Microeconomic theory typically concerns exchange between individuals or firms in a market setting. To make predictions precise, individuals are usually assumed to use the laws of probability in structuring and revising beliefs about uncertainties. Recent evidence, mostly gathered by psychologists, suggests probability theories might be inadequate descriptive models of individual choice. (See the books edited by Daniel Kahneman et al., 1982a, and by Hal Arkes and Kenneth Hammond, 1986.)

Psychological studies show that most people are overconfident about their own relative abilities, and unreasonably optimistic about their futures (e.g. Shelly E. Taylor and J.D. Brown, 1988; Neil D. Weinstein, 1980). When assessing their position in a distribution of peers on almost any positive trait-- like driving ability (Ola Svenson, 1981 ), income prospects, or longevity-- a vast majority of people say they are above the average, although of course, only half can be (if the trait is symmetrically distributed). This paper explores whether optimistic biases could plausibly and predictably influence economic behavior in one particular setting-- entry into competitive games or markets. Many empirical studies show that most new businesses fail within a few years. For example, using plant level data from the U.S. Census of Manufacturers spanning 1963-1982, Timothy Dunne et al. (1988) estimated that 61.5 percent of all entrants exited within five years and 79.6 percent exited within 10 years. Most of these exits are failures (see also Dunne et al., 1989a, 1989b; D. Shapiro and R.S. Khemani, 1987).

Noncooperative game theory combines strategic thinking, best-response, and mutual consistency of beliefs and choices (equilibrium). Hundreds of experiments show that in actual behavior these three forces are limited, even when subjects are highly motivated and analytically skilled (Camerer, 2003). The challenge is to create models that are as general, precise, and parsimonious as equilibrium, but which also use cognitive details to explain experimental evidence more accurately and to predict new regularities. This paper describes three exemplar models of behavior in one-shot games (thinking), learning over time, and how repeated “partner” matching affects behavior (teaching) (see Camerer et al., 2002b).

This paper considers the measurement of consumer loss aversion in product markets. We introduce a test based on a “substitution effect,” focusing on how the end of a sale affects sales not of the good itself, but a substitute good. Such an effect cannot be easily confounded with consumer stockpiling. Using a unique dataset from an online hardware retailer, we find evidence consistent with consumer loss aversion. Moreover, we find that less experienced consumers suffer a more prominent loss aversion bias compared to more experienced consumers.

We conducted experiments in Vietnamese villages to determine the predictors of risk and time preferences. In villages with higher mean income, people are less loss-averse and more patient. Household income is correlated with patience but not with risk. We expand measurements of risk and time preferences beyond expected utility and exponential discounting, replacing those models with prospect theory and a three-parameter hyperbolic discounting model. Comparable risk parameter estimates have been found for Chinese farmers, using our method. (C83, D12, O12, P38)

We test for consumption smoothing using bankruptcy data on players in the National Football League (NFL), who typically earn several million dollars during an income spike that lasts a few years. The life-cycle hypothesis predicts that players should save substantially while playing and then have little risk of bankruptcy post-NFL. However, players in our sample begin to file for bankruptcy soon after they stop playing and continue filing at a high rate through at least the first 12 years of retirement. Players' total earnings and career lengths have surprisingly little effect on the risk of bankruptcy.

We report experiments on sender-receiver games with an incentive for senders to exaggerate. Subjects “overcommunicate”—messages are more informative of the true state than they should be, in equilibrium. Eyetracking shows that senders look at payoffs in a way that is consistent with a level-k model. A combination of sender messages and lookup patterns predicts the true state about twice as often as predicted by equilibrium. Using these measures to infer the state would enable receiver subjects to hypothetically earn 16–21 percent more than they actually do, an economic value of 60 percent of the maximum increment.

We examine high stakes three-person bargaining in a game show where contestants bargain over a large money amount that is split into three unequal shares. We find that individual behavior and outcomes are strongly influenced by equity concerns: those who contributed more to the jackpot claim larger shares, are less likely to make concessions, and take home larger amounts. Contestants who announce that they will not back down do well relative to others, but they do not secure larger absolute amounts and they harm others. There is no evidence of a first-mover advantage and little evidence that demographic characteristics matter.

We study decisions that involve choosing between different numbers of options under time pressure using eye-tracking to monitor the search process of the subjects. We find that subjects are quite adept at optimizing within the set of items that they see, that the initial search process is random in value, that subjects use a stopping rule to terminate the search process that combines features of optimal search and satisficing, and that subjects search more often in certain focal regions of the display, which leads to choice biases.

This paper describes a series of laboratory experiments studying whether the form in which items are displayed at the time of decision affects the dollar value that subjects place on them. Using a Becker-DeGroot auction under three different conditions—(i) text displays, (ii) image displays, and (iii) displays of the actual items—we find that subjects' willingness-to-pay is 40–61 percent larger in the real than in the image and text displays. Furthermore, follow-up experiments suggest the presence of the real item triggers preprogrammed consummatory Pavlovian processes that promote behaviors that lead to contact with appetitive items whenever they are available.