“Hammond Equity for the Future”) and general existence is established. Any member of the class satisfies the key axioms of Chichilnisky’s “sustainable preferences”. The analysis singles out one of Koopmans’ original separability conditions (his Postulate 3′a), here called “Independent Present”, as particularly questionable from an ethical perspective.     

Evolution of vulnerability to pain in interpersonal relations as a strategic trait aiding cooperation

Why are humans so vulnerable to pain in interpersonal relations and can so easily hurt others physically and emotionally? We theoretically examine whether being offensively strong but defensively weak can evolve as a strategic trait that fosters cooperation. We study a population comprised of “thick-skinned” and “thin-skinned” agents by using an indirect evolution model that combines rational choice in strategic interactions with evolutionary selection across generations. We find that (a) the relatively vulnerable and cooperative thin-skins cannot evolve under purely random matching, (b) with some assortment thin-skins evolve and can take over the entire population, (c) vulnerability to greater pain makes it easier for thin-skins to evolve, and (d) proximate pain which merely feels bad but does not lower fitness helps thin-skins evolve even more than pain which accurately reflects fitness consequences. We draw contrast with the Hawk-Dove model and identify several ways in which rationality hinders the evolution of the relatively vulnerable and peaceful type of agent.     

On bubbling dynamics generated by a stochastic model of herd behavior

This paper suggests a class of stochastic collective learning processes exhibiting very irregular behavior. In particular, there are multimodal long run distributions. Some of these modes may vanish as the population size increases. This may be thought of as “bubbles” persistent for a finite range of population sizes but disappearing in the limit. The limit distribution proves to be a discontinuous function of parameters determining the learning process. This gives rise to another type of “bubbles”: limit outcomes corresponding to small perturbations of parameters are different. Since an agent's decision rule involves imitation of the majority choice in a random sample of other members of the population, the resulting collective dynamics exhibit “herding” or “epidemic” features. RID="*" ID="*" We are grateful to two anonymous referees for the comments and suggestions. Correspondence to: L. Gaio     

Sunspot Fluctuations in Two-sector Economies with Heterogeneous Agents

We study a two-sector model with heterogeneous agents and borrowing constraint on labor income. We show that the relative capital intensity difference across sectors is crucial for the conditions required to get indeterminacy and endogenous fluctuations. The main result shows that when the consumption good is sufficiently capital intensive, local indeterminacy arises while the elasticities of capital–labor substitution in both sectors are slightly greater than unity and the elasticity of the offer curve is low enough. Locally indeterminate equilibria are thus compatible with a low elasticity of intertemporal substitution in consumption and a low elasticity of the labor supply. As recently shown in empirical analysis, these conditions appear to be in accordance with macroeconomic evidences. We would like to thank R. Becker, J.P. Drugeon and an anonymous referee for useful comments and suggestions. The current version also benefited from a presentation at the conference “Public Economic Theory 04”, Beijing, August 2004.     

Subsidies on low-skilled workers’ social security contributions: the case of Belgium

In recent decades, many “Making Work Pay” policies have been implemented in OECD countries. These policies aim at improving the financial incentives for work, while maintaining high levels of social protection. Examples include the Earned Income Tax Credit in the USA and the Working Families’ Tax Credit in the UK. While these policies are proven to be quite effective with respect to poverty alleviation, many worry that they may discourage labor supply on the intensive margin. We consider an alternative measure implemented in Belgium: the Workbonus, which subsidizes social security contributions for low-skilled workers. This program differs from other measures in that the eligibility and the level of the subsidy are based on full-time equivalent earnings. The instrument therefore distinguishes between low skill and low effort and avoids the above-mentioned disincentive effect. We assess the effects of the Workbonus on labor supply using a particular discrete-choice labor supply model, in which individuals are assumed to choose among jobs belonging to individual-specific latent choice sets. In particular, we compare the Workbonus with a tax credit system temporarily implemented in Belgium in 2001–2004. Results show that both measures have a positive impact on labor supply. However, the Workbonus is more efficient in terms of cost per additional full-time equivalent position created and avoids the “part-time trap” implicit in the tax credit system.     

Fair welfare maximization

We consider the general problem of finding fair constrained resource allocations. As a criterion for fairness we propose an inequality index, termed “fairness ratio,” the maximization of which produces Lorenz-undominated, Pareto-optimal allocations. The fairness ratio does not depend on the choice of any particular social welfare function, and hence it can be used for an a priori evaluation of any given feasible resource allocation. The fairness ratio for an allocation provides a bound on the discrepancy between this allocation and any other feasible allocation with respect to a large class of social welfare functions. We provide a simple representation of the fairness ratio as well as a general method that can be used to directly determine optimal fair allocations. For general convex environments, we provide a fundamental lower bound for the optimal fairness ratio and show that as the population size increases, the optimal fairness ratio decreases at most logarithmically in what we call the “inhomogeneity” of the problem. Our method yields a unique and “balanced” fair optimum for an important class of problems with linear budget constraints.     

Competitive and core allocations in large economies with differential information

Summary. We study the core and competitive allocations in exchange economies with a continuum of traders and differential information. We show that if the economy is “irreducible”, then a competitive equilibrium, in the sense of Radner (1968, 1982), exists. Moreover, the set of competitive equilibrium allocations coincides with the “private core” (Yannelis, 1991). We also show that the “weak fine core” of an economy coincides with the set of competitive allocations of an associated symmetric information economy in which the traders information is the joint information of all the traders in the original economy. Received March 22, 2000; revised version: May 1, 2000     

Learning,diversification and the nature of risk

In many economic settings, faster learning is achievable only through greater exposure to risk. We study this conflict in the context of project choice, where a risk-averse agent must choose whether to invest in two projects of the same type (focus) or of different types (diversification). Focus enables faster learning across periods, but is riskier due to common type-specific shocks. Optimal choice involves balancing these two considerations. We show that focus is preferred for intermediate learning speeds, and that higher prior uncertainty may encourage focus. Thus, what matters for the focus-diversification choice is not only the level of risk, but also whether the risk is permanent or can be “learned away.” We are grateful to two anonymous referees, Serkan Bahceci, Steve Cecchetti, Adam Jaffe, Bojan Jovanovic, Kala Krishna, Blake LeBaron, Rachel McCulloch, Yana Rodgers, participants at the 2004 AEA-CSWEP Meetings and the 2003 North East Universities Development Conference, and seminar participants at Brandeis University for comments and suggestions.     

The quest for status and endogenous labor supply: the relative wealth framework

We analyze the implications of relative wealth preferences in a Ramsey model with endogenous labor supply. In contrast to relative consumption preferences, they allow for the possibility that agents work too little in the long run, while under both specifications the steady-state levels of consumption and the stock of physical capital exceed their socially optimal counterparts. Even in the case of excessive leisure agents are worse off in terms of intertemporal utility because initial transitional dynamics are characterized by under-consumption and excessive work effort. “Too much” long-run consumption of goods and leisure is possible due to the excessive capital-labor ratio.      

Subjective recursive expected utility

We axiomatize a subjective version of the recursive expected utility model. This development extends the seminal results of Kreps and Porteus (Econometrica 46:185–200 (1978)) to a subjective framework and provides foundations that are easy to relate to axioms familiar from timeless models of decision making under uncertainty. Our analysis also clarifies what is needed in going from a represention that applies within a single filtration to an across filtration representation.Part of this research was conducted when Ozdenoren visited MEDS in Fall 2003. We thank Tapas Kundu, Costis Skiadas, Jean-Marc Tallon and Tan Wang for helpful discussions and also thank audiences at Koc University, Northwestern University, the CERMSEM conference “ Mathematical Models in Decision Theory” at Universite Paris I, and the FUR XI conference on foundations and applications of utility, risk and decision theory     

Robust political economy

This paper introduces the idea of “robust political economy.” In the context of political economic systems, “robustness” refers to a political economic arrangement's ability to produce social welfare-enhancing outcomes in the face of deviations from ideal assumptions about individuals' motivations and information. Since standard assumptions about complete and perfect information, instantaneous market adjustment, perfect agent rationality, political actor benevolence, etc., rarely, if ever actually hold, a realistic picture and accurate assessment of the desirability of alternative political economic systems requires an analysis of alternative systems' robustness. The Mises-Hayek critique of socialism forms the foundation for investigations of robustness that relax ideal informational assumptions. The Buchanan-Tullock public choice approach complements this foundation in forming the basis for investigations of robustness that relax ideal motivational assumptions. JEL Code B53, P16, P26     

A characterization of consistent collective choice rules

We characterize a class of collective choice rules such that collective preference relations are consistent. Consistency is a weakening of transitivity and a strengthening of acyclicity requiring that there be no cycles with at least one strict preference, which excludes the possibility of a “money pump.” The properties of collective choice rules used in our characterization are unrestricted domain, strong Pareto, anonymity and neutrality. If there are at most as many individuals as there are alternatives, the axioms provide an alternative characterization of the Pareto rule. If there are more individuals than alternatives, however, further rules become available.     

Losses due to manipulation of social choice rules

In a companion paper, “Gains from Manipulating Social Choice Rules,” we analyzed the incentive to manipulate by considering the maximum number of ranks someone can gain in their preference ordering by manipulation. This paper treats the number of ranks someone else can lose due to manipulation. We find large classes of rules where that loss is very large, a few rules where the loss can be significantly smaller, and even some rules where no one ever loses—even though manipulation will take place.