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Homo Oeconomicus

Experiments on the topic

• Dictator and ultimatum game
• Wage negotiations
• Role of negotiating power

Behavioural models in the economic sciences

Economists create Modells of, for example, entrepreneurial and private economic behaviour or markets in order to explain reality and make recommendations for economic action in the respective situations. For such models, it is necessary to make assumptions about how people behave in economic situations. Such assumptions form a behavioural model.

The central behavioural model of economics is homo economicus. According to the assumptions of this behavioural model, homo economicus acts rationally as an individual, i.e. he makes decisions free of emotions, always focuses solely on his own benefit and makes no mistakes when taking in and processing information. It is true that classical economic theories assume that all people behave like homo economicus. Nevertheless, economists are aware that in many situations the assumptions of homo economicus do not provide an accurate description of actual human behaviour. But every model of human behaviour is the result of a balancing decision: on the one hand it should be realistic, on the other hand it should allow concrete predictions about how people behave in economic situations. This is why the behavioural model of homo economicus has a great advantage, precisely because its assumptions are extreme: It keeps economic theory models simple and meaningful. For example, predictions of behaviour in competitive situations  (Funktionsweise von Märkten) are possible on the basis of the behavioural model of homo economicus, while other, more complex models of human behaviour would make the analysis so difficult that it would be almost impossible to arrive at any clear prediction.

Human behaviour vs. homo economicus

Although the behavioural model of homo economicus is a central component of economics, real human behaviour often cannot be explained using the assumptions of this behavioural model. In recent decades, many economic studies have therefore looked at deviations in human behaviour from that of homo economicus, thus establishing what is known as behavioural economics. Although behavioural economics is a relatively young field of economics, it also has its origins in the work of classical economists. For example, Adam Smith (1723-1790) not only wrote ‘The Wealth of Nations’, but also ‘The Theory of Moral Sentiment’, in which he described psychological principles of individual behaviour. Behavioural economics examines the extent to which people violate the predictions of the homo economicus behavioural model when making economic decisions. The two defining assumptions of this behavioural model are financial self-interest and the comprehensive, error-free absorption and processing of information. Accordingly, there are two major sub-areas of behavioural economics.

The first sub-area is based on the observation that people do not only think about our own financial advantage, but also consider justice and fairness. People judge justice or fairness in terms of (at least) two aspects: Distributive justice and procedural justice. While distributive justice refers to the result of the distribution of goods, money or other things, i.e. who gets what or how much in the end, procedural justice refers to whether the path to a distribution, i.e. the decision-making process that led to the distribution, is fair. One example is a new tax law, which is not only judged according to who has to pay how much tax (distributive justice), but also according to how it came about (i.e. whether a lobby group had a strong influence on the legislation, for example).

The second area of behavioural economics, which deals with human information intake and processing, is part of economic psychology. In particular, it deals with systematic distortions in human perception (so-called biases) and heuristics, i.e. ‘shortcuts’ that people take in order to form a judgement more quickly. One example of a bias is the confirmation bias: people give more weight to information that confirms their existing opinion, even if this information is less reliable than other information that speaks against their (pre)judgement. We humans use heuristics, for example, when we have to make a judgement about how likely a possible event is. For example, we tend to overestimate the probability of events that are familiar to us (availability heuristic).

Distributive justice: altruism, fairness, force

Distribution games: Dictators and ultimatums

The three experiments on this topic relate to the first area of behavioural economics, and here to the topic of distributive justice. The experiments were developed in the 1980s and illustrate in a very simple way that people are not solely guided by financial self-interest, but that the prediction of the Homo Oeconomicus behavioural model is by no means always wrong. 

The dictator game is a very simple way of illustrating the behavioural model of homo economicus, because homo economicus keeps all his money for himself and gives nothing away. However, the situation is completely different in the second experiment on this topic. In the ultimatum game ‘1 to 1’ with only two people involved, Homo economicus would accept any allocation proposal that gives him more than 0 euros. But if homo economicus as the provider expects that he will not meet a second homo economicus, he will be wary of offering a split that would give him 99 euros and the other person only 1 euro. This is because many people perceive such splits as unfair and reject them. The provider must therefore consider which split is acceptable. In this situation, many people act according to the motto ‘fair is half and half’ and offer a 50 euro split for everyone. In this way, they (almost) guarantee that the offer will be accepted. In the ultimatum game ‘1 to 3’, the situation changes again: now three people are in competition with each other, because if one person refuses to split the money, another person may receive it. In most cases, the competition leads to unfair offers (where the provider wants to keep more than 50 euros) being accepted. If the providers anticipate this, they offer less accordingly.

The results of the experiments can be explained by the human need for distributive justice, but also by another aspect of human behaviour, which is expressed in the principle of ‘tit for tat’. According to this principle, human behaviour is characterised by reciprocity, i.e. cooperative, friendly and fair behaviour is answered with equally cooperative, friendly and fair behaviour, whereas the opposite behaviour is answered negatively.

The results of the experiments can also be explained by social norms. ‘Half-and-half’ is such a social norm: it states that fair sharing means that everyone receives an equal share, unless there are reasons to deviate from this (for example, differences in the neediness of the people involved or differences in performance if the sharing only becomes possible after the benefit to be shared has been earned). Existing social norms have an influence on human behaviour, but behaviour can in turn contribute to the emergence or enforcement of social norms. For example, the rejection of an unfair division in the ultimatum game can be understood as an attempt to persuade the provider to strive for fair divisions in the future.

Finally, a comparison of the ultimatum games ‘1 to 1’ and ‘1 to 3’ shows that the distribution of power plays a major role. in the ‘1 to 1’ game, you can argue about who has power: The person who proposes the division or the person who can ruin everything by refusing. In comparison, the provider in the ‘1 to 3’ game has more power and can use this power to secure a larger ‘share of the cake’. Power distributions are sometimes so deeply rooted in societies that power is taken for granted and thus legitimised.

Dictator and ultimatum games in reality?

The experiments on the subject make an artificial impression. This raises the question of what they actually stand for in reality. In fact, we often find ourselves in roles that we also see in the dictator or ultimatum game. Every guest in a restaurant who decides how much to tip is de facto playing a game of dictator. The same applies to donations to charitable organisations or ‘pay what you want’ models, where customers decide for themselves how much they want to pay. And of course we are also in the dictator game situation when we serve guests in a restaurant or collect donations.

We are far more often in the situation of the ultimatum game, because the game is ultimately the basic form of negotiation: one person makes an offer, the other accepts or refuses and leaves. Every purchase in a department store or supermarket corresponds to the ultimatum game (unless you have already said at the supermarket checkout: ‘I will only buy a litre of milk if you lower the price by 20 cents!’).

A good example of an ultimatum game in reality is the labour market. Companies employ workers to manufacture products or offer services. In doing so, they earn money, and the distribution of money among workers and owners is determined by the level of wages. If the worker in question has no bargaining power in the sense that they can demand a wage themselves, they will only be able to accept or reject the company's wage offer. If the worker refuses, the company will probably hire someone else. However, if all job seekers reject the wage offer (because no one is willing to work for such a low wage), the company will lack the labour to produce goods and provide services, and then there will be no money to share. The example obviously makes a connection to the topic of markets <<<insert link>>>: The question of pricing on the labour market is closely linked to the competitive situation among jobseekers, the bargaining power of employers and the perception of employers and jobseekers as to which distribution of money between workers and owners is (still) fair.

The ultimatum game in the ‘1 to 3’ variant, in which three people are in direct competition with each other, can be interpreted as a situation in which a company can choose from several equally qualified jobseekers. This is because in the game, each of the three people is interchangeable for the provider. In reality, such a situation can be found in low-wage sectors where low-skilled labour is employed, which is easily replaceable from the company's point of view and among whom there is therefore great competition. However, a small variation of the ultimatum game ‘1 to 3’ shows that the bargaining power can also shift quickly. All you have to do is assume that the three recipients of the offer can come to an agreement about which offers they will all accept or reject at the same time. The real-life counterpart to this variation of the game is a trade union: trade union representatives negotiate on behalf of all employees and thus create a countervailing power to that of the employers (who also organise themselves into employers' associations).

Ultimately, however, the roles on the labour market can also be completely reversed: Whenever jobseekers have special skills, it is the companies that compete with each other and vie for the same labour force. Examples of this are footballers or actors, who have little (or no) competition on the labour market due to their uniqueness.

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Here you will find our glossary

Here you can get the right Student text

Here you will find the Experiments

Here you can get Materials for further Discussion

Here you will find the Literatur