Rational or Irrational? (#2)

Last time, I wrote about how people would rather volunteer their time freely than do the same work for very low wages. It is an interesting result, because it shows that there are some psychological/social factors that can cause people to refuse money/gifts.

Results like this seem to cause problems in traditional economic theory, because they suggest that people do not act rationally, which is kind of a cornerstone assumption. However, as I alluded to before, I still think that people were exhibiting a rational response. I want to look at 'The Ultimatum Game' now, and further my argument that results like this do not refute the assumption that people act rationally.

The Ultimatum Game is a very simple experiment, involving two players (though you could feasibly extend and modify it for more people). Player A is asked to propose a way to split a pile of money between the two players, and Player B then gets to accept or reject the offer.

If Player B accepts, then both get the money as suggested by Player A. But if Player B rejects the offer, neither player gets any money.

Now, in theory, if the game was played between two rational people, then Player A would offer as little money as possible to Player B. Player B would then accept, because no rational person would reject what is essentially free money.

Of course, that's not how the game is played out. Studies show (according to Wikipedia, and other sources I've seen) that Player B will generally only accept the offer if they're getting at least 20-30% of the sum. Another interesting observation is that as the sum of money goes up, the offers by Player A become more and more fair (that is, closer to a 50-50 split).

So the question that arises is, why do people act in this way? After all, it would make sense to accept a 15% share, because the alternative is getting nothing. And also, if we're talking about a $40,000 pot, then you'd expect Player B to be MORE likely to accept a low offer (15% of this would be a $6000 payout), so you'd then expect Player A to make a LESS fair offer.

Now, I don't have exact answers, because I've never conducted research on this topic. I have ideas though (I didn't come up with them, but I've seen them elsewhere and agree):

First, people reject highly uneven offers because they feel it's unfair, or that they're being taken advantage of. What it essentially comes down to is that these low offers don't pay enough for Player B to accept the inequity. Most people would accept a 49-51 split, because their payoff is much greater than the inequity. This is interesting too, because it implies that people can be paid to ignore inequity/injustice. And I definitely think this is true... everybody has a price.

But if this is the case, why would you offer a more even split when the stakes rise? After all, with higher stakes, you can hit the other person's 'buy off' price to accept inequity with a lower percentage offer (if that makes any sense). But in this case, you need to think from Player A's perspective. If we're talking about $40,000, then I (as Player A) would definitely want to make sure I get my cut. So I'd offer a much fairer split, to ensure that I get my money.

After all, I'd rather take $20,000 for sure, rather than risk them rejecting an offer that could give me $30,000. Player A is essentially buying insurance by making a more equal offer.

But now, another question arises: If these are rational decisions (and I'm arguing that they are), AND if the 'expected' results are ALSO rational (which I also believe they are), then don't we have some kind of conflict? And what does this mean for economic theory?

I say that we don't have any conflict here, and that this only serves to reinforce the economic theory of rational people making rational decisions. See, I was a little sloppy earlier in explaining the rational consumer aspect of economic theory. What it actual suggests is that all consumers act rationally to maximize their own UTILITY, not their monetary wealth. Utility is essentially happiness - I'll accept any offer that makes me happier (be it due to more money, or because I feel better about myself, or whatever). This is why people volunteer their time for no compensation - they're still getting some kind of benefit (psychological, most likely). They're increasing their utility.

So when we look back at the game, if Player B is going to feel bummed about the offer, they won't accept it, even if it means giving up money. And Player A will offer to take less money, if it means that they don't lose out.

See? Rational. Now, one last question - do you agree?