Akerlof and Dickens's paper on the relevance of cognitive dissonance theory to economic theory and modelling. This can be a great example of how psychological insights can be used in economics.

1. The Economic Consequences
of Cognitive Dissonance
George A. Akerlof and William T. Dickens
American Economic Review, 1982
Presented by Amir Mohammad Tahamtan
Graduate School of Management and Economics
Sharif University of Technology

2. What is cognitive dissonance?
• Preferences(hedonic utility) shape behavior; or behavior shapes
preferences?

3. a story from a book on Jewish folklore
3
Why would members of the gang harass the
tailor for free, but not for a penny?
Wait for the
answer!

4. Cognitive Dissonance
• An aversive psychological state (excessive mental stress and discomfort) aroused when there is a
discrepancy between actions and attitudes:
• Holding two or more contradictory cognitions (beliefs, ideas, values, emotions) simultaneously.
• Holding cognitions which do not match up with reality or experience. (I can’t believe that ….)
• Holding a belief and performing a contradictory action, reaction or behavior.
• What you are and what you should be, what you do and what you should do.
4

5. Associated Emotions
• Guilt
• Dread
• Anger
• Surprise
• Embarrassment
5

6. Examples
smoking
Purchasing decisions
6
Using plastic products once
and throwing them away

7. Theory of cognitive dissonance
7
Leon Festinger, 1957
How humans strive for internal consistency between
their expectations and their reality.

8. Basic Hypotheses
1. "The existence of dissonance will motivate the person to try to
reduce the dissonance and achieve consonance“
2. "When dissonance is present, in addition to trying to reduce it,
the person will actively avoid situations and information which
would likely increase the dissonance“.
8
a powerful motive to maintain cognitive consistency can give rise to
irrational and sometimes maladaptive behavior.
 "Humans are not a rational animal, but a rationalizing one"

9. 9
Induced-compliance paradigm

10. • When asked to rate the boring tasks at the conclusion of the study,
those in the $1 group rated them more positively than those in the
$20 and control groups.
 Festinger and Carlsmith argued that students who were paid only a
$1 to lie to another person had experienced cognitive dissonance.
• Because ….
10

11. Dissonant Cognitions
Cognition #1: The tasks were extremely boring.
Cognition #2: For only $1, I just told some one that the tasks were
interesting and enjoyable.
→ 1+2 = I lied for no good reason
→ I lied for a large sum of money
11
Students were forced to internalize the attitude they were
induced to express, because they had no other justification.
Students had an obvious external justification for their
behaviour, and thus experienced less dissonance.

12. what about the Jewish tailor?
• He changed the gangs motivation from anti-Semitism to monetary reward,
• He made it inconsistent or dissonance-arousing for the gang to please him without financial
compensation.
• Without a sufficiently large payment, the kids could no longer justify behaving at variance with
their attitudes, which were, of course, to upset the tailor, not to make him happy.
12
Why would members of the gang harass the tailor
for free, but not for a penny?

13. Dissonance Reduction processes
13
Attitude: "I am going on a diet and will avoid high fat
food“.
Behavior: Eating a doughnut or some other high fat food

14. 1- Change behavior/ cognition
• Adjust beliefs or values or even adjust their perception of reality
• Stop eating the doughnut
• Giving up smoking
14
VERY DIFFICULT

15. 2- Rationalization (make excuses)
• changing the conflicting cognition:
• “I'm allowed to cheat every once in a while”
• “research has not proved definitely that
smoking causes lung cancer”
• adding new cognitions:
• "I'll spend 30 extra minutes at the gym to
work it off“
15
Justify behavior/cognition by

16. 3-Denial
• Ignore/Deny any information that conflicts with existing beliefs
• I did not eat that donut. I always eat healthy.“
16

17. 4- Trivialization
• Any fool can despise what he can not get
• "live for today" than to "save for tomorrow."
17

18. Free choice paradigm
choice-induced preference change
Actions can alter an individual’s preferences
• After making a difficult choice between two equally preferred items, the act of rejecting
a favorite item induces cognitive dissonance, which in turn motivates individuals to
change their preferences to match their prior decision (i.e., reducing preference for
rejected items)
• People no longer find the alternatives similarly desirable.
• They increase their preference for the selected option, decrease their preference for the
rejected option or both.
18

19. Why is cognitive dissonance important?
• Life is filled with decisions, and decisions (as a general rule) arouse
dissonance.
• Because it plays a role in many value judgments, decisions and
evaluation.
• Becoming aware of how conflicting beliefs impact decision making
process is a great way to improve your ability to make faster and
more accurate choices.
19

20. How is it related to economics?
The theory of CD can be fairly represented in economists’ terms in
three propositions:
• Persons not only have preferences over states of the world; but also over
their beliefs about the state of the world
• Persons have some controls over their beliefs; not only are people able to
exercise some choice about belief given available information; they can also
manipulate their own beliefs by selecting sources of information likely to
confirm ‘desired beliefs’
• Beliefs once chosen persist over time

21. Some evidence on the second proposition
• Benzene workers denying that they were working with dangerous
chemical substances (Ben-Horin, 1979).
• All workers in a plant, some of whom were Ph.D.s, failed to wear
safety badges to collect information on radiation exposure ; they were
put in workers' desks and only brought out for the weekly checkup.
• Failure for persons with high risk of flood or earthquake damage to
purchase flood or earthquake insurance (Kunreuther et al. 1978).

22. Why workers underestimate the likelihood of
dangers?
• Workers believe so, because:
• There’re some psychological benefits
• There’re some costs (realizations of dangers)
• Workers choose to believe so and gain utility of their beliefs of the states of
the world.
• There’s an implicit assumption that workers can choose whatever to
believe given available information.
• The authors claim that: “ in most economic transactions, there’s no
need of rationalization and CD plays no role”.

23. Description of the model: assumptions
• We have two periods:
• In the first period:
• Workers have a choice between working in a hazardous job or working in a safe job
• The worker will choose the job with the highest combined pecuniary and nonpecuniary
benefits
• Workers in the hazardous industry have no choice but to face the possibility of an accident as
there is no safety equipment available
• If the cost imposed by future wrong decisions is not too great, workers in the hazardous
industry will, because of cognitive dissonance, come to believe that the job is really safe.
• In the second period:
• Cost-effective safety equipment becomes available
• Safety legislation is needed to restore Pareto optimality since the workers have an incorrect
assessment of the marginal rate of substitution between safety equipment and money
income.

24. Description of the model: assumptions
• Both labor markets and product markets are competitive
• Workers begin with rational expectations:
• These workers know upon taking a job in the hazardous industry that they will
experience cognitive dissonance and alter their estimated probabilities of
accident.
• The Labor Market in the Safe Industry:
• The safe industry is pictured as large relative to the hazardous industry
• A job in the safe industry pays a fixed wage, denoted ws
• This wage anchors the wage of workers in the hazardous industry in both
periods 1 and 2.

25. Description of the model: assumptions
• The Demand for the Product and the Supply of the Product in the
Hazardous Industry:
• The demand for the product of the hazardous industry in each period is given
by a downward-sloping demand function D = D( ph )
• The good is produced by labor alone
• One worker produces one unit of the good in each period
• The producers are competitive, so that the supply of the good is infinitely
elastic at the wage in each period

26. Description of the model: assumptions
• The Nonpecuniary Disadvantages of Work in the Hazardous Industry”
• Without safety equipment, all workers in the hazardous industry have a
probability q of accident in periods 1 and 2
• The cost of an accident to a worker is ca
• a worker in the hazardous industry can purchase a new safety device which
eliminates the possibility of an accident at a cost cs
• qca > cs

27. Description of the model: assumptions
• Each worker in the hazardous industry in each period has a psychic
cost of fear, equal to cff.
• As an expositional convenience the uncomfortable feeling of a worker
in a job believed to be unsafe is called "fear.“
• f = 𝑞∗
𝑞, where 𝑞∗
is the subjective assessment of the probability of an
accident and over 0≤ 𝑞∗ ≤ 𝑞.
• CD is modeled by letting each worker choose any value of in the 𝑞∗
range between 0 and 𝑞.

28. Description of the model: Equilibria
• The wage in hazardous industry in period 2 is: 𝑤ℎ2 = 𝑤𝑠 + 𝑐 𝑠 ∶ (1).
• A worker in the hazardous industry in period 2 chooses to buy safety
equipment if 𝑞∗ >
q𝑐 𝑠
𝑞𝑐 𝑎+𝑐 𝑓
: 2 .
• The worker buys safety equipment in period 2 if the perceived cost of
fear(
𝑞∗
𝑞
𝑐𝑓) and the perceived cost of accident(𝑞∗
𝑐 𝑎) exceeds the cost of the
safety equipment(𝑐 𝑠).

29. Description of the model: Equilibria
• A worker in the hazardous industry in period 1 chooses:
• 𝑞∗ = 0 if 𝑞𝑐 𝑎 − 𝑐 𝑠 <
𝑐 𝑠 𝑐 𝑓
𝑞𝑐 𝑎+𝑐 𝑓
: (3)
• 𝑞∗ =
𝑞𝑐 𝑠
𝑞𝑐 𝑎+𝑐 𝑓
𝑖𝑓 𝑞𝑐 𝑎 − 𝑐 𝑠 >
𝑐 𝑠 𝑐 𝑓
𝑞𝑐 𝑎+𝑐 𝑓
: (4)
• The worker choosing 𝑞∗
below the critical value in (2):
• He will make the wrong decision in period 2 regarding the purchase safety
equipment.
• He should choose 𝑞∗= 0 minimizing his level of fear.
• His level of fear is now 0, however, the cost of wrong decision is 𝑞𝑐 𝑎 − 𝑐 𝑠.
• This analysis is the same for any value of 𝑞∗ below
q𝑐 𝑠
𝑞𝑐 𝑎+𝑐 𝑓
.

30. Description of the model: Equilibria
• The worker choosing 𝑞∗ above the critical value in (2):
• The worker could maintain 𝑞∗ sufficiently high so that we will correctly
purchase safety equipment.
• putting 𝑞∗ at
𝑞𝑐 𝑠
𝑞𝑐 𝑎+𝑐 𝑓
minimizes the cost of fear.
• What level of 𝑞∗ should the worker choose?
• He should compare the cost of fear at 𝑞∗ =
𝑞𝑐 𝑠
𝑞𝑐 𝑎+𝑐 𝑓
and the cost of not
purchasing safety equipment at 𝑞∗ = 0.
• the cost of fear(@𝑞∗ =
𝑞𝑐 𝑠
𝑞𝑐 𝑎+𝑐 𝑓
) =
𝑞∗
𝑞
𝑐𝑓 =
𝑐 𝑠 𝑐 𝑓
𝑞𝑐 𝑎+𝑐 𝑓
• Thus, (3) and (4) hold.

31. Description of the model: Equilibria
• The wage of workers in the hazardous industry in period 1 is :
𝑤ℎ1 = 𝑤𝑠 + 𝑞𝑐 𝑎 + min(𝑞𝑐 𝑎 − 𝑐 𝑠,
𝑐 𝑠 𝑐 𝑓
𝑞𝑐 𝑎+𝑐 𝑓
)
• If 𝑞∗ = 0: the worker must be compensated for the expected costs due to
accidents and wrong decision in period 2.
• If 𝑞∗
=
𝑞𝑐 𝑠
𝑞𝑐 𝑎+𝑐 𝑓
: he buys safety equipment in period 2

32. The Equilibrium Discussed: Introduction of
Safety Legislation
• What are the distributional implications of this equilibrium?
• All workers no matter what their employment history will have the same
expected income: 2𝑤𝑠.
• If the relative costs of safety, fear, and accidents in the hazardous industry are
such that all workers will choose to buy the safety equipment, all workers will
have an expected income of 𝑤𝑠 in each period.
• If otherwise: the workers will perceive themselves as earning 𝑤𝑠 + 𝑐 𝑠in the
second period when in fact their expected income is 𝑤𝑠 + 𝑐 𝑠 − 𝑞𝑐 𝑎 < 𝑤𝑠.
• However, their first-period wages compensated for this loss.
• Thus, the introduction of CD does not change the distribution between
workers.

33. The Equilibrium Discussed: Introduction of
Safety Legislation
• What about the distribution between workers and consumers?
• We compare this equilibrium with the one in which safety legislation is
required.
• 𝑤ℎ1
′
= 𝑤𝑠 + 𝑞𝑐 𝑎, 𝑤ℎ2 = 𝑤ℎ2
′
= 𝑤𝑠 + 𝑐 𝑠
• Thus, the second-period wage is the same, however, the first-period wage is lower with
this legislation.
• With this legislation:
• Workers have the same expected payoff over two periods. But, consumers are better off
since they pay lower price.
• Thus safety legislation causes a Pareto improvement.

34. Potential Application
• Sources of innovation
• Advertising
• Social security
• Economic Theory of Crime