Fairness and Reciprocity in economics

In behavioural economics, studies have suggested individuals value the concept of reciprocity. If people are kind to us, we have a greater tendency to respond in kind – behaving more altruistically than self-interest theory suggests.

Reciprocity can also work in a negative sense, with agents willing to ‘punish’ those who abuse the ‘rules of the game.’ We can be willing to punish others, even if it harms our own individual utility.

The importance of fairness and reciprocity is that it suggests the importance of social rules for influencing decisions and economic behaviour. It challenges assumptions of ‘rational economic man’ and standard self-interest theories of classical economics.

Another issue with fairness and reciprocity is that not all individuals behave in the same way. Some pursue quite selfish aims – even if they could help the welfare of others at small cost. But, others are quite concerned to prioritise the well-being of others and fairness. It makes modelling economic behaviour harder because there is no uniformity in approaches.

How fairness and reciprocity impact economics

Wage premium above market clearing rates. Classical economic theory suggests firms will pay according to MRP. However, in the real world, labour markets involve significant uncertainties. When you employ a worker, you don’t know how hard they will work; it is not possible to accurately measure productivity. Labour markets require significant trust and good will to work effectively. Therefore, a firm may find it advisable to pay a wage greater than market clearing wage (efficiency wage theories) – as this encourages the worker to feel they are fairly treated. Concepts of fairness mean that workers may judge their treatment compared to how they are treated compared to others in the workforce. Perceived fairness of work salaries can influence worker motivation, loyalty and company theft
Fairness of tax system can influence rates of tax evasion.
Are welfare payments deserving? Welfare payments which are deemed to reward laziness can soon lose popular support.
Charitable gift-giving. Charities who give something in return for a donation (e.g. badge) receive higher levels of donations.

Perfect competition and imperfect competition

Ernest Fehr argues standard economic theories of self-interest are good guides to predicting behaviour in perfectly competitive markets with many different agents, however, in imperfect competition with a small number of actors, the model is less applicable and issues of fairness and reciprocity become more important – especially in areas of repeat transactions ‘games’

Games on reciprocity

Ultimatum Game

Person A proposes how to divide a sum of money. Person B (responder) can accept or reject the proposal.
If the proposal is rejected, neither get any money.
From the perspective of rational self-interest, person B (responder) should accept any positive sum of money because anything is better than nothing.
However, numerous studies show if the proposer (person A) offers less than 20% of the total, the responder (B) has a probability of 0.4 to 0.6 of rejecting the offer. In other words, person B rejects the prospect of receiving money because they want to punish person A who offered an unfair division of the total money.
(Güth, Schmittberger and Schwarze, 1982; Camerer and Thaler, 1995; Roth, 1995)

Public Good Game

In the public good game, participants simultaneously decide who much of their endowment to give to a public good.
The total surplus of the group is maximised if all players contribute all their endowment. However, for an individual, the dominant strategy to maximise their individual utility is to give nothing – and free ride on the contributions of others.
Examining the final period of the game – 75% of all subjects contribute nothing to the public good, and the rest contribute very little. Suggesting there is logic in the self-interest theory.

Public good game with punishment

However, if public good game is introduced with the possibility of punishment, then the game changes.
In stage two, individuals are told about the contributions of other people and can implement ‘punishment’ points to other players. Punishment points cost the person who does the punishing and also those who get punished.
From self-interest theory, we would not expect anyone to impose ‘punishment points’ because they become worse off as a result. However, in practice, many do decide to impose ‘punishment points’ on those they consider trying to free ride on contributions.
Furthermore with ‘punishment strategies’ allowed it causes much higher cooperation rates – with around 75% of subjects endowment volunteered towards the public good – far higher than in public goods games without punishment rounds.

(see Ledyard, 1995, Dawes and Thaler 1988 for surveys).

The implication

Individuals choose to engage in non-utility maximising strategies of imposing punishment despite cost to self.
Allowing decisions to be seen and punished – changes behaviour and creates a situation to enable contributions to public goods and overcome free-rider behaviour.
It shows that individuals value fairness and are willing to try and punish and reward good behaviour.

Understanding fairness and reciprocity

Some argue that we have social preferences. Our utility function does not just depend on our own material payoff, but also on the material resources allocated to others.
Our utility can also depend on how we are perceived by others. Altruism, fairness and altruistic gift-giving create a ‘warm glow’ feeling.
Rabin (1993) argued behaviour is often a reaction to intentions of other people. If someone is kind to us, we have a desire to return favour. If someone is mean, we want to retaliate – even if it is personally costly.
Economic anthropologists argue societies often are based on concepts of ‘gift-giving’ and mutually looking after others in society. Marcel Mauss argues that western economies where free-market economies, relying on self-interest theory are as much an exception as the rule.

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