Essay About Particular People And Economic Exchanges

Can Contract Theory Explain Social Preferences?
Join now to read essay Can Contract Theory Explain Social Preferences?
For several decades, a growing body of research has shown that humans do not always
choose to maximize material payoffs. Economists following the lead of psychologists Daniel
Kahneman and Amos Tversky (1979) and Matthew Rabin (1993) have built on such research
to suppose that individuals are attentive to fair distribution rewards between themselves as
well as personal payoffs. (Ernst Fehr and Klaus Schmidt (1999)) An alternative approach,
suggested by Elizabeth Hoffman, Kevin McCabe and Vernon Smith (1996) argue that laboratory
subjects that perceive a potential for future interaction as approximated by social
distance act on a preference for reciprocity.
Both approaches capitalize on the power of psychology to enhance understanding of
economic exchanges between particular people in specific laboratory conditions. Yet, psychology
is not only concerned with the problem of explaining behavior, but it is also in the
business of modifying behavior. On of the shelves of the psychology section of any bookstore
one will find numerous works devoted to helping individuals modify their behavior so that
they drink and smoke less, and learn to have more rewarding social interactions at work and
in private life.
Economists suppose that individuals maximize rewards not because they believe that
people do so in every case, but because the maximizing supposition provides a useful unified
model of behavior in designing better economic institutions. The model not only rationalizes
the profit motive, but explains how even successful institutions may be destroyed by the
common human desire to maximize possessions—if that leads to malfeasance, theft, or general
corruption.
In this note I suggest that economics may also learn more frompsychology about positive
behaviors — such as the complex dynamics of honesty, fairness, and trust. Rather than insist
that people are endowed with a stable set of unchanging preferences, we may ask instead
how small modifications in preferences can lead to significant improvements in economic
performance.
Specifically, I suggest that contract theory can be a starting point for a larger enquiry
into exactly how preferences might be modified to enhance market performance. I consider
two substantive themes. First I show how contract theory may help to anchor a theory of
fairness. Second, I show that a small taste for trustworthiness can lead to a large increase
in cooperation in a relational contract.
Fairness is a crucial theme because notions about it are decisive in determining whether