The idea of rationality that people try to maximize their self-interest probably lies, it’s the one unifying factor in economics.
I'd like to start with a story about Professor Selten over here,
Reinhard Selten, who always walks around with an umbrella, no matter what the weather is.
It can be raining, and then of course it’s rational to carry an umbrella.
Or the sun could be shining and then it appears irrational to carry an umbrella.
Of course it’s always possible that even when the sun is shining, it could begin to rain.
The clouds could gather and then it could begin to rain and then you are sorry that you didn’t take an umbrella.
But professor Selten goes further than that.
I have personally observed him in the Israeli Negev desert in the summer (laughing) carrying an umbrella.
This lecture is devoted to trying to explain Professor Selten’s behaviour!
Professor Selten is a famous economist, and as we have just said, economics is about studying irrationality.
It’s true that if one studies rationality one does not have to be rational oneself.
Just like if one is an entomologist, you do not have to be a bee in order to study bees.
Nevertheless I think Professor Selten’s behaviour is interesting and worthy of study and explanation.
So let’s go to the next slide.
We just spoke about bees and let me tell you about an experiment carried out by an entomologist called Andreas Bertsch,
the German entomologist who did this experiment about 1985.
He had a field of artificial flowers, artificial flowers consist of discs
in the middle of which is a nectar tube which provides nectar or does not provide nectar,
as the experimentor, in other words Professor Bertsch, wishes.
And what he did was he had a field of blue and yellow flowers and he released some bees on this field.
For a while, when the bees were fairly young, I don’t know how much, a week or two weeks,
he would provide nectar only in the blue flowers and he did not provide nectar in the yellow flowers.
The bees learnt that and they went to the blue flowers.
And then, after a few weeks he switched.
He turned off the nectar in the blue flowers and he turned on the nectar in the yellow flowers.
And the bees kept going to the blue flowers and found no nectar there and they kept going to the blue flowers again and again.
And they found no nectar and eventually they starved to death.
They died from starvation and never tried a yellow flower.
Now, that is irrational.
(laughing).
Now, I think one can expect rationality from Professor Selten, but why would one expect rationality from a bee?
One doesn’t normally associate the idea of rationality with bees.
But there is an important connection between rationality and all living things, plants and animals.
And that connection is provided by evolution.
The theory of evolution is based on the idea of survival of the fittest, and fitness means staying alive.
That’s one element, one important element, perhaps the most important element in fitness is staying alive.
So one would expect all living things to develop genes, through the process of evolution,
to develop genes which enable them to stay alive.
And therefore one would expect also bees to develop genes which would enable them to stay alive.
And when a bee behaves in a blatant way which leads it to die, as in the experiment of Professor Bertsch, this raises a question.
One expects a certain degree of rationality from all living beings,
because otherwise, without this rationality they would not survive.
I don’t want to go too much into the details of this, but in fact in game theory
there is a very important connection between the game theoretic equilibrium, the equilibrium of Professor Nash,
and the behaviour of living things, the behaviour of plants and animals, even lower animals like bees.
So one does expect rationality from a bee,
and the experiment of Bertsch shows that at least in this case bees behave irrationally.
Let’s go to the next example, this is the ultimatum game.
I’ll describe the ultimatum game, the experiment was done by Güth and collaborators.
Werner Güth is a student of Professor Selten, so Professor Selten is really the star of this show,
let’s give him a hand (applause).
Okay, the rules of the ultimatum game are as follows:
Two people must divide 100 DM, nobody over here knows what a DM is anymore.
But this was done in 1981, I think I'm not too far off the mark by saying that a 1981 DM is approximately 1 Euro today.
Well, more or less, it’s in the ballpark.
So two people must divide 100 DM, they are in separate rooms, they do not know each other and can interact only this one time.
A designated one of the two, whom we’ll call ‘the offerer’ makes an offer.
The other one, ‘the responder’, may either accept or reject the offer.
So this is done via computer.
They cannot communicate in any way, the offerer makes the offer without any explanation of how to divide,
the other one can only type in yes or no, that’s all.
If the responder accepts, the amount is divided accordingly, if not no one gets anything.
Now, one would expect in this case that the offerer would offer something like perhaps 99/1.
The subject was students over here, students are preverbally poor and no one would turn down 1 DM.
But let’s be generous, let’s say that the offerer should offer 95/5 or 90/10 perhaps.
Because he would expect the responder not to walk away from 1 DM, from 5 DM, from 10 DM,
certainly he wouldn't walk away from 10 DM, you can buy a lot of beer for 10 DM.
And the offerer would take advantage of this and take the lion’s share for himself.
That’s not what happened.
Most offers were 65/35 or even more generous and were accepted.
Some offers were 80/20, and even offers that were 80/20 were rejected.
Now, this is irrational.
Why would a student walk away from 20 DM?
Well, possible explanations are pride, self-respect, the student felt insulted by such an offer.
He wants to take revenge for an offer that he considers unfair.
So these are possible explanations.
Irrelevant explanation is a reputational effect.
In other words that the responder does not want to develop a reputation for being what we call in the United States a sucker.
A person who, well, you know what it means!
(laughter).
So we have those explanations of pride, self-respect, insult, revenge.
Somehow they are not quite satisfactory, those explanations,
because I think the purpose of game theoretical, more generally economic analysis, is to account for feelings like this.
One does not want to take something like pride, self-respect, insult, revenge and take it as given.
Especially from an evolutionary viewpoint one wants to say how did feelings like this evolve.
But this is a possible explanation.
Let me go to a different topic.
I think these two things, the ultimatum game
and the behaviour of the bees are problems over here that we want to try to understand within the framework of rationality.
I want to go off on a tangent a little bit
and that is to discuss the idea of utilitarianism and specifically to compare rule utilitarianism with act utilitarianism.
Let me remind you what utilitarianism is.
Utilitarianism is not part of economics.
Utilitarianism is a philosophical doctrine of ethics.
It’s an ethical philosophical doctrine which says how people should behave.
What is the basis of good moral ethical behaviour?
It was started by Jeremy Bentham in the late 18th century.
The idea of utilitarianism is that one should act in a way which maximizes total benefit to society.
If you wish, you could take the utilities of everybody in society and add them up,
and then you should make your choices on the basis of what maximizes not your own utility but the utility of all of society,
the sum of the utilities.
One does not necessarily have to talk about sums of utility functions but in general the benefit to society in some sense,
that does not have to be further specified.
This is the idea of Jeremy Bentham.
John Stuart Mill and John Harsanyi, who shared the prize,
the Bank of Sweden - it’s a long word - it’s the Bank of Sweden Prize in Memory of Alfred Nobel, that’s it.
He shared the Bank of Sweden prize in memory of Alfred Nobel with Professor Selten and with Professor Nash,
who was also at this conference in 1994, and he died a few years after that.
And John Stuart Mill refined this concept of Bentham’s concept.
And, in order to describe this refinement, let me refer to the book by Fyodor Dostoyevsky called Crime and Punishment.
You remember, there was a young gentleman in Dostoyevsky’s book by the name of Raskolnikov,
and it was an old money lender who was in some sense a drag on society.
Raskolnikov needed money, the money lender had money, she did not want to lend it to Raskolnikov,
because she was a little different from Dr. Yunus,
who we heard this morning (laughing).
So he thought that, according to the doctrine of Jeremy Bentham of utilitarianism, it was okay to murder her and take the money.
For two reasons:
First of all, society would be better off without this old hag, and second of all, he could use the money much better than her.
Sorry, he could use the money much better than she could use it.
So the sum total benefit to society would be increased if he murders her and takes the money.
This is the backbone of this story and he does it now.
There’s something wrong with this.
I think Dostoyevsky feels it and all of us feel it in reading Dostoyevsky’s book.
And Raskolnikov himself felt it, because he fell ill,
he got a fever, immediately afterwards of course he was eventually apprehended by the police and all that.
Now, what’s wrong with that feeling?
The point is that in making ethical judgment, one should consider the rule, the rule is ‘thou shalt not murder’.
And not ‘does this particular act increase the benefit to society?’.
It’s important to consider the rule, it’s the rules that have to be utilitarian.
In other words, you should consider a rule that in general maximizes the benefit to society.
It’s not that each act has to maximize the benefit to society.
This is the improvement that was suggested by John Stuart Mill, or not the improvement, the modification of Bentham’s rule,
which was suggested by John Stuart Mill and was actively promoted by John Harsanyi in his discussion of utilitarianism.
So in either case, judgments are made on a utilitarian basis, i.e. maximum welfare of society.
But in one case, you are maximizing the utility of the act and in the other case, you are maximizing the utility of the rule.
Now we take a similar distinction and we apply it to the idea of rationality.
In other words, in making decisions should one consider the rule, should one go by rules or should one go by acts.
Does one maximize the utility of each act separately, or does one develop rules by which to act
and then one maximizes the utility of the rule.
Now, in this case the judgments are made on an egotistic basis.
You are maximising your own welfare, you are not maximizing the welfare to society.
Now we are talking about economics or game theory.
We are not talking about ethical behaviour, this is not ethics anymore.
But does one develop rules or does one maximize each act separately.
Maximize the utility to yourself of each act separately.
And what I'd like to suggest is that people do not actually maximize the utility of each act separately.
What they do is that they develop rules of behaviour, people and also bees,
develop rules of behaviour and they adopt those rules which usually, on average or in total yield maximum utility.
They do not maximize, they do not do a separate calculation for each act.
So in the ultimatum game:
Should you consider the rule?
And the rule is ‘don’t let people kick you in the stomach’.
A 90/10 offer is a person kicking you in the stomach.
And that’s not a good idea to let people kick you in the stomach.
That’s the rule in general, or should you consider the act, should I take 20 DM or nothing?
Now, if you are considering the act, then certainly you should take 20 DM,
you don’t know the other guy, there’s no reputational effect.
But the rule is ‘don’t let people kick you in the stomach’, and then one should turn it down.
But these are not ethical philosophical issues.
In the ultimatum game, in the behaviour of the bees, it’s not a philosophical issue, it’s not an ethical issue.
Why shouldn't I just maximize my welfare?
Whereas it makes sense in the manner of utilitarianism, it makes sense to maximize the rule,
it doesn’t seem to make sense to maximize the rule in individual behaviour.
The answer is that rule rationality is a positive notion.
In other words, I'm not recommending rule rationality, I'm saying that’s how the world works.
The world, people do not maximize each act separately.
They develop rules of behaviour either by learning or by evolution or by copying or whatever.
And this is how the world actually works.
It’s not something that I recommend.
If I were a student and participating in the experiment of good and is collaborative I would take the 20 DM.
I would recommend taking the 20 DM.
Maybe I wouldn't do it myself but I certainly would recommend taking the 20 DM.
So rationality is an expression of evolutionary forces, which work by the rule, not the exception, not the contrived situation.
...
There’s something wrong with this presentation, because these little boxes should be around the word ‘not’...
What do you do with computers?
I have never learnt to live with them.
They never work for me, they don’t like me and I don’t like them either.
(laughter).
All right, how does this work out in the two examples we’ve given?
In the example of the bees and the flowers,
the rule is ‘learn which flowers give nectar and then go to those flowers’, that’s the rule.
In the ultimatum game it is, as I said before, ‘don’t let people kick you in the stomach’.
How does this work out?
How do these rules form?
Well, in each case there’s some kind of mechanism that leads to the rule.
In the case of the bees and the flowers we have what’s called a learning window.
The learning window is that evolution has constructed bees
so that they have a period at the beginning of their lives in which they are able to learn.
By the way, human beings also have a learning window,
if a child does not learn to speak by the age of - I don’t know exactly what the age is –
but let’s say ten or so, give it an upper band, then he’ll never learn to speak.
Similarly with reading and other things, there are learning windows.
If you don’t learn how to use a computer by the age of 70 you’ll never learn!
(laughing).
So there’s a thing called the ‘learning window’ and this is how the bees learnt to use the blue,
learnt that the blue flowers give nectar, they learnt this in the time that they were able to learn anything.
Afterwards they were not able to learn anything and it’s not that they purposely starved themselves to death,
but rather that they were unable to switch to the yellow flowers.
Now why didn’t the bees develop?
Why didn’t evolution develop something other than the learning window?
Why didn’t evolution develop a gene which will enable the bees to try something else when the blue flowers don’t work?
At least to try the yellow flowers.
Well, the answer is very simple, Bertsch’s experiment is a contrived unnatural situation to which evolution doesn’t apply.
In the open field, if blue flowers gave nectar up to week two, then they’ll give nectar after week two, also.
These are things that happen in Bertsch’s laboratory.
They don’t happen out there in nature.
So evolution doesn’t apply to them.
Evolution is not going to work on things that don’t occur in nature.
So that is how the learning window developed, it is perfectly adapted to evolutionary forces.
That’s how the learning window developed, that’s how the rule developed
and that is why these bees are rule rational but not act rational.
Another example of a mechanism is the ultimatum game, which we just described.
In the ultimatum game we have the mechanism that works is exactly those things that I mentioned before.
Evolution has built into people a sense of pride, a sense of self-respect.
The idea of being insulted, the idea of revenge, because usually, in most situations those things enhance your reputation,
they keep you from letting other people kick you in the stomach.
And that is a mechanism, just like the learning window is a mechanism for the bees and flowers,
these things of pride and self-respect insult and revenge
are mechanisms for keeping people from letting other people kick you in the stomach.
In other words for enhancing the reputational effect.
In this case the reputational effect is irrelevant because people don’t see each other, they don’t know each other,
it’s only just this once, but just like Bertsch’s experiment is not natural,
so also Güth’s experiment is not carried out in a natural setting.
The natural setting is a setting in which when you accept an 80/20 split, it gets known that you’re a sucker.
Okay, other examples, let me first go to the last item, Professor Selten’s umbrella.
This is the one case in which the choice of a rule is conscious.
Usually the rule is not consciously adopted as in the other cases we saw.
But Professor Selten adopted the rule because he lives in Germany.
And sometimes the sun shines and sometimes it rains, and sometimes the sun shines and very quickly it turns to rain.
Selten says ‘I'm always going to take an umbrella, I’ve had enough of this crap,
I don’t take an umbrella and then it starts raining’.
So he adopts this rule and then he says ‘I can’t be bothered to change this rule, just because I'm in Israel’.
I take an umbrella and that’s it.
I do this also myself.
I fasten the seat belt when I go around the block in my car.
It doesn’t make any sense, you fasten the seatbelt
when there’s some kind of significant probability that you’ll get into a serious accident.
And I'm just driving around the block at 10 km/h, it doesn’t make sense to fasten the seatbelt.
But why think about it?
You just automatically fasten the seatbelt, and that’s why Selten automatically takes an umbrella.
We can discuss this afterwards.
Okay, let me give some other quick examples, recency, we are going backwards in the thing.
Recency is one of the supposedly irrational elements that were discovered by the behavioural economists.
They take the most recent results,
the more recent results have a much bigger effect on people’s behaviour than things that happened long ago.
But this is something which is rule rational.
When you’re doing a filing system in a computer, always the first item that comes up is the last item that you used.
Recency plays a very important role in computer programs and that is because people usually,
the more recent results are indeed more significant.
Sometimes they are not, but the rule of recency is rule rational, it doesn’t have to be act rational.
I just want to give two other examples, one other example.
I’ll just talk about hunger, it’s rational to eat.
Okay, when you are hungry, it’s rational to eat.
Hunger is a mechanism that allows you to nourish yourself.
You don’t eat because you feel ‘well, I need energy to keep myself going’.
It’s not something that you figure out rationally.
If you are hungry you eat.
But it’s rule rational, it’s not act rational.
Some people are very obese.
I don’t see anybody like that in the audience, but if you go to the United States you see a lot of very obese people,
and when they are hungry, they should not eat.
So it’s not necessarily act rational.
When people came out of the concentration camps after the Second World War, many of them, all of them were very hungry.
And when you are hungry, you should eat, right?
No, some people who ate too much after coming out of the concentration camps died as a result.
So it’s not always act rational, it’s rule rational.
I’ll quit now and allow some questions.
QUESTION.(inaudible)…
ROBERT AUMANN. In all over, let me say this in response to that question.
If you think of act rationality as a thesis, act rationality traditionally underlies classical economics.
Milton Friedman already said in the mid-50s that people are not really rational, but they only act as if they were rational.
So there you’re already approaching rule rationality.
But traditionally act rationality is the basis of classical economics.
Kahneman and Tversky and other behavioural economists are saying ‘no, that’s all wet, it doesn’t make any sense,
people don’t really behave rationally at all, how they do behave isn’t clear, but they don’t behave rationally’.
And then comes your humble servant, so we have act rationality as a thesis, behavioural economics is the antithesis and then,
like Hegel, we come with a synthesis, which would be rule rationality.
Okay, next question.
QUESTION. (inaudible)
ROBERT AUMANN. When I fasten my seatbelt, I sort of do it automatically.
I don’t want to start thinking ‘should I, is this trip long enough?’
And until I figured out whether the trip is long enough to justify fastening the seatbelt,
I could have made the trip three times.
In other words, I just adopt this rule out of convenience.
I'm going to fasten my seatbelt and that’s it.
I think Professor Selten has a similar idea in his umbrella rule.
It’s just he doesn’t want to bother every time ‘okay, in Israel I shouldn’t do it,
in Germany I should do it, if I'm in Venezuela should I do it or shouldn't I do it?
I have to ask how the weather changes, it’s too much trouble.
I adopt the rule umbrella, that’s it.’ Next question?
QUESTION. (inaudible)
ROBERT AUMANN. Does updating of rules lead to rationality, to act rationality?
Most rules are adopted unconsciously.
Selten’s umbrella rule is an exception, it was adopted consciously.
Aumann’s seatbelt rule is an exception, it was adopted consciously.
But most rules are adopted unconsciously, so probably some updating can take effect,
even in unconscious things because these things are learnt.
So if you’re Selten and you move to Israel, you start living there and you adopted the rule unconsciously,
then you would probably update it.
Yes?
QUESTION. (inaudible)
ROBERT AUMANN. Okay, that’s an easy answer, that’s an easy one to field.
There are no normative implications.
In other words, I do not suggest rule rationality.
It’s not a good idea usually, with a few exceptions,
like when it’s too much bother to figure out each time is it rational this time, or is it not.
But in general I do not think that people should act rule rational.
It’s foolish to do that.
In other words, in Güth’s experiment, I would say to the student ‘take the 20 DM!’.
Next question.
QUESTION. (inaudible)
ROBERT AUMANN. Okay, let me respond to that.
Your mention of Smith is very apt, because the 02 prize, let me try to get this right.
The Bank of Sweden prize in memory of Alfred Nobel for 2002 was shared by Daniel Kahneman and Vernon Smith.
Now, very often that prize is taken as a celebration of behavioural economics, as a stamp of approval for behavioural economics.
Actually it isn’t because what Kahneman did was behavioural economics,
in other words, he proved through experiments and polls and things like that, that people behave irrationally.
What Vernon Smith did was he proved through experiments that people behave rationally.
Vernon Smith, the experiments for which he got the prize
were experiments that showed that neoclassical economics worked just fine.
So what the ’02 prize was celebrating were not these two contradictory positions
but they were celebrating again what Professor Selten did many years before,
and that is the use of experiments in economics and game theory.
He should have gotten that prize, too.
So let’s give him a hand again.
(applause).
Okay, thank you I think that’s about it.