1. Read Freys Motivation as a limit to pricing and explain the title.

How could (problems with) motivation limit the possibilities of

pricing?
Pricing here is variable wage, monetary goods. This can lead to crowding out of
intrinsic motivation. This goes for both rewards and punishments. Economists
should take into account the circumstances in which monetary incentives lead to
beneficial outcomes.
Intrinsic motivation
->
Self-motivated due to interest, enjoyment of the
task, coming from
an induvial himself.
Crowding out
->
driving down
A monetary reward
->
extrinsic motivation
This crowding out of intrinsic motivation could result in workers reducing their
effort level.
a) If the employee feels that his effort is not recognized
b) If they feel that monetary incentives are unfair
c) If they feel that they are driven to behave a certain way due to payment
structure rather than determining their own actions (decrease in selfdetermination).
2. Shirking can be a large problem for an employers. Instead of
implementing monetary incentives like flexible wage schemes (the
potential dangers of which are discussed in Freys motivation as
a limit to pricing), also directly regulating employees can offer a
solution for this. In Shirking or work morale? Frey warns,
however, of a possible negative effect of such regulation. Describe
under which conditions this negative effect (see e.g. The Swiss
professors) will appear.
Monitoring can have positive and negative effects.
-

Rightly monitored workers will increase effort: without monitoring they

would provide low effort.
For workers that did not need to be monitored it could have a
counteracting effect. One of the factors of which effort depends is work
morale. By monitoring, the principal does not acknowledge work morale
which can erode effort.

Conditions under which this might occur:

- When individuals believe that their performance is better than average.
- When there is a high level of motivation form inside
- Example: professors of Swiss
3. Read Fehr et al., Does fairness prevent market clearing?. Which type of
efficiency wage theory is tested in this article? Describe the experiment
and the main results.
Fehr et Al conduct experiment:

o
o

Stage one
= One sided oral auction in which employers
offered workers wages. Employees could choose to accept.
Stage two
= Workers that found an employer had to
choose effort (no way for employer to force or induce effort)

Note that
- Wokers had an alternative, which resulted in employers having to offer
some minimum amount in wage.
- There was an excess of workers, giving employers and opportunity to
offer low wages, which would be likely to taken.
Outcome: Employers offered substantially more than the minimum necessary to
attract workers and expected workers to respond by setting a high level of effort
which, on average, they did. Differs from neo-classic economics. Workers
reciprocate.
They test the fair wage hypothesis: workers form a notion of fair wage and adjust
their effort depending on how high their wage is (workers reciprocate higher
wages by employers).
Note that this is related to the idea of efficiency wage theory. Wages are set
above market clearing level in order to increase productivity. However, the
reasoning differs (reciprocity (wisselwerking) instead of fear of losing job).
4. In happiness research having children proves not to add to ones
happiness. Give a possible explanation.
Measuring the utility
1) Objectivist approach -> cardinality of utility, not being open to broader and
wider interpretations of well-being
2) Subjectivist approach dominant one -> ultimate goal
a) Procedural utility process prior to the goal achievement
b) Experienced utility experiences form getting the goal
How can we measure subjective Utility? -> measuring happiness
1) Past experiences
2) Expectation of the future
3) Comparisons to other persons
Income and happiness
Is a rich person happier than a poor person? Not necessarily, theoretically yes,
but it is non-linear
Diminishing marginal utility with respect to an absolute income
In line with the Prospect theory
1. People do not care about the absolute level of their
income, but rather about their relative level of income.
Income and happiness over time
a) While countries are getting richer, the happiness level declined
b) No clear relationship between income and happiness
a. The reason for this is that subjectively approach is not purely
determined by an absolute income level -> Aspiration levels ->
we are unable to make absolute judgments, instead we tend to
compare the present with the past and the future.

b. Adaption -> the precise reason why to strive for the same level of
happiness we need to set for ourselves the new and ever
increasing aspiration levels.
c. Theory of rising aspirations -> increasing income, the aspiration
levels, makes us want to achieve more and more -> our goods are
insatiable -> the more we get of a good, the more we want it
d. It makes sense that people expected to fell less happy in the past,
but will want to feel happier in the future -> happiness
asymmetry due to rising aspiration levels
Happiness and unemployment
When you have a job -> happier -> 3 other findings
1. Men can adjust their subjective well-being down by more than woman
2. Higher educated people tend to lose a lot more in terms of their happiness
once unemployed
3. Young-age and old-age are suffering less when becoming unemployed than
middle-class people
1. Social factors
2. Psychological factors
To the question
Possible answer: There is a difference between decision utility and experienced
utility.
Decision is the utility that one expects to get from a certain action. Utility that is
used in decision making.
5. Explain what economists can learn from happiness research.
6. See Figure 1 in Frey & Stutzer.
Explain:
the curvature;
the lower location of the 1994-96 trend line compared to the 1972-74 trend line.

Exercises Friday Tutorial

1) Read the article by Lindenberg & Frey, Alternatives, frames, and relative
prices: a broader view of rational choice theory.
-

What is the importance of relative prices and what does economic

theory say about them?

Relative price theory, also known as the law of demand: as one good becomes
more costly in comparison to others, a person will purchase less of that good.
The relative price effect has been found to be very robust. It is true for consumer
goods and monetary prices. But more broadly applicable in the social sciences, as
it is also true for other kinds of goods and shadow prices (estimated price of a
good for which no market exists). This means that a change in relative scarcities
(comparable to a change in relative prices) leads to change in behaviour.
-

What is the difference between economists and sociologists when

they incorporate relative prices in their analysis?

What divides sociology and economist regarding relative prices is that sociology
considers the question of how large the relative price effect is (where economics
is concerned with the sign of the effect). What is meant is that sociologists
consider how important the effect is as a part of general human behaviour.
For example the size of relative price effect can vary according to situation.
When making a moral decision (in the paper example: paying for you mothers
operation) the effect appears to play a much smaller role. What matters for
decision making is the size of the effect relative to other considerations.
2) Why do Lindenberg & Frey think that it is important to develop a
theory of alternatives? According to them which elements should
form a part of it?
Lindenberg and Frey argue that theorists should seek to specify conditions that
affect the size of relative price effect. One of those conditions are the prices of
their goods (that could be a substitute or a complement). But how can we
decide are the goods whose relative prices matter? We need some kind of
insight into the relevant alternatives for the good under consideration.

Elements
1. Instrumental goals
Universal goals are identical to all people. Instrumental goals can differ
between people and are an instrument to attain universal goals. We see an
example in the Theory of Social production functions with 2 generals
goals -> heuristic
a) Physical well-being -> purchase of most goods
(i) Comfort
(ii) Simulations
b) Social approval/well-being
(i) Status
(ii) Behavioural conformation -> done something right to others
(iii)Affection -> how much your ego is being influenced by alter
2. Non-given alternatives -> produced by an individual himself
Incomplete information plays a role: person might not be aware of all this
alternatives ( a person needs to search to generate alternatives). Might
also mean that a person keeps searching instead of accepting given
alternatives.
a) The search
Instead of accepting the present list of alternatives available to you,
you will look for the better non-given alternatives until finding the
one that suits you best.
b) The fundamental uncertainty
You are not aware of the means to achieve your top goal/you do not
know the instruments available at your disposal to solve the
problem.
c) The self-command
Two types
(i) Short-term
(ii) Long-term
3. Ipsative constrains
An individual may view their feasible alternative differently than they really
are (we will see an example of this in the next question). A person believes
that the probabilities of the outcomes happen to apply only to the others,
while he/she is immune to the risk of having to face different outcomes.
3) Lindenberg & Frey present a theory of framing.
a) What is a frame?
Illustrate your answer by using an example.
A frame subjectively structures a situation. Main idea is that in every
choice situation, individuals have several relevant goals. The goal that
causes the largest utility difference when attaining or not attaining that
goals serves as the frame for that situation.
Example:
Situation
Someone bought a theatre ticket but it started to rain.
Alternatives Going or not going
Goals
Avoid throwing away money, avoid getting wet, anticipated
joy from the show
Frame
Whichever goal has the largest difference in utility between
going and not going
b) What are ipsative constraints?
People seeing their alternatives differently than they really are.

Explain, using an example, that the behaviour of economic

actors becomes less sensitive to relative price signals in the
case of ipsative constraints.
Generally, individuals tend to underestimate the possiblility of
negative events (judgemental bias). This distorts the relative price
effect. Price signal could be spreading information about health
risks. Due to Ipsative constraint, effect on cigarettes sold is smaller
than it otherwise would have been.

4) Next week your brother celebrates his birthday. You intend to give him a nice
present that you know he likes to receive. However, the present is rather
expensive and you dont have much money. Besides, it will cost you a lot of
time to buy the present, which conflicts with the time you need to prepare an
exam. At home you have a cinema token. Of course, you might give the
cinema token to your brother. However, you know he prefers the abovementioned present.
a) What are, in Lindenberg & Freys (Towards a theory of
alternatives) terminology, in this choice problem the alternatives
and what possible frames are relevant?
Situation
Give him a present
Alternative
Buy the present, give the cinema token
Goals
Joy of giving a nice present, saving time for exam, not
spending money
b) Translate the above-mentioned choice problem in terms of the
social production function approach.
All individuals strive for the same ultimate goals. They maximize their overall
well-being but also their social well-being. To make the choice between giving the
present and giving the cinema token, one would have to consider which of the
two produces the most utility:
a) Giving the present -> affection, which leads to better social wellbeing
b) Giving the cinema token -> produces more time to prepare exam,
passing exam brings behavioural confirmation which leads to better
social well-being
Als je veel waarde hecht aan effection, dan kies je voor het cadeau.
5)

Explain the existence of anonymous gifts using a SPF-framework.

On the one hand, giving an anonymous gift reduces ones financial means which
leads to a reduce of physical well-being. On the other hand, it could increase
social well-being through behavioural confirmation (sell-approval). It is
therefore that through this gift, overall well-being is increased would explain why
people give anonymous gifts.
6)

Explain the difference between the goal hierarchy of the social production
function approach and the need hierarchy of Maslows theory. Show how
the latter can be incorporated into the former.

Maslows theory
Theory suggests that the most fundamental needs must be met before
individuals will desire the needs higher up the pyramid.

Lower hierarchy goals (higher up in the pyramid) do not contribute to the more
fundamentals goals, and do not add to persons well-being when
fundamental goals are not et. Also social well-being is put on a different
level than physical well-being
Creativity, fulfilment

Self-actualization

Achievement, mastery

Self-esteem

Friends, family, community

Belonging

Shelter

Safety

Food, water

Physiological

7)

Suppose it is more difficult for women than for men with a given amount of
education and skills to arrive at a higher social status.
a)
What does this imply for the production of social approval for men
and women, respectively?
When it is more difficult for woman to gain status, they will choose to improve
their social well-being in other ways that are more efficient (behavioural
confirmation or affection) to maximize their overall well-being. If it is
comparatively easy for men to gain status, then men will end up with a higher
production of social approval.
b)
Translate your answer given to question 1.a. into two CobbDouglas functions.
Cobb-Douglas: shows the relationship between inputs and outputs that can be
produced with them.
DellaVigna
Nonstandard preferences
Time preferences
Social preferences
Risk preferences
Standard utility theory assumes that the discount factor between the two time
periods does not depend on when the utility is evaluated -> Time-consistent ->
preferences about the futur and now is the same, regardless of the point of time
chosen
But, we are discounting our utility by a lot more in the nearest future, than we do
in the distant future -> time-inconsistency problem
U_t=u_t+u_(t+1)+^2 u_(t+2)+^3 u_(t+3)+
Self-control , als =1 -> people are time-consistent

Sophisticated als <1 -> time-inconsistent

Partially naive als <^'<1 met ^' is expected self-control factor
Fully naive als <^'=1
Global utility theory
Attitude towards risk
Reference dependencce
Loss aversion -> more sensitive tot he prospect of loss
Dimishing sensitivity
Probability weighting
Norrow framing