# 50 Social preferences exercises

## 50.1 Fehr-Schmidt preferences

Alby has the following distributional preferences:

U_A(x_A,x_j)=\underbrace{x_A}_{(1)}\underbrace{-\alpha\text{max}\{x_j-x_A,0\}}_{(2)}\underbrace{-\beta\text{max}\{x_A-x_j,0\}}_{(3)}

where:

x_A is the outcome for Alby

x_j is the outcome for any agent j with whom Alby interacts.

a) For \alpha>0 and \beta>0, what are preferences of this form are normally called?

Inequality aversion.

b) For \alpha>0 and \beta>0, describe the role of each of the three terms labelled (1), (2) and (3) in the utility function.

The first term captures the utility of Alby’s own outcome.

The second term captures Alby’s dislike of having less than others.

The third term captures Alby’s dislike of having more than others.

c) Explain the intuition for why we normally set \alpha>\beta.

Most people dislike having less than others more than they dislike having more than others. In some instances, \beta<0 in which case people like having more than others - they are fine with inequality as long as it is to their advantage.

## 50.2 Charness-Rabin preferences

Bob has the following distributional preferences:

u_B(x_B,x_j)=\left\{\begin{matrix} \rho x_j+(1-\rho)x_B\quad &\textrm{if} \quad x_B \geq x_j \\[6pt] \sigma x_j+(1-\sigma)x_B \quad &\textrm{if} \quad x_B < x_j \end{matrix}\right.

where:

x_B is the outcome of the game for Bob

x_j is the outcome of the game for any agent j with whom Bob interacts.

a) For 1\geq \rho \geq\ 0 \geq \sigma, what are preferences of this form are normally called?

Inequality aversion.

b) For 1\geq \rho \geq\ 0 \geq \sigma, describe the role of the terms in each of the two equations where x_B\geq x_j and x_B< x_j.

\sigma and \rho are the weight that is Bob gives to the outcome for agent j. \sigma is applied where Bob’s outcome is better than or equal to that of agent j, and \rho where it is worse.

The residual 1-\sigma and 1-\rho is the weight that Bob gives to his own outcome.

c) Explain the intuition why we normally set \rho>\sigma for the utility function.

People tend to be more willing to see others have better outcomes when those others are worse off than them.

d) What values of \rho and \sigma would result in a utility function where Bob is purely self-interested?

If Bob were purely self interested, \rho and \sigma would have a value of zero. In that case, agent j’s outcomes would not enter into the utility function. The utility function would become u_B(x_B)=x_B.

e) What value must \sigma have to explain Bob’s rejection of low offers in the ultimatum game?

Sigma must be negative such that the decrease in utility from agent j’s payoff is larger than that through the payoff Bob receives himself.

f) Consider the following two scenarios involving the Ultimatum game.

Scenario 1: A proposer has a choice between offering a split of ($8, $2) or ($5, $5). In experiments with this choice, responders tend to reject offers of ($8, $2).

Scenario 2: A proposer has a choice between offering a split of ($8, $2) or ($10, $0). In experiments with this choice, responders tend to accept offers of ($8, $2).

A utility function of the type that Bob has cannot result in this behaviour. Explain why.

In both cases, the outcome is ($8, $2). This would result in the same level of utility regardless of the other option that the proposer had. If compared with the outcome ($0, $0) from rejecting the offer, the action should therefore be the same.

An explanation for the difference between scenarios is that people care not just about outcomes, but also the intentions of those with whom they interact. In that circumstance the good (or otherwise) intentions of the proposer in offering either less than they could or as much as they could would shape the responder’s action. However, intentions do not enter into Bob’s utility function.