Dilemmas of An Economic Theorist

Presidential Address

Econometric Society, 2004

Ariel Rubinstein
School of Economics, Tel Aviv University
and
Department of Economics, New York University

This version: June 2005

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Abstract
The paper discusses three dilemmas:
The dilemma of absurd conclusions: Should we abandon a model if it produces absurd
conclusions or should we regard a model as a very limited set of assumptions which
will inevitably fail in some contexts?
The dilemma of responding to reality: Should our models be judged according to
experimental results, should they provide the hypothesis for testing or are they simply
exercises in logic and regularities can be found without theoretical models?
The dilemma of relevance: Do we have the right to give advice or to make statements
which are meant to have an influence in the real world?
Lurking in the background is one big question "What on earth am I doing?"

JEL Codes: A11, A20

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1. An economic theorist’s motivation

I could say that I am going to talk about several pieces of research which I have been
involved in during the last few years. And I could say that these are only a means to
an end and that I would like to use them to illustrate three dilemmas which I have
encountered in my work as an economic theorist. The three dilemmas are:

The dilemma of absurd conclusions: Should we abandon a model if it produces absurd

conclusions or should we regard a model as a very limited set of assumptions which
will inevitably fail in some contexts?
The dilemma of responding to reality: Should our models be judged according to
experimental results, should they provide the hypothesis for testing or are they simply
exercises in logic and regularities can be found without theoretical models?
The dilemma of relevance: Do we have the right to give advice or to make statements
which are meant to have an influence in the real world?

Lurking in the background is one big question which I ask myself obsessively: What on
earth am I doing? What are we trying to accomplish as economic theorists? In some
sense, we essentially play with toys called “models”. We have the luxury of remaining
children for our whole professional lives and are even well paid for it . We get to call
ourselves economists and the public naively thinks we are improving the economy,
increasing the rate of growth or preventing economic catastrophes. Of course, we can
justify our public image by repeating some fancy sounding slogans we often use in our
grant proposals, but do we believe in those slogans?

I recall a conference I attended in Lumini, France in the summer of 1981 which was
attended by the giants of the game theory profession. They were standing around in a
beautiful garden waiting for dinner after a long day of sessions. Some of us, the

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junior, were standing off to the side eavesdropping on their conversation. They loudly
discussed the relevance of game theory and one of them suggested that we are just
”making a living”. I think he merely intended to be provocative but nonetheless his
response traumatized me. Are we no more than ”economic agents” maximizing our
utility? Are we members of an unproductive occupation which only appears to others
to be useful?

Personally, I did not fulfill any childhood fantasy by becoming a professor. It was never
my dream to become an economist. Frankly, I respect philosophers, teachers, writers
and nurses more than I do economists. I don’t care about stock market prices and I’m
not sure I know what ”equities” are. I am reluctant to give advice to government bodies
and I am not happy with the idea that I may be acting in the service of fanatic profit
maximizers. Fortunately, people seldom ask me what I do. I was once asked for
advice about real estate. My very honest answer - that I didn’t have the slightest idea
about real estate - was viewed as arrogant. Perhaps, I am a proud skeptic. However,
after many years in the profession, I still get excited when formal abstract models are
successfully constructed and meaning emerges from the manipulation of symbols. It
is moving when I observe that same excitement in students’ faces. Thus, my greatest
dilemma is between my attraction to economic theory on the one hand and my doubts
about its relevance on the other. In this lecture I will try to decompose this basic
dilemma into three parts.

2. The Dilemma of Absurd Conclusions

Consider lonely Adam in the garden of Eden who is taking a crash course in what life
is all about (the “course” follows Rubinstein (1998, 2001)). At each episode he will be
endowed with the right to pick a certain stream of apples from the trees. Each date he
will have to exercise his right to pick the apples or not, however once he picks them he
has to eat them right away, namely he cannot store apples from one day to the next.
At each episode he will be given options for exchanging his endowment for other
streams of apples.

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Adam was created rational and he is aware of the fact that a rational decision maker
has to identify first what a “final consequence” is. This is an opportunity to say that I
am more than a little confused about the meaning of this concept. Can there be a
“final consequence” when it appears that most of us do in fact care about events after
our death? Shouldn’t the term “consequence” be interpreted as subjective,
corresponding to what the decision maker considers “final” in a particular context? In
any case, at this point Adam adopts the standard economic view that a “final
consequence” is a list of quantities of apples to be consumed on each day. Thus, for
example, the sequence which describes eating one apple on April 13th 2071 is a final
consequence (not only for the apple) independent of the day on which I pick the
decision to consume this sequence.

Assume that Adam enters Eden satisfying the following assumptions:

 Adam possesses preferences  over the set of streams of apple consumption
(sequences of non negative integers).
 Given a consumption stream c  c s  and a day t, his preferences  t,c over the
changes in his consumption from time t on are derived from  (that is, for any two
vector of real numbers Δ and Δ ′ , interpreted as changes in apple consumption in
periods from t on, Δ  t,c Δ ′ iff c 1 , . . . , c t  Δ 1 , c t  Δ 2 . . . .   c 1 , . . . , c t  Δ ′1 , c t  Δ ′2 . . . . ).
 Adam likes to eat up to 2 apples a day and cannot bear to eat 3 apples a day.
 Adam is time impatient. He will be delighted to increase his consumption today day
t from 0 to 1 in exchange for two apples tomorrow and from 1 to 2 apples in exchange
of one apple tomorrow. (Note that this strong time impatience assumption is not
implausible even for individuals outside the garden of Eden. One of the primary
motivations of the hyperbolic discounting literature is the fact that there are people
who prefer one apple today over two apples tomorrow and at the same time prefer two
apples in 21 days to one in 20 days.)
 Adam does not expect to live for more than 120 years.
 Adam is endowed with a stream of 1 apple per day starting in day 18 for the rest of

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his life.

We now look at the first traumatic event experienced by Adam in Eden. We prove
for him the following “calibration theorem”: Adam should be willing to exchange the
stream of an apple per day starting in day 18 for the rest of his life for 1 one apple right
away! You are supposed to say ”wow!”.

The simple proof can be understood from the following observation: Denote by
a 1 , . . , a K  the stream a 1 , . . , a K , 0, 0, . . . . The stream of an apple per day for 2 1 days
after a delay of 1 day, namely 0, 1, 1, is inferior to 0, 2, 0, and also to 1, 0, 0.
Similarly, the stream of one apple per day for 2 2 days with a delay of 2 days, namely,
the stream 0, 0, 1, 1, 1, 1, is by the previous step inferior to 0, 0, 2, 0, 2, 0 and therefore
to 0, 1, 0, 1, 0, 0 and to 0, 1, 1, 0, 0, 0 and thus to 1, 0, 0, 0, 0, 0. By induction we
conclude that he must find the stream of 2 17 days of one apple per day with a delay of
17 days inferior to receiving 1 apple right away. It is only left to calculate that in 120
years there are less than 2 17  17 days and we are done.

 You might have noticed a similarity between the above observation and an
argument made in Rabin (2001) in the context of Decision Making under uncertainty.
Consider a decision maker who behaves according to expected utility theory, is risk
averse and takes the final consequence to be the amount of money he will hold after
all uncertainties are resolved. Such a decision maker, who rejects, at all levels of
wealth in the interval, 0, $4000), the lottery 0. 5−10 ⊕ 0. 511, will reject an equal
chance to lose a moderate amount like $100 and to make a large gain like $64000
when he holds the initial wealth of $3000. The basic idea is as follows: denoting the
vNM utility function by u we obtain uw  11 − uw  uw − uw − 10 for all w ∈
0, $4000 and thus the marginal utility function muw satisfies
muw  11 ≤ uw  11 − uw/11  10/11uw − uw − 10/10 ≤ 10/11muw − 10
in that domain. In other words, it falls at a faster rate than that of a geometrical
sequence.

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When I initially added the argument to the material for my graduate micro-economics
course, I added sarcastically: “What conclusion should we derive from this
observation? Do we economists take our own findings seriously?” My first instinct
was that something is deeply wrong with the model we so commonly use. I felt that
the situation is similar to the case in which a set of assumptions yields a contradiction
and thus any conclusion can follow. If our model of decision making with time
preferences or under uncertainty yields conclusions which are absurd, what is the
validity of conclusions which are not? So how should we proceed? Will changing the
assumptions prevent the absurd conclusions?

 Following his first traumatic event (and following Strotz) Adam learns that he should
split his personality. He withdraws from the assumption that the consequences are
independent of time. He thinks about himself as a collection of egos each with a
different perspective. The consequences of an agent’s choice at time t are streams of
apples from time t on. Thus, the meaning of eating an apple at day 27 will not
necessarily be the same at t  0 as at t  26. He is ready to replace 2 apples
tomorrow for one today but not two apples at date 27 for one apple at date 26. Adam
holds a sequence of preference relations  t  one for each date, each is defined on
the streams of future consumption streams.

The same type of model alteration would fit the context of decision making under
uncertainty. The absurd conclusion reached in Rabin (2001) was used in
Rabin and Thaler (2001) to attack expected utility theory while commenting they feel
“much like the customer in the pet shop, beating at a dead parrot”. However, the
absurd conclusion was an outcome not only of expected utility theory assumptions. It
was based also on the assumption that there is a single preference relation  over the
set of lotteries with prizes being the “final wealth levels” such that a decision maker at
any wealth w who has a vNM preference relation  w over the set of “wealth changes”

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derives that preference from  by L 1  w L 2 iff w  L 1  w  L 2 . Nothing in the vNM
axioms dictates that consequences should be the final wealth levels rather than wealth
changes. When discussing vNM theory, standard textbooks are actually vague on the
interpretation of “w”- usually they state that the decision maker derives utility from
“money”, with no discussion of whether “money” is a flow or a final stock. Kahneman
and Tversky (1979) have already pointed out that this assumption clashes with clear
cut experimental evidence and in particular that there is a dramatic difference between
our attitudes towards relative gains and our attitude towards relative losses.
Withdrawing from the assumption that the consequences are always the final wealth
level prevents from deriving Rabin’s absurd conclusion. (See Cox and Sadiraj (2001)
for an independent similar argument). It will allow us to make the plausible
assumption that for a wide range of moderate wealth levels w a decision maker rejects
the lottery 0. 5−10 ⊕ 0. 511 (as he holds an instinctual aversion to risk) and were he
to start from wealth 0, for example, he would prefer the lottery
0. 5w − 10 ⊕ 0. 5w  11 over the sure amount w (using an argument of the type that
all possibilities are similar and thus I will decide simply by calculating the expectation).

 Once Adam was split into a collection of infinite agents, one for each point in time,
naive Adam approaches his second experience: His first trauma changed his
preferences and he has less appetite and does not eat more than one apple per day.
He lost his confidence and he has become an extreme example of a hyperbolic
discounter who cares only about what happens in the next two days. On the other
hand, whenever he compares eating an apple today to eating an apple tomorrow, he
prefers to delay the delight.

By now, Adam finds Eve, who is a very tempting lady. Eve offers Adam one apple.
When he is about to eat the apple she tells him, “Why don’t you give me the apple and
get another one tomorrow?” At this point Adam still does not realize that he might
have a conflict between his selves. He is still naive. Each of his selves takes actions
as if the others did not exist. Naive Adam will take the bait and never eat the apple.

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Sad.

 Frustrated by Eve, Adam goes to Mr. Snake, a successful consultant who has
graduated from a course in game theory. The snake tells Adam that he must be more
sophisticated regarding the interaction between his various selves. He explains to
Adam that the common assumption made in economics is that the decision maker’s
behavior must be consistent with a “perfect equilibrium procedure” (“sophisticated
behavior” as it is called in the behavioral economics literature). The snake shows
Adam that there are only two perfect equilibria for the game between his selves and
thus that as a “sophisticated” decision maker he should eat the apple on the first or
second day. Adam feels relieved.

 The snake has already won Adam’s trust, but now Adam has his third traumatic
experience. Adam is told that he can pick one free apple every day. What could be
simpler than that? Adam plans to pick an apple every day. However, the snake has
other plans for Adam. He recommends a “perfect equilibrium” to Adam : Adam should
pick an apple only after an odd number of consecutive days in which he has not done
so.

Adam is impressed by the snake’s originality and he verifies that there is no

hypothetical history after which one of Adam’s selves can find a reason not to follow
the snake’s advice.
Consider a self after an history in which he is not supposed to pick an apple, that is,
after an even number of dates that he did not eat apples. The self expects to get an
apple a day later which is better for him than eating the apple now and not eating it on
the second day (he recalls that the equilibrium suggests that the next self will not eat
the apple after he has eaten it the previous day).
Consider a self after an history in which he is supposed to eat an apple, that is, after
an odd number of dates that he did not eat apples. The self expects to get an apple a

9
day later which is better for him than eating the apple now and not eating it on the
second day (he recalls that the equilibrium suggests that the next self will not eat the
apple if he does not since he will have in his history even number of days of not eating
apples) and this is worse for the self than eating the apple right away.
To conclude, Adam does not find any problem with the snake’s advice and eats
apples only once every two days.

 We have now arrived at the Dilemma of Absurd Conclusions. We want

assumptions to be realistic and to yield only sensible results. Thus, nonsensical
conclusions will lead us to reject a model. However, unlike parrots, human beings
have the ability to invent new ways of reasoning that will confound any theory.
Attempting to escape from the calibration theorem, Adam found Eve. Escaping from
Eve he found the snake. If we were following the methodology of rejecting a theory if
it reaches absurd conclusion we would follow Behavioral Economics and trash
expected utility and constant discounting but then we would continue and dump
hyperbolic discounting as well. I doubt if there is any set of assumptions which will not
produce absurd conclusions when we apply them to circumstances which are far
removed from the context they were originally intended for. So, how should we
respond to absurd conclusions derived from sensible assumptions?

3. The Dilemma of Response to Reality

The connection between our models and reality is tricky. I don’t think that many of us
take our theoretical models seriously enough as to consider them to be a platform for
producing verified predictions in the same way the sciences do. When comparing a
model to real data, we hope at best to find some evidence that ”something” in reality is
correlated with a prediction of the model. A theoretical model in economics is judged
by the plausibility of both its assumptions and its conclusions. Experiments are used
to verify its assumptions and often applied economists feel they need a model to
derive a conjecture before they mine data for a pattern or regularity. Should we
change the model if one of its assumptions is experimentally refuted? Do we need a

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model to come up with plausible conjectures about reality?

Let us consider, just as an example, the evaluation of assumptions regarding time

preferences. Recently, there has been a trend in “behavioral economics” to replace
the traditional discounting formula with a variation of the hyperbolic discounting
formula whereby for each day the payoffs from that point on are discounted by 1, ,
 2 ,  3 ….. This trend has gained popularity despite the problem mentioned above,
that it involves much more than just changing the scope of the preferences: it
introduces time inconsistencies and requires assumptions about the interaction
between the different selves.

The hyperbolic discounting literature (see for example Laibson (1996)), states quite
unequivocally that: ”Studies of animal and human behavior suggest that discount
functions are approximately hyperbolic”. In our case we have reliable evidence
(especially as it is confirmed by own thought experiments) that for certain decision
problems stationary discounting is inconsistent with the experimental results while
hyperbolic discounting preferences fit the data better. For example, there are more
people who prefer an apple today over two apples tomorrow than there are who prefer
2 apples in 21 days over 1 apple in 20 days. So, we adopt hyperbolic discounting or,
to be more precise, a simple version of this approach characterized by two
parameters,  and . But what if we can easily design experiments which reject the
alternative theory as well?

Following are the results of an experiment I conducted in 2003 on the audiences of a

lecture I delivered at two universities. Students and faculty at the University of British
Columbia were asked to respond online to Problem 1:

Problem 1

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Imagine you have finished a job and have to choose between two payment schemes:
A) Receiving $1000 in 8 months time.
B) Receiving $500 in 6 months and $500 in 10 months.
What scheme would you choose?

Students and faculty invited to a lecture at Georgetown University were asked to

respond online to Problem 2:

Problem 2
Imagine you have bought a computer and you have to choose between two payment
schemes:
A) Paying $1000 in 8 months time.
B) Paying $500 in 6 months and $500 in 10 months.
What scheme would you choose?

Receiving $1000 in 8 months time is not much different from receiving $500 at 8 −  and
$500 at 8  . Thus, a reasonable application of the (hyperbolic) discounting approach
in this case would imply that advancing the receipt of $500 from t  8 to t  6 has more
weight than postponing the receipt of $500 from t  8 to t  10. Therefore we would
expect the vast majority of people to choose B in Problem 1 and A in Problem 2. Here
are the “survey” results:

Problem University # 8 6/10

1-Receipt U. British Columbia 354 54% 46%
2-Payment Georgetown U. 382 39% 61%

The survey results are the opposite of what is predicted by the standard economic

12
approach. In fact, a majority of subjects chose one payment when they had to choose
between ”gains” and an even larger majority chose two installments when they had to
choose between ”losses”.

I believe that the phenomenon we are observing here is related to the findings of
Kahneman and Tversky (1979) in the context of decision making under uncertainty.
People tend to prefer the average, certain expectation of a lottery when the lottery
involves only gains and tend to prefer the lottery over the expected sum when it
involves only losses. In the context of streams of money the averaging is done on the
time component and leads one to prefer one installment in the case of receipts and
the multiple installments in the case of payments.

So should we dismiss the hyperbolic discounting model? According to the

methodological principles implicitly followed by some behavioral economics, the
answer is yes. Of course, there is an alternative, to simply dismiss evidence we don’t
like. I know of one paper which presented the results of several experiments aimed at
refuting the hyperbolic discounting theory. The editor of a very prestigious journal,
which has published many of the hyperbolic discounting papers, commented as
follows: ”Ultimately this seems like a critique of the current approach which is right in
many ways, but criticisms and extensions of existing research are best sent to more
specialized outlets.”
Taking a more serious approach, we are faced here with one part of the dilemma of
response to reality. We want our assumptions to reflect reality, but you can spell out a
combination of reasonable assumptions and someone will find an experiment to defeat
your theory. So how can we find a balance between our desire for reasonable
assumptions and the fact that rejecting assumptions using experimental results is so
easy?

Theoretical Economic models are also used to suggest regularities in human behavior

13
and interaction: By regularities I mean similar phenomena which are repeated in
similar social scenarios at different points in time and at different locations. Do we
need economic theory to find these regularities? Somehow, we hope that real life
regularities will miraculously emerge from the formulas we write leisurely at our desks.
Wouldn’t it be better to go in the opposite direction: examining the real world, whether
through empirical or experimental data, to find unexpected regularities? My limited
personal experience creates doubt in my mind as to the need for theories to find
regularities.

To illustrate, let us have a look at the traveler’s dilemma (due to Kaushik Basu):

Imagine you are one of the players in the following two-player game:
- Each of the players chooses an amount between $180 and $300.
- Both players are paid the lower of the two chosen amounts.
- Five dollars are transferred from the player who chose the larger amount to the
player who chose the smaller one.
- In the case that both players choose the same amount, they both receive that
amount and no transfer is made.
What is your choice?

Assuming that the respondents care only about their final dollar payoff, the only
equilibrium strategy in this game is the choice of 180. Thus, the standard game
theoretic analysis points to the unique prediction that all participants in the game will
choose 180. I am not familiar with any game theoretical model that would predict a
distribution of responses like the following:

180 181-294 295 296-8 299 300

13% 15% 5% 3% 9% 56%

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During the past two years, I have had the opportunity to collect large amounts of data
from audiences of a public lecture titled “John Nash, Beautiful Mind and Game
Theory”, which I have delivered at several universities. In the lecture, I spoke about
my personal encounter with John Nash, critically introduced the basic ideas of Game
Theory and spoke a little bit about the book and the movie. People who planned to
attend the lecture (mostly students and faculty) were asked to respond to several
questions via the site gametheory.tau.ac.il before the lecture.

Here are the results for 9 universities in 5 countries: Beer Sheva, Tel Aviv, Technion
(Israel), Tilburg University (Holland), the London School of Economics (UK), University
of British Columbia and York Univeristy (Canada), Georgetown University (USA) and
Sabanci (Turkey), where I delivered the lecture:

The six graphs look quite similar revealing a regularity which I have no explanation to.

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Any hope to explain such a distribution will require a better psychological
understanding of the meaning of each of the responses. The group of players who
chose 180 seem to be playing according to the game theoretical prediction, they do
extremely badly and can consider themselves to be "victims" of game theory. The
subjects whose answers were in the range 295-9 clearly exhibit strategic reasoning.
300 seems to be an instinctive response in this context and the responses in the
range 181-294 appear to be the results of random choice.

To support this interpretation I found it useful to gather more data. For 7 out of the 9
lecture audiences I also recorded the subjects’ response time. It is true that response
time is a very noisy variable due to differences in server speeds, differences among
subjects in the speed with which they read and think, etc. Nevertheless, when the
sample is large enough, as this one was, we should get a reliable picture. The
following table and figure summarize the results for 2985 subjective:

Nash Lectures Median Response Time (MRT)

n 2985 77s
180 13% 87s
181-294 14% 70s
295-299 17% 96s
300 55% 72s

Next figure presents the accumulative distribution of the time response of the subjects

in each of four categories, 180, 181, . . . , 294, 295, . . . , 299 and 300:

16
 Bid 180-300 - time frequencies

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 210

180 181_294 295_299 300

There is a clear pattern in the responses: the response 300 and the results in the
range 181-294 are the quickest. Apparently 300 is indeed the instinctive response.
The results 181-294 seem to be the result of a “random” process without a clear
rationale. The responses in the range which require more cognitive efforts, i.e.
295-299, indeed take the most time. The “victims” of game theory are somewhere in
between. The shape of their graph seems to indicate that some of them calculated the
equilibrium (a cognitive operation) and that some of them were already familiar with
the game. A regularity is found. Time response data adds meaning to the various
results. No model preceded looking at the data. And we are still very far from
explaining the stable distribution of responses across different populations.

So, we have arrived at the second part of the dilemma of response to reality. We
want our models to produce interesting conclusions which are consistent with
observed regularities. However, finding interesting regularities can be done very
satisfactory without solving complicated models but rather by looking at data directly,
even without having any model in mind.
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4. The Dilemma of Relevance
Yes, I want to change the world just like everyone else. I want people to listen to me.
But as an economic theorist, do I have anything to tell them?

One of my earliest interests in economic theory was bargaining theory. There were
two sources for my interest: First and most important, it allows for the construction of
models which are simple but nevertheless rich in results which have attractive
interpretations. The possibility of deriving meaningful statements through the
manipulation of mathematical symbols was something which attracted me to
Economics in the first place. Second, as a child I frequented the open air markets in
West Jerusalem and later the Bazaar in the Old City of Jerusalem and as a result
bargaining had an exotic image for me. I came to prefer bargaining theory over
auction theory since auctions were associated with the rich while bargaining was
associated with the ordinary people in the markets of Jerusalem. But, I have never
dreamed of becoming a better bargainer. When people approached me later in life for
advice in negotiating the purchase of an apartment or to join a team planning strategy
for political negotiations, I declined, telling them that as an economic theorist I had
nothing to contribute. I did not say that I lacked common sense or life experience
which might be useful in negotiations, but rather that professional knowledge was of
no help in these matters. This response was sufficient to deter them. Decision
makers usually look for an assertive advisor and not one who is offering common
sense; they believe, perhaps rightly so, that they have at least as much of that as do
professional economists.

But I am a micro economics teacher. I am a part of a big “machine” which I suspect

not only influence the world but even is brainwashing students to think in a way which
I do not particularly like. In 2004 I conducted a survey among six groups of Israeli
18
students. The students were approached by E-mail and had to respond to a series of
questions on the web (for a demo see http://gametheory.tau.ac.il/expEconEng/ ). The
six groups were comprised of undergraduate students in the departments of
Economics, Law, Mathematics and Philosophy at Tel Aviv University, MBA students at
Tel Aviv University and economics undergraduates at the Hebrew University of
Jerusalem. I will refer to the six groups using the abbreviations Econ-TAU, Law, Math,
Phil, MBA, Econ-HU. The students were explicitly told that the questionnaire was not
an exam and that there were no “right” answers. The core of the questionnaire was
the following question:

Q1-Table (translated from Hebrew)

Assume that you are vice president of ILJK company. The company provides
extermination services and employs permanent administrative workers and 196
non-permanent workers who are sent out on extermination jobs. The company was
founded 5 years ago and is owned by three families. The work requires only a low
level of skills: each worker requires only one week of training. All the company’s
employees have been with the company for between three to five years. The company
pays its workers more than minimum wage. A worker’s salary includes payment for
overtime which amounts to 4,000 to 5,000 shekels per month (comment: the minimum
wage in Israel was about 3,300 IS at the time of the experiment). The company makes
sure to provide its employees with all the benefits required by law.
Until recently, the company was making large profits. As a result of the continuing
recession, there has been a significant drop in its profits although the company is still
in the black. You attend a meeting of the management in which a decision will be
made regarding the layoff of some of the workers. ILJK’s Finance Department has
prepared the following forecast of annual profits:

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 Number of workers who will continue to be employed Expected annual profit in millions of IS
0 (all the workers will be laid off) Loss of 8
50 (146 workers will be laid off) Profit of 1
65 (131 workers will be laid off) Profit of 1.5
100 (96 workers will be laid off) Profit of 2
144 (52 workers will be laid off) Profit of 1.6
170 (26 workers will be laid off) Profit of 1
196 (no layoffs) Profit of 0.4

I recommend continuing to employ ______ of the 196 workers in the company.

The following table presents the 764 responses (of 100 or more) to question 1-Table:

Q1-Table EconHu EconTA MBA Law Math Phil Total

n 94 130 172 216 64 88 764
100 49% 45% 33% 27% 16% 13% 31%
144 33% 31% 29% 36% 36% 19% 31%
170 7% 9% 23% 18% 25% 25% 18%
196 6% 13% 12% 13% 11% 36% 15%
other 4% 2% 3% 6% 13% 7% 5%
Average 127 133 142 144 151 165 143

The differences between the groups are striking. The economics students both at the
Hebrew University and Tel Aviv University are much more pronounced profit
maximizers than the students in the other groups. 45-49% of the Econ students chose
the profit maximizing alternative, as compared to only 13-16% of the Phil and Math
students. The MBA and Law students are somewhere in between.
The response of “no layoffs” was given by only a small number of respondents
(ranging 6-15%) in five of the six groups; the only exception was the philosophers -

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36% of them chose to ignore the profit maximizing target. A major surprise (at least
for me) was the fact that the MBA students responded differently than the Econ
students. My conjecture is that this has to do with the way in which the MBA program
is taught. The study of cases triggers more comprehensive thinking about real life
problems. Study using formal exercises conceals the need to balance between
conflicting considerations.

Following their response to question 1, all subjects had to indicate what do they
thought would be the choice of a real vice president? I found that there were almost
no differences between groups as to what the subjects thought a real vice president
would do.

In Law and Phil all subjects received the version 1-Table (presented above). The
other four groups, who were better trained mathematically, were randomly allocated
two versions of the question. The second version, Q1-formula, was identical to
question 1-Table with the only difference that the table was replaced with:
“The Finance Department has prepared a forecast of profits according to which the
employment of x workers will result in annual profits of (in millions of shekels):
2 x − 0. 1x − 8”
This profit function yields similar values to those presented in the table. Its maximum
is at x  100. Note that Q1 explicitly emphasized that with no layoffs, profits will be still
positive.

The following table summarizes the 298 answers of 100 or more:

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 EconHu EconTA MBA Math Total
n 55 74 125 44 298
100 74% 77% 73% 75% 75%
101-195 10% 9% 11% 15% 11%
196 16% 14% 15% 10% 14%
Average 120 117 120 116 118

There are no major differences between the groups. A vast majority of subjects in all
groups maximized profits though many of them were aware of the existence of a
trade-off (as is evident from the fact that many of those who chose 100 said that they
believe that a real vice president would fire less than the number required to maximize
profits). Thus, presenting the problem formally, as we do in economics, seems to
conceal the real life complexity of the situation from most students (including Math
students).

Our view of the results cannot be separated from our personal evaluation of the
behavior of economic agents in such a situation. If you believe that the manager of a
company is obligated morally or legally to maximize profits, then you should probably
hail economics for its achievement in educating its students so well. On the other
hand, one might approach the results with the belief that a manager should also take
into account the welfare of his workers, particularly when the economy is in recession
and unemployment is high, but then one feels uncomfortable about the results.

Of course, it is possible that the differences between the two groups of economics
undergraduates and the other groups is due to selection bias and not a result of
indoctrination. The fact that the economists are different from the lawyers and MBA
students and not only from the philosophers and mathematicians makes this
possibility more doubtful. The minimal differences in the responses to question
1-formula appear to also somewhat support the indoctrination hypothesis.

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And, it may be that there is no connection between the responses of subjects in such
a questionnaire and the choices they would make in practice. But if there is no
connection, are we saying that what a student learns in economics will have no
influence on his future behavior? And if there is such a connection, shouldn’t we be
revising our curriculum?

Overall, I am left with the suspicion that in the best case the formal exercises we give
our students, make the study of economics less interesting; in the worst case, they
contribute to the shaping of a rather unpleasant ”economic man”. I find it difficult to
say that the way I teach economics does not effect the world in a direction I am not
happy with.

 Guilt feelings probably led me to a recent paper (Piccione and Rubinstein (2003)) I
coauthored with Michele Piccione. This may be a provocative statement, but let me
say that this was my only paper which was motivated by real world problems. We
constructed a model which we called a jungle. Whereas in an exchange economy
transactions are made with the mutual consent of two parties, in the jungle it is
sufficient that one agent who happens to be stronger than another is interested in the
transaction. The model is meant to be similar to the exchange economy model with
the exception that there is no ownership and agents do not come to the model with an
initial endowment. The main difference is that the vector of initial endowments is
replaced in this model with a power relationship.

After spelling out the model and the definition of a jungle equilibrium examples are
brought to illustrate the richness of the model. Several propositions are proved:
Existence. Uniqueness. “First Fundamental Welfare Theorem”: Under some
smoothness assumptions the jungle equilibrium is efficient. . An analogy to the
second welfare fundamental theorem is discussed and it is shown that every jungle
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equilibrium allocation is almost supported by equilibrium prices such that the stronger
are also the richer. One might like to interpret this statement as saying that power and
wealth go hand in hand.

When I present the model in public lectures I ask the audience to imagine that they
are attending the first lecture of a course at the University of the Jungle designed to
introduce the principles of economics and to show how the visible iron hand
produces order out of chaos and results in the efficient allocation of available
resources without the interference of a government. Making an analogy, I argued that
the market economy accepts the natural desire of people to be richer, to have more.
In the same way, the jungle economy accepts people’s desire to use their strength to
take advantage of those weaker than them. The market economy encourages people
to produce more, the jungle economy encourages people to develop their power, thus
facilitating society’s expansionist desires.

I view our jungle model as a rhetorical exercise. The whole idea was to build a model
which is as close as possible to the standard exchange economy, using terminology
that is familiar to any economics student and to conduct the same type of analysis
found in any microeconomics textbook on competitive equilibrium. Standard economic
courses impress students with their elegance and clarity. We have tried to do the
same with the model of the jungle. This exercise is directed at economics students
with the goal of creating more question marks in their minds when they study models
of competitive markets.

 This brings me to the dilemma of Relevance. I believe that as an economic

theorist I have very little to say which is of relevance in the real world and I do believe
that there are very few models in economic theory (and the more elaborate ones not
among them) that could be used to provide serious advice. But I cannot hide behind
the view that there are pure theoretical musings. I cannot ignore the feeling that our
work as teachers and researchers influences students’ minds in a direction I am not

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happy with. Can I find a way to be relevant or am I doomed to be another charlatan?

5. Concluding Words
 It’s time to sum up the discussion. How do I relate to these three dilemmas?

As economic theorists, we organize our thoughts using what we call “models.” The
word “model” sounds more scientific than “fable or fairy tale” but I don’t see much
difference between them. The author of a fable draws a parallel to a situation in real
life. He has some moral he wishes to impart to the reader. The fable is an imaginary
situation, somewhere between fantasy and reality. Any fable can be dismissed as
being “unrealistic” or simplistic. But this is also a fable’s advantage. Being between
fantasy and reality gets rid of extraneous details and annoying diversions. In this
unencumbered state, we can clearly discern what cannot always be seen from the real
world. On our return to reality, we are in possession of some sound advice or a
relevant argument that we can use in the real world.

We do exactly the same thing in economic theory. A good model in economic theory,
like a good fable, identifies a few themes and elucidates them. We perform thought
exercises which are only loosely connected to reality and which have been stripped of
most of their real life characteristics. However, in a good model, as in a good fable,
something significant remains in our mind.

Like us, the teller of fables confronts the dilemma of Absurd Conclusions. The logic of
his story may lead to absurd conclusions as well.
Like us, the teller of fables confronts the dilemma of Responding to Reality. He wants
to maintain a connection between his fable and what he observes. There is a fine line
between a fantasy without content and a fable with a message.
Like us, the teller of fables confronts the dilemma of Relevance. He wants to influence
the world, but knows that his fable is only a theoretical argument.

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Like in the case of fables, absurd conclusions reveal contexts in which we find the
model to be reasonable and may not necessarily make the model uninteresting.
Like in the case of fables, models in economic theory are derived from observations of
the world but they are not meant to be testable.
Like in the case of fables, a good fable and a good model can have an enormous
influence on the real world, not by providing advice or by predicting the future, but
rather by influencing culture, that is, the collection of ideas and conventions which
people believe in and which influence the way they reason and act.

Yes, I do think we are simply tellers of fables. But, isn’t it wonderful?

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References
Cox, J.C. and V. Sadiraj (2001) ”Risk Aversion and Expected-Utility Theory:
Coherence for Small- and Large- Stakes Gambles”, (mimeo),

Kahneman, D. and A.Tversky (1979) “Prospect Theory: An Analysis of Decision under

Risk”, Econometrica, 47, 263-292.

Laibson, D., “Hyperbolic Discount Functions, Undersaving, and Savings Plans,”NBER

Working Paper 5635, 1996.

Palacios-Huerta, I., Serrano, R. and O.Volij (2001) ”Rejecting Small Gambles Under
Expected Utility: A Comment on Rabin” (mimeo).

Piccione, M. and A. Rubinstein (2003) ”Equilibrium in the Jungle”, mimeo.

Rabin, M. (2000) ”Risk Aversion and Expected Utility Theory: A Calibration Theorem”,
Econometrica, 68, 1281-1290.

Rabin, M. and R. Thaler (2001), ”Anomalies: Risk Aversion”, Journal of Economic

Perspectives, 15, 219-232.

Rubinstein, A. (1998), Modeling Bounded Rationality, MIT Press.

Rubinstein, A. (2001), “Comments of on the Risk and Time Preferences in

Economics”, mimeo.

Rubinstein, A. (2004), “A skeptic’s comment on the studies of Economics”, mimeo.

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