CEU, Economics Department, Spring 2006

Lecturer:: Prof. Lorenz Goette
Course: 2 credits

This course offers a theoretical and empirical introduction to the new field of Economics and

Psychology, or "Behavioral Economics". This new field in Economics attempts to integrate systematic,
important departures from the standard assumptions in economics into formal models.
Course Description:
This course has three parts: Present-biased preferences, reference-dependent preferences, and dual-self models.
The structure behind each topic is the same: We first discuss evidence, typically, form laboratory experiments that
documents an important departure from the standard model in economics. We then discuss ways to integrate the
psychological motives into a formal model. Finally, we examine the model's predictions in new settings applications.
About half the time of the course will treat formal models, with the other half covering empirical papers. The course
analytically demanding and a graduate course in microeconomic theory and econometrics is a prerequisite.
In part one we consider one of the most important departures from the standard economic model: Individuals
discount more strongly between today and tomorrow than between a year from now and a year and a day from now.
This present-bias in preferences produces time-inconsistent behavior and has important implications in several areas:
It may lead to too high credit card debt, poverty after retirement, too little investment into health, and unwanted addictions.
In this course, we will introduce a simple way to characterize these phenomena analytically and discuss the empirical
evidence for present-biased preferences.
In part two of this course, we will discuss a second important departure from the standard economic model: Individuals
care about changes in wealth much more than the standard model in economics can account for: We will characterize
how the standard model fails to account for the intuition that losses loom larger than gains and present an alternative
model that incorporates this motive. We then review the evidence on reference-dependent preferences in several
settings, including consumer behavior, labor supply, and investment.
Part three of the course outlines a new class of models that are strongly inspired by new insights from neuroscience:
The so-called dual-self models model behavior as a struggle between "cognitive" and "impulsive" areas in the brain.
We will discuss some of the motivating evidence and a simple model that may account for, both, present-biased and
reference-dependent preferences. We also discuss some of the limitations of this emerging literature.
Course credit:
This is a two-credit course. Students will be required to turn in three problems sets. The problem sets account for 40
percent of the grade. The final exam counts for the remaining 60 percent.
The course is taught in May, according to the CEU teaching schedule. Office hours are on Tuesday and Thursday, 4pm
to 6pm. It is important for the students to keep up with the reading in order to be able to follow the lecture and do the
problem sets. I strongly encourage everyone to use the office hours if there are any questions or any topic you would
like to discuss and we did not have time for it in class.

Lecture 1
Evidence of present-biased preferences
Burks, Carpenter, Goette, and Rustichini (2006)
Lecture 2
(b,d) – prefences
O'Donoghue und Rabin (1999a)
Lecture 3
Credit Cards and Self-Control
Laibson et al. (2003)
Lecture 4
Field evidence of present-biased preferences 
Shapiro (2003)Ariely und Wertenbroch (2003)
Lecture 5
Field evidence of present-biased preferences 
Della Vigna und Malmendier (2004)Mullainathan and Gruber (2005)
Lecture 6
Evidence of Reference-Dependent Preferences
Problem Set 1 due.
Rabin and Thaler (2000), Kahneman, Knetsch and Thaler (1990)
Gächter, Herrmann and Johnson (2005)
Lecture 7
Modelling Referefence-Dependent Prefereces
The Endowment Effect
Köszegi and Rabin (2004*)
Lecture 8
Modelling Reference-Dependent Preferences
Income Targeting
Köszegi and Rabin (2004*)
Lecture 9
Field Evidence of Reference Dependence
Problem Set 2 due
Genesove and Mayer (2001)
Gächter, Herrmann and Johnson (2005)
Lecture 10
Field Evidence of Reference Dependence
Goette, Huffman, and Fehr (2004*)
Fehr and Goette (2004)
Farber (2005)
Lecture 11
Dual-Self Models: Motivating Evidence and Theory
O'Donoghue and Loewenstein (2005)
Lecutre 12
Dual-Self Models: Applications
O'Donoghue and Loewenstein (2005)
Lecture 13
Review session
Problem Set 3 due



Ariely, Dan and Klaus Wertenbroch (2002), "Procrastination, deadlines, and performance: Self-control by
precommitment", Psychological Science 13 (3), 219-224.

Della Vigna, Stefano and Ulrike Malmendier, (2003), "Overestimating Self-Control: Evidence from the Health
Club Industry", mimeo, University of California, Berkeley.

Farber, Henry (2005), "Is tomorrow another day? The labor supply of New York Cad drivers", Journal of Political
Economy 113, pp. 46 - 82.

Fehr, Ernst and Lorenz Goette (2004), "Do Workers work more when Wages are High? Evidence from a randomized
field experiment", mimeo, University of Zurich.

Gächter, Simon, Eric Johnson, and Andreas Herrmann (2005), "Exploring the Nature of Loss Aversion",
IZA Working Paper # 2015.

Genesove, David and Christopher Mayer (2001), "Loss Aversion and Seller Behavior: Evidence from the Housing
Market", Quarterly Journal of Economics 116(4), 1233 – 1261.

Goette, Lorenz, David Huffman und Ernst Fehr (2004), "Loss Aversion and Labor Supply", Journal of the European
Economic Association 2(2), 215 – 228.

Kahneman, Daniel, Jack Knetsch and Richard Thaler (1990), "Experimental Tests of the Endowment Effect and the
Coase Theorem", Journal of Political Economy 98(6), pp. 1325 – 1348.

Köszegi, Botond und Matthew Rabin (2004), "Modelling Reference-Dependent Preferences", mimeo, University
of California, Berkeley.

David Laibson, Andrea Repetto and Jeremy Tobacman (2003), “A Debt Puzzle” in eds. Philippe Aghion, Roman
Frydman, Joseph Stiglitz, Michael Woodford, Knowledge, Information, and Expectations in Modern Economics: In Honor
of Edmund S. Phelps, Princeton: Princeton University Press, pp. 228-266.

Mullainathan, Sendhil and Jonathan Gruber (2005), “Do Cigarette Taxes Make Smokers Happier?” Advances in
Economic Analysis and Policy, forthcoming.

O'Donoghue, Ted and Matthew Rabin (1999), "Doing It Now or Later", American Economic Review 89 (1), 103-24.

O'Donoghue, Ted und George Loewenstein (2004), "Animal Spirits: Affective and Deliberative Processes in Economic
Behavior", mimeo, Cornell University.

Shapiro, Jesse (2003), "Is there a daily discount rate? Evidence from the food stamp nutrition cycle", Journal of
Public Economics, forthcoming.

Rabin, Matthew and Richard Thaler (2001), "Anomalies: Risk Aversion" ,  Journal of Economic Perspectives 15(1),
Winter 2001, pp. 219-232.