Chapter 10. Levels of Reasoning in Keynesian Beauty Contests: A Generative Framework

We introduce a generalization of the Beauty Contest (BC) game as a framework that incorporates different models from micro- and macroeconomics by formulating their reduced forms as special cases of the BC. Examples include public good games, ultimatum games, Bertrand, Cournot, some auctions, asset markets, New-Keynesian, and general equilibrium models with sentiments/animal spirits. This becomes feasible by considering BC specifications with a best response or optimal action as a function of other players' aggregated actions. For characterizing an integrated account of heterogeneity in economics, as observed in BC experiments, we employ a non-equilibrium model, the so-called “level-k” model, based on one (or more) reference point(s) and (limited) iterated best responses. Level-k and related models thus bridge the gap between non-strategic (e.g. irrational, intuitive or random) behavior and equilibrium choices. We also give a brief overview of interactive decision-making within experimental economics, and discuss elicitation methods, cognitive and population measures, to better understand heterogeneity in human reasoning in general, and in economic experiments in particular.