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Economics meets Applied Psychology
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  1. Economics meets Applied Psychology Mana Komai (Economist) John Kulas (Psychologist)

  2. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Outline • Definitions • Introduction to basic concepts • History • Economics • Collaboration • How we can work together • Example • Project focused on ethics and leadership • Applications • Relevance to business (help!)

  3. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Game Theory • Analysis of strategic behavior among rational players • Rational players can be firms, consumers, countries, political agents • Can be applied to organizational behavior, market behavior, evolutionary biology, business strategies, contracts

  4. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS I/O Psychology • Application of Psychology principles, methods, and theories to work applications • can be applied to the selection of employees, training, performance evaluation, motivation

  5. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Experimental Economics • Experimental economics is the application of experimental methods to study economic questions • Do sequential (visible) contributions to charities increase total contributions? • Do different wage schemes effect job performance?

  6. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Behavioral Economics • Effects of Psychological factors on economic decision making • Why do some consumers make irrational purchases (for example, big screen TV when they can’t afford [on credit])?

  7. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS An important assumption in classical economics • People are rational, selfish, utility maximizing economic agents • Complicated psychological traits do not much matter to a classical economist

  8. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Power of economic prediction depends on assumptions • Our theoretical results and predictions highly depend on these assumptions • We did not question ourselves much for a while, until…

  9. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS The emergence of experimental economics • Experiments in economics were introduced in the 1960s and 1970s • Mainstream economists began to acknowledge their relevance in 1980s • Game theory • Public choice theory • Industrial organization theory • Information economics • Financial economics

  10. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • Results from economic experiments went against so many predictions which were highly dependent on our rigid “we are all rational, selfish, economic robots” assumption • Led to alternative theories • Sometimes people do some decisions based on, for example, rules of thumb

  11. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Economists started to talk about: • Bounded rationality • Altruism • Warm glow • Trust • Appreciation for fairness • Inequality aversion • Envy • Reciprocity

  12. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS We can work well together: • In 2002 a Nobel prize in experimental economics was shared by Vernon Smith (an economist) and Daniel Kahneman(a psychologist)

  13. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Our collaboration • Mana’swork is on organizations and leadership – Mana thought as a psychologist, John could contribute, John thought Mana could provide a solid mathematical framework to the study of organizational issues • We started working on leadership and organizations • Game structure based on a previous paper (Komai & Stegeman, 2010)

  14. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Problems/Friction • Very few economics articles discuss leader characteristics • At first only “risk aversion” allowed by Economists • Now “Ethics” permitted • Risk aversion was more of an economics construct (economists pay attention to it)

  15. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Leadership and Ethics An Example of Collaboration Mana Komai Philip Grossman John Kulas

  16. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Ethical Leadership • Modeling and promotion of morally appropriate behavior (Brown, Treviño, & Harrison, 2005) • Applied and academic interest following ethical scandals of early 2000’s (Enron, Worldcom, Tyco) • Always1measured with field samples (Ng & Feldman, 2014)

  17. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS We investigate whether followers’ perceptions of leaders’ ethics can affect group behavior in a collective action game in which leaders can privately benefit from deceiving their followers

  18. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS The collective action game • 3 players • Each player decides whether or not to invest in a group investment project • Two possible projects, which are equally likely to happen • Payoffs are shown on the next page:

  19. Payoff structure DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Payoffs

  20. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Efficient outcome (what is good for the group) • All group member should invest in the project

  21. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS The predicted outcome (the Equilibrium) • In Project 1: either all 3 invest or nobody does • In Project 2 nobody invests

  22. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • The predicted problem in Project 1 is called the “coordination problem” • The predicted problem in Project 2 is called the “free-riding problem” • In this collective action game, both problems can hinder “efficient” group cooperation

  23. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Leadership Structure • One player is chosen randomly to be the leader. • The leader observes which project is assigned to his/her group • The other two players (followers) do not. In other words, the leader has exclusive access to critical information

  24. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS The leader moves first, making two separate but simultaneous decisions. • Investment (not observable or verifiable by followers) • Suggestion (observable by followers) • Followers observe the leader’s suggestion and decided simultaneously whether or not they want to invest

  25. The predicted outcomes (the equilibrium) • Either nobody invests. • The leader invests in Project 1 but not 2 and followers invest • The leader’s suggestion is not costly for him/her. Thus, the leader may very well choose to deceive his/her followers in project 2

  26. Predictions • A leader’s personal characteristics (including his/her ethics) plays no role in the economic analysis of the outcomes

  27. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Psychological twist • In this game, the leader has an incentive to deceive his followers by suggesting a course of action, which he/she may decide not to follow • You would think a leader’s ethics may matter

  28. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Let us see Whether information about a leader’s ethics would affect the final outcome of the game Whether information about a leaders’ ethics impacts which equilibrium is more likely to happen Whether information about a leaders’ ethics impacts the occurrence of the efficient outcome

  29. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS The Experiment • Student subjects from Monash University participate in the experiment • The experiment takes place in the MONLEE lab with fully partitioned workstations and is conducted with computers running a z-Tree program

  30. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Leaders and followers • In each group, one player is chosen randomly to become the first mover or the Type A player (the leader) • The other two players are second movers or Type B players (followers)

  31. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Two experimental treatments • Treatment 1: Ethical information about the leaders results are left out • Treatment 2: Followers make their investment decisions after they are informed of their leader’s ethical standing

  32. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Treatment 2 classification • Followers are informed that the leader’s score placed him/her in the lower 1/3, middle 1/3, or upper 1/3 compared to a sample of 184 university students who previously completed the 15-item survey

  33. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Leader action • The leader makes both an actual investment decision and an invest/not invest recommendation for both possible projects • The recommendation does not have to reflect the leader’s actual decision • One of the two projects is then randomly selected for the group and the leader’s invest/not invest recommendation is passed to her followers

  34. (Preliminary) results

  35. (Preliminary) results

  36. (Preliminary) results Table 5: Followers’ Behavior

  37. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS (Preliminary) results • Leaders are 30% more likely to deceive their followers in Treatment 2, where leaders’ ethical category is revealed to their followers • Being introduced as a highly ethical leader to their followers makes them 31% more likely to deceive their followers for their own advantage (and not the benefit of their group)

  38. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Implications • Followers are much more likely to follow leaders who are introduced to them as highly ethical compared to the ones categorized in the lowest ethical category in Treatment 2.

  39. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Relevance to Business • Moving forward – where the future of behavioral and experimental economics is in respect to business (e.g., how it can help)

  40. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Behavioral economists acknowledge: • Unrealistic assumptions of rational man model: • unbounded rationality (the ability to process unlimited information and solve problems optimally) • unbounded willpower (the ability to forgo impulse purchases) • unbounded selfishness (care only about own wellbeing) • bounded rationality (i.e. the adoption of “rules of thumb”) • limited self-control (i.e. buying that flat screen TV today on credit, rather than saving for it or having that slice of cheesecake for dessert even though you know you need to lose 10 pounds) • bounded selfishness (i.e. giving to charities or helping a stranger)

  41. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Real-world relevance • How to get people to contribute more (time/money) to public goods/charitable foundations • Signing up for voluntary training • Participation in health & wellness initiatives • Contextual Performance

  42. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Other applications? Any behavioral change application with relaxed rational man assumptions…