The Experimental Study of Behaviour in Economics1

Sujoy Chakravarty2

Abstract: The study of behavior in economics using paid experiments has a history of about half a century. This article tracks not just the chronological history of the field of experimental economics but the intellectual history of the way agent behavior has been studied in economics since the advent of the rational-actor framework in the nineteenth century. I examine the methodologies that form the bedrock of experimentation in economics, their origins, their advantages and their antecedents. I also explore the manner in which experimental economics has enabled theories and frameworks from fields in social sciences like psychology, anthropology and political science to influence the way behavior is modeled in economics, leading to newer theoretical understandings that go far beyond the traditional view of the agent as homo-economicus, i.e. - a self interested rational maximize interested in merely increasing his material wealth. JEL Classification: B41, B21, C9, D03 Keywords: Behaviour, Experiment, Rationality, Institution, Norms

The author would like to thank Bhaswar Moitra, Emmanuel Dechenaux, E. Somanthan, Gerd Gigerenzer, Parikshit Ghosh and Priyodorshi Banerjee for some particularly insightful conversations that have informed this essay. 2 Associate Professor, Centre for Economic Studies and Planning, School of Social Sciences, JNU, New Delhi 110067.

1. Introduction this theory is not speculative in origin; it owes its invention entirely to the desire to make physical theory fit observed fact as well as possible. Albert Einstein on the theory of relativity, Kings College, 1921 Economics is a discipline that has repeatedly thrown up questions that are deeply anchored in social phenomena. These questions include ones on how industries grow and organize themselves, how consumer tastes and preferences evolve and why some societies are poor whereas others experience untold riches. All of these questions have led economists to the study of human behaviour, which from all accounts is fraught with contradictions. Human beings are capable of great foresight and analysis but they are also guided by a diffuse set of motivators, some of which are biological and others societal. Given that these nature and nurture variables may be different over different individuals, individual behavior observed in economic situations may differ widely depending on the actors involved and the environment in which they operate. Examples of phenomena in which we see a distribution of behavioural realizations include the amount of contribution made to charities, the proclivity towards acquiring resources through corrupt means, cooperation displayed towards teammates and co-workers and the wherewithal to take on monetary risks. In spite of this large variance in observed behaviour, the theory used in economics to model individual behavior has grown to be highly axiomatized and mathematized. We would not be unjustified in saying that economic theory over the last century has concerned itself more with rational benchmarks and less with trying to model empirically observed behavior. According to Smith (1989) most economists feel that economics is an a-priori science rather than an observational one. According to Milgrom and Roberts (1987, p. 185) no mere fact was a match in economics for a consistent theory. Thus most economic theorists believe that economic problems and agent behavior therein can be fully conceptualized by thinking about them. Accordingly after the thinking has produced sufficient technical rigour, internal coherence and interpersonal agreement, economists can then apply this to the world of data. (Smith, 1989, p. 152)

The rational agent thus modeled is a self-interested maximizer always taking a decision that maximizes his expected wealth. However, if we look around us we see serious violations of this behavioural norm. Human beings are prone to voluntary acts of kindness sometimes motivated by altruism. Most people cooperate with their neighbours in the upkeep of their neighbourhoods and most would trust another human being unconditionally often suffering negative consequences from this trusting behavior. Are most people then irrational? If that were the case shouldnt theory reflect this divergence from the norm especially as this divergence is often systematic and not random? Ariely (2008) refers to these divergences as predictably irrational ones. Basu (1983), Sugden (1986) and Coleman (1990) have attributed social norms (especially those that inculcate values and a sense of morality) as modifiers on our desire to maximize our material wealth. The field of experimental economics (not to mention experimental social psychology) stands at the centre of this debate on observed behavioural deviations from rational theoretical prediction. The method of controlled experiments from the fifties onwards has allowed us to test game theoretic models as well as individual choice models with human subjects in the laboratory. Observed economic behaviors are compared to rational theoretical benchmarks, divergences from the rational norm are noted and in certain cases theories are advanced to explain these deviations. This article attempts to trace the evolution and success of using experimental methods in the form of paid experiments that test economic theories and principles. In doing so we also explore the interrelationships that experimental economics has spawned with other fields in social science like psychology, political science, sociology and anthropology. In the new millennium, experimental economists have ventured out beyond the laboratory to the field, using participants who are not college students and framed environments, which bear resemblance to natural contexts for studying specific economic behaviour. Today we stand at the point where experimentalists studying economic problems may not necessarily be individuals who are steeped in traditional economic theory. This democratization has enriched the set of problems that were traditionally studied under the banner of economics to include work on the evolution of social norms and the role of culture on economic behaviour, which is a far cry from the modest and narrow goals of theory testing originally posited by the founders of this sub-field. The next section discusses the evolution of the study of human behaviour in economic theory.
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2. The study of human behavior in mainstream economic theory At the heart of the microeconomic model (and the set of axioms that drives the majority of its results) stands the homo-economicus or the economic man - a representative agent who can attach a well defined probability distribution over the entire set of outcomes that are available to him from any choice problem and choose the one that would yield to him the highest expected payoff. Legions of self-interested rational maximizers such as these, armed with private endowments and no barriers to exchange form a market in which they can mutually trade to increase agents welfare. Yes, purportedly the invisible hand of the market manages to coordinate buyer and seller decisions, so that people with none other than purely selfish motives may conduct mutually beneficial trade. The idea of the economic man has found place in the writings of Mill (1836) who proposed an arbitrary definition of man, as a being who inevitably does that by which he may obtain the greatest amount of necessaries, conveniences, and luxuries, with the smallest quantity of labour and physical self-denial with which they can be obtained. The idea of exchange between rational and self-serving individuals has been around for hundreds of years. Almost a century earlier than Mill, Adam Smith refers to it in the Theory of Moral Sentiments (1759) as well as his better known later work, The Wealth of Nations (1776). It is however in Moral Sentiments where we see glimmers of what would ultimately be a behavioural revolution in economics two centuries later. In this treatise Smith writes about an important psychological motivation that governs the way that economic agents conduct exchange. The particular moral sentiment that Smith describes at length is sympathy, i.e. the feeling of compassion or concern for others. This tempers self-interest in socio-economic transactions and leads us to sacrifice narrow profiteering in order to maintain ties of affection with our fellow human beings. In positing this opinion Smith builds on the work of Scottish moral philosopher David Humes A Treatise of Human Nature (Hume, [1740], 1978). In this work Hume argues that morals and belief rather than reason governs human nature in stark contrast to the rationalists like Descartes who preceded him. These initial behavioural asides notwithstanding, the dominant and mathematized microeconomic framework developed in the late nineteenth century by Leon Walras, Alfred Marshall, William Jevons and Vilfredo Pareto did employ the rational-actor framework in
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extending the work of Smith, Mill and David Ricardo, and came to be known as neoclassical economics. In the first fifty years of the twentieth century Lionel Robbins, Frederick Von Hayek, John Hicks and others further refined and extended this framework to create elegant mathematical frameworks for consumer behavior, the IS-LM model, the business cycle, welfare economics and various other theories that have become the bedrock of modern mainstream economics. Neoclassical economics went through a paradigm shift in the forties with two works of great import. They were The Theory of Games and Economic Behaviour by John von-Neumann and Oskar Morgenstern (von Neumann and Morgenstern, 1944), and John Nashs doctoral dissertation from Princeton University on non-cooperative games (Nash, 1950), which included the powerful idea of Nash Equilibrium. Put simply, the main contribution of von-Neumann and Morgenstern (v-NM) was to develop a framework of individual decision making under uncertainty and that of Nash was to find an internally consistent set of strategies that decision makers would employ in a situation of strategic interaction, from which no one had any unilateral incentive to deviate. v-NM and Nashs theories allowed us to obtain behavioural predictions incorporating two very important features of economic decision making, namely, the presence of uncertainty (embodied in probability distributions) regarding outcomes in a situation of choice and the effect of the behavior of other economic agents (other players in a game who may for example have conflicting interests) on an agents payoffs. These more modern theories had more directly testable point predictions, which facilitated the formulation of testable hypotheses that could be compared to behavioural observation. Though they came up with more test-friendly theories of agent behaviour both von- Neumann and Nash were pure mathematicians who had never been involved with any form of empirical or experimental work. Morgenstern, on the other hand, felt that statistical data collected in economics had inherent (sample selection) biases which made it difficult to isolate the true causes of observed behavior. Of the three it was he who was more amenable to controlled experiments, as is clear from his comments on Chamberlins pioneering experiments on competitive markets from the forties (Morgenstern, 1954). According to Morgan (2003), in the middle of the twentieth century, economics was in the process of becoming a tool-based science and distancing itself from the old, discursive moral

science of the political economy framework of the late nineteenth and early twentieth centuries. This led to theoretical models with sharp equilibrium predictions and more involvement of computational scientists and mathematicians in theory formation and testing. By the early fifties (fuelled no doubt by the rapid growth in computing power) computer simulations followed by controlled experiments entered the economists toolkit. The next section discusses the applicability and advantages of experimental methods as applied to social sciences particularly economics. 3. The advantages of the experimental method In this section we trace the main ways in which the experimental method has enriched economic theory building. Economics experiments have opened intellectual directions that would have been impossible if we were not able to observe human agents interacting in laboratory environments that attempted to model specific theoretical contexts. As discussed below, the observations on human behavior in the laboratory has led to a deeper understanding of economic motivations that took researchers far beyond simple laboratory games into field contexts, institutions and culture. This interest in variables which were not considered traditionally to be important to the behavior of economic agents has over time brought the discipline of economics closer to the other more non-mathematized social sciences. 3.1 The usefulness of the laboratory Before experiments entered the analytical toolkit for economists, happenstance (naturally occurring) data was the only way in which economic principles could be tested. However happenstance data is not generated as per the convenience of the researcher, and it is most often prohibitively expensive to be present at the site of data generation, like a factory (cost data) or a marketplace (transactions data) to record it. The presence of the researcher who merely observes and records naturally occurring processes (and hence can control for environmental variables that could be ex-post unknown) creates a natural experiment, which if performed carefully may be the best way to test economic theories and principles. However besides the expense involved, there is another basic problem with natural experiments. This is the problem of bias in the behavior of agents that is introduced because of the presence of someone recording data. A way around this is of course to be purely anonymous which may be very difficult to do in all

situations.3 The ideal natural experiment (and indeed the purest form in which behavior can be recorded) is the randomized natural experiment, in which we can study the actions of agents by selecting our experimental unit randomly over the entire set of available focus variables that influence behavior.4 Banerjee et al. (2007) perform a randomized study in Vadodara and Mumbai in India, where they evaluate the effect of two remedial programs on childrens performance in school. At the other end of the spectrum from the natural experiment is the laboratory experiment. Here we dont attempt to observe behavioural phenomena in a naturally occurring setting. We usually design a stylized version of the problem to be studied in a non-natural environment. Unlike in the natural sciences where laboratory environments that are very close to the naturally occurring phenomena can be created, in the social sciences, the environments created tend to be stylized versions of the naturally occurring field environments. These stylizations often allow us to collect data related to economic problems for which it is very difficult (or impossible) to obtain happenstance data. Examples include studying the effect of insider information on traders in asset markets, studying agent behavior in principal agent models and exploring labour market discrimination. The usage of treatments allows us to also create the counterfactuals in theory, which may be impossible to obtain with field data.5

The main problem with using natural experiments on human behavior is that unlike inanimate matter, human beings are sentient and respond to stimuli. Thus unless the experimenter/observer is completely invisible to the agent, the behaviour we observe will be necessarily different from what is natural to them. Contrast this for example with observational astronomy, a branch of physics that deals with the study of movements of celestial objects. In this scenario, natural experiments are the only empirical methodology available and they have no bias, as we are dealing with celestial objects that are largely invariant to observation. 4 In experimental design, we can broadly delineate all variables that affect subject response into focus variables and nuisance variables. For example suppose we are trying to study the behavior of traders in a market. We may be interested in how the trading institution and level of seller costs affect performance. These would be our focus variables. There may be other variables such as the gender of traders, which may well influence their behavior but we are not explicitly interested in it. We deem this to be a nuisance variable. Our purpose in designing treatments is to minimize the impact of such a nuisance variable. For more on experimental design techniques see Box et al. (1978). 5 For example we may be interested in how asset traders in a stock market aggregate diverse information regarding the assets they buy and sell. Real world stock market data will obtain for us the behavior of agents who possess such fragmented pieces of information. However to really comprehend how information gets aggregated we need a counterfactual, i.e. - how do agents behave when there is no probabilistic information regarding the assets that they possess? Real world data cannot provide this to us but laboratory procedures allow us to create this situation with comparative ease.

3.2 Anomalies and the emergence of behavioural economics An important aspect of laboratory experiments in economics and psychology (the two main social science disciplines that use experimental methodology) is the degree of parallelism, i.e. how closely does the laboratory problem correspond to the problem in the field? Often this parallelism is low in laboratory environments where closeness to the field is sacrificed in order to gain a high degree of experimental control. Observing subjects in a specially set up environment necessarily increases the level of bias but allows us to fine tune focus variables in a way that would be impossible in the field. As economic theory (rather than psychological theory) is concerned with more abstract behavioural consequences that depend less on the environment and the institutions (for example Nash equilibrium in games or the Walrasian equilibrium), a stylized interface that distils the essence of these models without too much operational detail may be enough to test theory somewhat satisfactorily albeit in a narrow fashion. However, can we make the claim that experimental methods allow us to test theory in a foolproof manner? If indeed subjects display behavior concordant with theory can we say that the theory is correct? What about if behavioural violations of theory are observed? Will it then inform us that the theory is incorrect? Unfortunately an economics experiment does not give us the wherewithal to accept the theory in the first case and reject it in the second. According to Friedman and Sunder (1994), experiments can never exactly replicate the conditions laid out in formal economic theory. All theories leave out significant operational detail and so any attempt in the experimental design to try to fill these in necessarily alters the theoretical model, i.e. - the laboratory version of the theory is necessarily different from the written version of theory. What then do laboratory experiments contribute? They provide another understanding of economic phenomena separate from economic theory and empirical analysis of happenstance data. It would be fair to say that theory, empirical data analysis and laboratory experiments move on parallel tracks, reinforcing our understanding of the behavior being modeled in a subtly different but ultimately unified manner. For the first half-century of the application of experimental methodology to economics, laboratory studies were the mainstay of the sub-discipline. The laboratory allowed us to comprehend the power of the market in aggregating trader bids and asks in a decentralized manner to clear markets. It also blew the door open on many anomalies, or persistent violations
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of theoretical equilibria. In game theory experiments, these anomalies often take the form of paradoxes of rationality, where the rational outcome predicted by theory is consistently violated by behavior observed amongst human subjects. The Prisoners Dilemma (Axelrod, 1970, 1984; Andreoni and Miller, 1993), the classic Bertrand duopoly game (Dufwenberg and Gneezy, 2000), the Ultimatum Bargaining Game (Guth, et al., 1982) and the Travellers Dilemma (Holt, 1999) provide such examples. These anomalies led to the adoption of approaches from cognitive psychology such as bounded rationality. As the problems involved more and more complex computation to reach the equilibrium, the limits on human computational ability necessitated the use of thumb rules or heuristics in order to be able to optimize over a small set of variables, (a subset of the larger set of variables that govern the problem) which were considered central to solving the problem. Over time to cite an evolutionary argument, the heuristics that got adopted were ones that optimized over a smaller set of variables and obtained desirable outcomes for agents. The other rules which got less than desirable outcomes got discarded. The origin of this boundedly rational approach is from Simons (1955) idea of procedural rationality whereby agents follow reasonable heuristics and on average achieve close to optimal outcomes. This is distinct from substantive rationality, where the agent considers the entire set of variables to make her decision.6 The integration of psychological motivations/limitations into economic decisions led to theory building and experimental studies that went well beyond testing simple economic models and over time led to the more cross-disciplinary sub-field of behavioural economics that combines analytical tools from primarily the fields of psychology and economics. See section 4 for more discussion on behavioural economics. 3.4 Institutions matter as do culture and norms Institutions provide the rules by which agents transact in an economy. Traditional economic theory is free of institution specific cues on behaviour. For example, market clearing is not influenced by the trading rules specified for the agents in the Arrow-Debreu (Arrow and Debreu, 1954) model. Another example would be the four major auction formats, the English ascending
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The idea of heuristics as a second best approach, originating because of mental limitations has been recently questioned. Studies such as Gigerenzer and Brighton (2009) have shown us that very often, fast and frugal computations give us much more predictive accuracy (not in terms of mean prediction but with respect to individual prediction) than models that compute over the entire set of variables.

price auction, the Dutch descending price auction, the first price sealed bid auction and the second price sealed bid auction, all of which are revenue equivalent for risk neutral agents. Experimental data from auction experiments do not bear out the equivalence of these four formats. Smith (1989) presents a schematic diagram of the way behavior has been conceptualized and studied in economics over the twentieth century. I update it below in figure 1 to include newer developments some of which are from literatures other than economics such as psychology, political science and anthropology. Before 1960, economic theory was largely not concerned with institutional differences, asserting that as long agent preferences and firm costs were the same, it did not matter what the specific rules of interaction were for the agents.7 The outcome in such theory is determined directly from environment (given by cost and preference parameters), whereas in an institution-specific theory the outcome is determined both by the institution as well as the environment. The two most important market institutions explored in experimental economics are the double auction and the posted offers markets. From laboratory studies it was evident that human agents did not behave the same way in these different institutions (Ketcham et al. (1984)). Kagel and Levins (1986) study of common value auctions, Friedmans model (1991) of the double auction market are two institution specific theoretical studies. For a detailed discussion on the role of institutions in economic theory see Aoki (2001).

A very important intellectual direction that emerged out of the paradoxes of rationality observed in laboratory games was the study of the effect of culture and demographics on economic behaviour through the formation and enactment of social norms. Sen (1973) alludes to social norms when he discusses the prevalence of cooperative action in the Prisoners Dilemma game. Arrow (1982) clearly states that The model of laissez-faire world of total self-interest would not survive for ten minutes; its actual working depends on an intricate network of reciprocal obligations, even among competing firms and individuals. The interest in social norms and culture in turn has fed back to the design of experiments with the emergence of the Artefactual
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According to North (1991, p. 97) institutions are the humanly devised constraints that structure political, economic and social interaction. Throughout history, they have been created by human beings to promote order and reduce uncertainty in markets. Together with the standard constraints in economics (i.e. - those imposed by preferences and costs) they define the choice set and therefore determine transaction and production costs and hence the profitability and feasibility of different economic activity.

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Field Experiment (AFE). An AFE lies between a laboratory and a natural experiment in that laboratory tasks are now performed not by college students (the usual subject group used in Economics and Psychology experiments) but by more unsophisticated subjects from the field.8 Some early work in field experiments includes Lichtenstein and Slovic (1973), Kagel et al. (1979), Binswanger (1980, 1981) and DeJong et al. (1988) who study decision and game theoretic problems in the field. North (1991) in his essay on institutions recognizes the power of norms as informal constraints on behavior which include sanctions, taboos, customs, traditions and codes of conduct. These non-legally binding but morally enforceable informal institutions have become very important in the study of economic outcomes today. Hume ([1740], 1978) was the first to discuss the central role that norms play in the construction of social order. Since the evolution of norms is necessarily culture specific, the study of these norms and their effect on economic equilibria has meant that cultural and demographic variables which were hitherto unstudied have found their way into the economics literature. Norms influence the choice of equilibria and sometimes cause outcomes to be adopted which may not necessarily be equilibria in a game theoretic sense. Accordingly, fairness norms may influence the playing of the cooperation (dominated) strategy in an N-player Prisoners Dilemma (NPD) game such as the public goods game. Furthermore, informal social sanction such as threat of ostracism in communities may cue agent behavior towards more equitable outcomes in spite of the presence of short term economic incentives for self aggrandizement. Coleman (1990), Henrich et al. (2004), Bowles (2004) and Ostrom (1995, 1998) provide empirical evidence as well theoretical frameworks that analyse the role of culture, demographics and social norms on economic outcomes. As indicated in figure 1, social norms influence behaviour both directly and indirectly. Norms related to social incentives and sanctions influence agent behavior directly by identifying focal points (some of which may not even be equilibrium in the game theoretic sense).Furthermore, norms indirectly affect agent behavior either by altering the evolution of institutions and the rules of interaction therein or affecting the evolution of preferences and costs over time.
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In a related class of field experiments, Framed Field Experiments, the experimental tasks given to the subjects in the field are framed in a context that is relevant to the field. See Harrison and List (2004) for a more detailed discussion.

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OUTCOMES Prices, allocations

theory

Pre-1960 institution free

Post 1960 institutions matter Post 1980 culture and demographics matter.

CHOICE BEHAVIOUR

ENVIRONMENT Agent values, costs, endowment, technology

CULTURE and DEMOGRAPHICS Social Norms

INSTITUTIONS Language of the market Rules of communication and contract Extensive form structure

Figure 1: Institutions, culture, environment and behaviour in economics (extended from Smith, 1989)

4. Experimental economics contrasted with experimental psychology The methodologies used to study bounded rationality and divergences from normative behavioural paradigms are different in Social Psychology from Experimental Economics, which had initially led to very little joint experimental work between the two disciplines. Over time a significant number of economists have actually started to appreciate the problems investigated and methodologies used by psychologists, which has led to some convergence between the fields though serious divergences regarding procedure and implications remain. The main methodological conflict between economists and psychologists arises on the issue of subject payments. A significant number of psychology experiments do not actually pay subjects

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for their responses. This includes the classic Kahneman and Tversky (1979) study on Prospect Theory. Even when experimental psychologists pay their subjects, often these are flat payments and not contingent on the decision they make.910 Psychologists have defended the no/low payment paradigm in psychology studies variously, as a large number of individual choice experiments in psychology deal with non-monetizable utilities or even payoffs that are difficult to measure.11 A second point of contention deals with deception, i.e. misleading subjects regarding the actual objectives of the experiment. Again, according to many psychologists who study boredom, cheating, excitement, pain and anger, the treatments critically hinge on the subjects not being aware of the stimuli they are going to be subjected to, or the purpose behind the experiment, as this would lead to biased actions. Another important point of divergence between experimental psychology and experimental economics is related to the theoretical underpinnings behind various results that may be obtained from an experiment. Most economists dont really need a precise and accurate theory at the individual level, just as long as it is general enough to explain some of the observed behaviour accurately and generate an aggregate prediction that is more or less accurate. So elegance and generality are generally desirable in economic theory, whereas psychologists and cognitive scientists are interested in modeling the precise nuances of behavior displayed by individuals. An example should make this clear. A typical economics experiment on attitudes towards risk would have the researcher make an assumption about the form of the utility function (say constant relative risk aversion or CRRA) that the agents purportedly follow. Using this function and the choice response in the experiment, one can calculate some measure (maybe Arrow-Pratt) of risk aversion and then compare this across agents, over time, cross-culturally etc. If anyone questions the validity of using this functional form over another one, most of the time the answer
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See Harrison (1989, 1992 and 1994) for a payoff dominance critique of experiments in economics. The three main principles that should govern payments in an economic experiment are salience, dominance and monotonocity. Salience requires that the payment given to a subject must be different for different outcomes in the game/decision theoretic situation. Dominance requires that the reward medium dominate decision costs for the subjects and monotonicity implies more of the reward medium is preferred to less of the reward medium. See Friedman and Sunder (1994), Harrison (1989, 1992 and 1994), Plott (1991) and Smith (1989) for more detailed exposition on monetary incentives in economic experiments. 11 For studies where the payoffs are non-monetizable see Ariely and Loewenstein (2005), Ariely, Loewenstein and Prelec (2003) and Berns et al. (2007)
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that a theorist or an experimental economist would give you would be that it doesnt matter as long as everyones attitude to risk is measured using the same CRRA specification. Most psychologists and cognitive scientists would be quite unhappy with this as if way of evaluation. They would be more interested in the cognitive processes that govern the choice made by the decision maker, rather than obtaining some measure which has good internal validity but potentially scanty external support.12 According to Camerer (1995), most economists have a one-size-fits-all approach to studying economic problems vis--vis psychologists. So if a task involves elicitation of a probability, most psychology experiments would frame the problem in a natural setting using a vignette. This would anchor the tasks to certain specific stimuli. Most economists would go ahead and attempt to elicit the same probability using a more decontextualised device such as a pair of dice or a bingo cage. This is in keeping with the institution free pedagogy of neoclassical economics where elicitation of a probability is coming up with a specific statistical measure rather than an assessment of a contextualized measure of uncertainty. Economists are also interested in static repetition of tasks with a view to studying convergence to equilibria or some non-equilibrium outcome. On the contrary psychologists would be the most interested in the behaviour of a subject the first time they experience the stimulus as they feel that quick static repetition overstates the speed and clarity of feedback that would be provided in a natural setting. The development of the hybrid field of behavioural economics in the 1970s represented a convergence between the fields of economics and experimental psychology. However, given that psychology as a discipline has a significant interface with other social sciences such as anthropology and the biological sciences, especially evolutionary biology, these too have found their way into behavioural economics. This subfield draws from a lot more than economic theory and attempts to actually provide a handle on the more primitive elements that make up behavior by studying context specific biases and documenting deviations for norms in a precise and detailed manner. Some behavioural economists are also interested in finding how behaviour correlates with neural substrates or pathology, which may sometime in the future give us a more
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In fact the evolutionary biologist Dawkins (1989) too expresses some reluctance at accepting this as if approach to decision making when he states that in problems that involve spatial computation like a baseball player running to catch a ball he behaves as if he had solved a set of equations in predicting the trajectory of the ballat some subconscious level, something functionally equivalent to the mathematical calculations is going on.

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precise medical answer to questions like why some people are risk loving (which is manifested in the theory as a convex utility function) and others risk averse (concave utility function). Indeed, behavioural economics studies behaviour such as procrastination or explores physical or emotional states such as boredom, pain and sexual arousal, which may not have received much (or any) importance in economic theory, but which have huge implications for economic behaviour.13 For more detailed analyses regarding the methodological differences between experimental psychology and experimental economics see Camerer (1995), Sonnemans (2007), Ariely and Norton (2007) and Zwick et al. (1999). At the crux of this methodology debate is the fact that the raison-d etre of experimental economics for many decades was to test highly axiomatized economic theories. Not much was asked by way of speculation regarding deviations from normative behaviour. According to Erev and Roth (1998, p. 848) Economists have traditionally avoided explaining behavior as less than rational for fear of developing many fragmented theories of mistakes. Thus the appeal of utility maximization and Nash equilibrium is that they provide useful approximations of great generality, even if they do not precisely model human behavior (Roth, 1996). 5. Historical progression of experiments in economics The earliest experiments were run in the forties by Edward Chamberlin at Harvard to show his graduate students the falsity of the theory of competitive markets. Although the results of such experiments were published in Chamberlin (1948), nobody at the time, including Chamberlin himself, attributed much scientific value to them. Merrill Flood and others were also performing experiments at the RAND Corporation in the early fifties. In 1952, the Ford Foundation and the University of Michigan organized a twomonth seminar in Santa Monica on the design of experiments in the study of decision processes in which Flood and his group participated. This seminar did not yield significant research work in experimental economics but sensitized many researchers who participated in it to the possibilities of using controlled experiments to study behaviour. As an interesting aside, a game
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The idea that motivations beyond the simple calculus of self-aggrandizement could drive human behaviour was noted more abstractly by Hume (1739) and extended by Smith (1759) in his Theory of Moral Sentiments. Smith may have been the first economist (or as they were then known, moral philosopher) to attribute psychological motivations towards economic activity such as other-regarding preferences and bounded rationality.

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entitled the Prisoners Dilemma, originated by Melvin Dresher and Flood a few years before and discussed at the Santa Monica seminar, proved to be an important game in experimental economics as it provided a stark example of a broad class of game theoretic problems in which the rational maximizing strategy when played by all would lead to an equilibrium outcome in which everyone is worse off.14 This paradox of rationality would capture the imagination of experimental researchers in later decades and many other dilemma games such as the Trust game (Berg et al., 1986), the Voluntary Contributions Mechanism (Isaac at al., 1988a, 1988b) and the Travellers Dilemma (Basu, 1984, Capra et al., 1999) would be studied to actually see if players played like rational fools (Sen, 1977) and displayed behaviour according to the normative theoretical paradigm. In all such games, human subjects in paid experiments deviated significantly from theoretical predictions, i.e. - they were less rationally foolish than predicted by theory. At the same time as the Santa Monica seminar, Sidney Siegel and Lawrence Fouraker studied bargaining behaviour at Pennsylvania State University. They combined aspects of methodology from both Economics and Psychology and provided one of the first examples of the study of how behaviour alters with monetary incentives and amount of information provided to experimental subjects (Siegel and Fouraker, 1960). In this way, Siegel and Fourakers experiments profoundly influenced younger researchers like Vernon Smith who would incorporate this idea of salient monetary incentives and double blind experimental procedures in important publications in the seventies and the eighties. Smith would later formalize these methods in the precepts or rules related to his proposed induced value theory, (the use of monetary incentives to control subjects preferences) which would be the methodological touchstone of laboratory experimentation in economics (Smith, 1976, 1982). This practice of using salient payments (subjects obtain payments that are monotonically linked to the outcomes in an experiment as opposed to flat payments that were common in psychology experiments) also allowed Smith, Charles Plott and other newly christened experimental economists to differentiate themselves on the academic spectrum from researchers in experimental psychology and contributed greatly to establishing a distinct methodology in this new sub-field of economics.

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See Flood (1952) for accounts of early experimental examination of zero and constant sum games.

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Though not an economist himself, Herbert Simon of Carnegie Mellon University was a cognitive scientist who studied individual decision making in the fifties and his experiments largely in a managerial environment indicated that individuals made decisions in a boundedly rational manner, i.e. - with an intent to do as well as possible for themselves, but unable or unwilling to take into account all possible contingencies and/or outcomes. Thus Simon posited that agents satisficed rather than optimized, i.e. - they played in a boundedly (or procedurally) rational manner and obtained a sufficiently high payoff with which they were satisfied (Simon, 1955, 1956). In this way Simon can be said to be the first behavioural economist and laid the foundations for the study of systematic bias, the use of heuristics and other psychological underpinnings of economic behaviour that were studied by both psychologists and economists through the next four decades. The two most well known behavioural economists of the next two decades were Daniel Kahneman and Amos Tversky of the Hebrew University whose most important contribution was the formulation of Prospect Theory (Kahneman and Tversky, 1979), a behavioural alternative to von-Neumann and Morgensterns Expected Utility Theory (von Neumann and Morgenstern, 1944) that they established in the seventies. Used to explain deviations from Expected Utility Theory (notably the Allais Paradox, see Allais (1953)), Kahneman and Tversky made several behavioural assumptions (that were psychological in nature) regarding agents state dependant attitude to risk, their underestimation or overestimation of probabilities that they confront and their inability to process compound lotteries. In doing so, they made one of the first and maybe the most celebrated theories that were created in order to explain deviations from mainstream theoretical predictions among laboratory subjects. Over the last two decades Gigerenzer (2008) and Guth (1995, 2008) have criticized Kahnemann and Tversky for their methodology, describing it as repair program for neoclassical economics. According to them Prospect Theory models decision making under risk in an as-if manner by adding transformations and free parameters to the standard expected utility framework, instead of attempting to actually map psychological processes that may lead to the observed behavior of agents. In the sixties and seventies experiments in economics went through a period of slow growth and certain experimenters distinguished themselves by both their prolific output and their desire to posit economics as an experimental science. Vernon Smiths study of competitive market

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behavior (Smith, 1962) showed that the institution of the Double Auction market with financially motivated agents worked well in reaching equilibrium. In doing so Smith replicated Chamberlins earlier classroom experiments on competitive markets using students of Purdue University, where he was employed as Assistant Professor. To his surprise he got the opposite results from Chamberlins experiments using careful laboratory procedures and financially motivating subjects. Over the next two decades Smith studied market behaviour, different auction formats, public goods and models of altruism and reciprocity until the eighties when his prolific research output in both experimental game theory and competitive markets brought him to the forefront of the newly consolidating field. Smith ultimately received a Nobel Prize in 2002 for being a leading light in establishing laboratory experiments as a credible tool for economic analysis, especially in the study of different market mechanisms. He shared the 2002 Nobel with Daniel Kahneman whose cited contribution was in incorporating insights from psychological research into economics, especially with respect to individual decision making under uncertainty. The eighties and nineties were good decades for experimental economics and by the turn of the millennium major universities in both the US and Europe had groups of experimental researchers who worked on problems in game theory, decision theory and market behaviour. An influential researcher who made significant contributions to experimental economics in this era was Charles Plott, an ex-colleague of Vernon Smiths from Purdue who was now a professor at the California Institute of Technology. Like Smith, Plott too was interested in market behaviour especially experimental asset markets. His studies with Thomas Palfrey and Shyam Sunder on securities markets (Plott and Sunder, 1982, 1988) were very influential in sparking off interest in the then nascent sub-field of behavioural finance. An important reason why experimental economics flourished in the eighties and nineties was keen interest taken in it by theorists. The reason that a lot of theorists felt attracted to experiment was that especially in game and decision theory, many anomalies (unanticipated divergences from the normative prediction) had emerged from experimental studies. Important theoretical results had been seen to not hold when human subjects were asked to make decisions in the laboratory. Thus there was a need felt to perform stress tests in the laboratory in order to help formulate theories with better empirical support. The most notable of the early theorists who took an interest in experimenting was Reinhardt Selten, who shared a Nobel Prize in 1994 with John Harsanyi and John Nash, for his work on the theory of dynamic games. From the early seventies Selten had a keen interest in the experimental
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verification of theory. His experimental publications largely dealing with learning and evolution of behavior in laboratory games in the seventies and eighties had an empirical flavor that would be in vogue in the field in the new millennium (see Selten and Stoecker, 1986; Selten et al., 2005 and Ockenfels and Selten, 2005).Many other theorists such as James Andreoni, Alvin Roth, Daniel Friedman and Thomas Palfrey published thought provoking experimental studies on altruistic motivation and charitable giving (Andreoni, 1990, Andreoni and Miller, 2002), reinforcement learning in games (Erev and Roth, 1998), equilibrium in evolutionary games (Friedman, 1997), belief learning (Cheung and Friedman, 1996) and quantal response equilibrium (McKelvey and Palfrey, 1995). In this era, experiments in economics were posited primarily as being of the theory testing variety, often involving stylized laboratory games, markets and decision problems with negligible parallelism to the corresponding field institutions. External validity of laboratory environments used was not considered important (as long as the laboratory economy was internally consistent) and subject pools were often limited to undergraduate students of US and European institutions. It is true that some studies explored scaled down laboratory versions of various real world mechanisms such as airport time slot allocation (Rassenti et al. (1982), telecommunication spectrum auctions (Plott, 1997) and pollution permits (Cason (1995), Cason and Plott (1996), Cason and Gangadharan (2003)), but these were relatively rare.15 6. New millennium, new directions Today half a century after the first economics experiments were performed we stand at an interesting juncture in the field where the desire to test theory has given way to actually attempting to understand behavior and its underpinnings. This has led to economists collaborating with researchers from other fields in basic and social sciences such as cognitive psychology, evolutionary biology and sociology/anthropology. Henrich et al. (2001) was the first major study that investigated the impact of demographics on human cooperation using the ultimatum game.16 They obtained the results that far from the rational-actor framework of the
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Experiments that study mechanisms from the real world using scaled down environments in the laboratory are referred to as testbed experiments. The results from testbed experiments can be then used to refine institutional rules or design new rules of interaction. 16 An ultimatum game, first studied experimentally by Gth et al. (1982) is one where a proposer sends an offer to a responder splitting a rupee in the proportion that is acceptable to him. If the responder agrees to the split (say

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canonical microeconomic model, peoples cooperative behavior is not exogeneous, and critically depends on the economic and social realities of everyday life. The fact that culture and demographics matter in determining choice in humans is here to stay in economics and several studies after Henrich et al. (2001) such as Kurzban and Houser (2001), Harrison et al. (2002), Sosis and Ruffle (2003), Cardenas and Ostrom (2004) and Andersen et al. (2008) investigate the effect of culture and individual (non-economic) characteristics on economic choice behavior. An important consequence of the diversification of the subject pool brought about by these field experiments is the comparisons that are starting to be made between results obtained from decades of laboratory experiments in the behavioural sciences that involve primarily undergraduate students from industrial nations and the newer results from societies in developing nations. Henrich et al. (2010) show that the behaviours in a variety of decision-making situations differ significantly in this larger slice of humanity from that displayed by subjects from what they refer to as the WEIRD societies.17 They conclude that members of WEIRD societies are among the least representative populations one could find for generalizing about human behaviour.

The prevailing atmosphere of interdisciplinarity has also led to collaborations between economists and clinical neurologists leading to the sub-field of Neuroeconomics, which attempts to find the roots of behavior as reflected in the working of neural substrates. Both game and decision theory problems have been investigated by projects in Neuroeconomics that have both social scientists as well clinicians who are familiar with the working of fMRI (Functional Magnetic Resonance Imaging) machines. The idea is simple: put subjects in MRI machines with the electrodes connected. Then give them tasks to do and observe which sets of neurons fire up. McCabe at al. (2001) was the first major research study in Neuroeconomics, which posited that mentalizing was important in games involving trust and cooperation.18 They found that players who were more trusting and cooperative showed more brain activity in Brodmann area 10
60p./40p.) then these are the final allocations. If the responder does not agree to the split, both get zero. The SPNE of this game is for the proposer to keep the full rupee and offer the responder nothing. The responder in equilibrium should accept this offer. Empirically however, this SPNE is rarely played: proposers are mostly equity preserving in their offers and responders often reject moderately non-egalitarian offers. 17 WEIRD stands for Western, Educated, Industrialized, Rich, and Democratic. 18 Many neuroscientists believe there is a specialized mentalizing (or theory of mind) module, that controls a persons inferences about what other people believe, feel, or might do. This is of particular interest to game theorists who create theories regarding how agents behave in strategic environments.

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(thought to be the locus of mentalizing) and more activity in the limbic system which processes emotions. In the Smith et al. (2002) experiment, payoffs and outcomes were manipulated independently during choice tasks in the form of gambles (involving risk or ambiguity) as brain activity was measured with positron emission tomography (PET) scans. Their analyses indicate that the interaction between belief structure (whether the prospect is ambiguous / risky) and payoff structure (whether it is a gain frame / loss frame) shapes the distribution of brain activity during choice. Accordingly, there are two disparate, but functionally integrated, choice systems with sensitivity to loss. A neocortical dorsomedial system is related to loss processing when evaluating risky gambles, while a more primitive ventromedial system is related to the processing of other stimuli. See Camerer et al. (2005) for a detailed survey of Neuroeconomics studies and their impact on mainstream economics. Though Neuroeconomics claims that many fundamental insights in economics can be generated from these imaging studies, Harrison (2008) and Rubinstein (2008) have criticized this sub-field for adding no fundamental insight in our understanding of how economic decisions are made, and have variously referred to it as a faddist technological gimmick, attempting to provide hard evidence for violations from normative behavior. According to them, results from Neuroeconomics studies are inconclusive and the insights if any are far from re-shaping the way we think about economics. The crux of the problematic nature of Neuroeconomics presented in Rubinstein (2008) is as follows- even if we know the exact centre of the brain that engages (and the extent to which it engages) when we perform certain activities, it is unclear how that would help us design mechanisms or devise strategies (short of surgical intervention) that would help humans make better decisions. Furthermore, unless imaging techniques available allowed us to monitor brain activity in real time for all humans (a proposition that harkens to a dystopic world portrayed in science fiction novels), it would be really difficult to use this information for anything meaningful.

In conclusion, the recognition of the fact that behavior as modeled in economics cannot be treated independently of human behavior observed in studies in psychology or anthropology or even medical science has greatly augmented the breadth and depth of experimental work in economics. This has also spurred numerous interdisciplinary collaborations some of which have been more fruitful than others, but the writing on the wall is clear its no longer possible to think of economic choice problems to be mutually exclusive to similar problems studied in other

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disciplines in social and biological sciences. A healthy concomitant of this is the relatively smaller weight put on narrow results arising from specific formulations of problems that are studied in research programs. Behavioural researchers today seem more interested in the direction of their results than the magnitude of their divergence from some field-specific theoretical norm. This is inevitable because we do ultimately need to correlate our results with those from other disciplines that have different parameterizations of the same problem. Today it is increasingly becoming clearer that just numerical averages on outcomes help us very little in terms of generating insights pertaining to populations. As researchers, we often have to actually spend some time connecting the dots and synthesising observation from across two to three fields in an attempt to actually gain an insight into the behavior being explored.

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