Transcript Chapter 2

Chapter 2
People, Preferences and Society
Human Behaviour
• Human Behavior in economics is modeled as
being purposive:
• Individuals make choices to take various
actions (within their constraints); they seek
to bring about the outcomes they desire
(according to their preferences); and they
base their choices on their understandings
(beliefs) about how certain actions may bring
about the desired outcomes.
Homo Economicus
• Recall Definition of ‘Homo Economicus’;
most economists short hand description of
human behavior
• Self-interested, rational, maximizer of
utility.
Trying to Assess Human interaction
when Self Interest Prevails
• Entire Sub Branch of Economics: Game
Theory
• A Beautiful Mind?
• Strategic Interactions giving rise to social
outcomes
• Use Self-interest to model institutional
regularities
Inspiration: John von Neumann
Founded Game Theory
with Oskar Morgenstern
(1928-44)
John von Neumann (1903-1957)
created two intellectual currents
in the 1930s and 40s
GAME THEORY PIONEERS
John Nash Jr
1928 Nobel 1994
Robert Aumann
1930 Nobel 2005
John Harsanyi
1920 - 2000
Nobel 1994
Thomas Schelling
1921 Nobel 2005
Richard Selten
1930 Nobel 1994
Lloyd Shapley
1923 Nobel ????
What is a Game?
• There are many types of games, board games, card games,
video games, field games (e.g. football), etc.
• We focus on games where:
– There are 2 or more players.
– There is some choice of action where strategy matters.
– The game has one or more outcomes, e.g. someone
wins, someone loses.
– The outcome depends on the strategies chosen by all
players; there is strategic interaction.
• What does this rule out?
– Games of pure chance, e.g. lotteries, slot machines.
(Strategies don't matter).
– Games without strategic interaction between players,
e.g. Solitaire
Why Do Economists Study
Games?
• Games are a convenient way in which to model the
strategic interactions among economic agents.
• Many economic issues involve strategic interaction.
– Behavior in imperfectly competitive markets, e.g.
Coca-Cola versus Pepsi.
– Behavior in auctions, e.g. Investment banks
bidding on U.S. Treasury bills.
– Behavior in economic negotiations, e.g. trade.
• Game theory is not limited to Economics.
Five Elements of a Game:
1. The players
– how many players are there?
– does nature/chance play a role?
2. A complete description of the strategies of
each player
3. A description of the consequences (payoffs)
for each player for every possible profile of
strategy choices of all players.
4. Sequence in which game is played
5. Can represent in a ‘payoff matrix’
The Prisoners' Dilemma
Game
• Two players, prisoners 1, 2.
• Each has two strategies.
– Prisoner 1: Don't Confess, Confess
– Prisoner 2: Don't Confess, Confess
– Payoff consequences quantified in prison
years.
• fewer years=greater satisfaction.
– If P1 confesses and the other does not, P1
gets 10 years, P2 gets 1 year,and vice versa.
If P1 does no confess and P2 does not
confess, they both get 2 years each. If they
both confess, they get 5 years each.
Dominant Strategy Equilibrium
A dominant strategy is a best response whatever the
strategies of the other players
No Confess
NC
Confess
C
No Confess
NC
- 2, - 2
- 10, - 1
Confess
C
-1, - 10
- 5, - 5
(C,C) is a dominant strategy equilibrium
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Nash Equilibrium
A Nash equilibrium occurs when every player is
undertaking the best strategy given the strategies of
the other players
No Confess
NC
Confess
C
No Confess
NC
- 2, - 2
- 10, - 1
Confess
C
-1, - 10
- 5, - 5
(C,C) is a Nash equilibrium
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Dilbert!
http://www.gametheory.net/media/Dilbert.wmv
Applications: Many!
• Two countries share a water body. Two
strategies: pollute or don’t pollute. Not polluting
is costlier than polluting. What will happen?
• Two firms can collude or compete. If they
collude, they set higher prices and both make a
profit of 10. If one competes with a slightly lower
price, it makes 15 and the other 5. If they both
compete, they both make 5. What will happen?
Concept of Nash Equilibrium
• Nash Equilibrium: Every player is
undertaking his or her best strategy given
the strategies of the other players
• Some games have more than one Nash
Equilibrium
• Not all games need have Nash Equilibria
The coordination game
• I am supposed to meet a friend for Coffee.
I prefer to meet at UMB. My friend prefers
to meet me at Cambridge. We both prefer
to meet rather than not to meet.
• What is the game structure for this game?
Example : Coordination Game
F
UMB
Cambridge
A
UMB
Cambridge
50,10
0,0
0,0
10,50
Models the strategic conflict when two players
have to choose their priorities
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Equilibria in Coordination Game
Frd
UMB
Cambridge
Arjun
UMB
50,10
Cambridge
0,0
0,0
10,50
Two Nash Equilibria
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Matching Pennies
• Player A and Player B. Each player has a
penny and must secretly turn the penny to
heads or tails. The players then reveal
their choices simultaneously. If the
pennies match (both heads or both tails),
Player A receives one dollar from Player B
(+1 for A, -1 for B). If the pennies do not
match (one heads and one tails), Player B
receives one dollar from Player A (-1 for A,
+1 for B).
Example : Matching Pennies
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1, -1
-1,1
-1,1
1,-1
Equilibria in Matching Pennies
(1,-1)
(-1,1)
(-1,1)
(1,-1)
No pure strategy NE here
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Try this one out yourself
• http://www.youtube.com/watch?v=LGUYsu
YudVA
• If you jump out first- you lose face, the
other guy wins. If you both jump out, no
one loses. If you both don’t jump out-you
die.
Example : Chicken Game
Swerve
Straight
Swerve
0, 0
-1,1
1,-1
-1000,-1000
Straight
Is there a Nash Equilibrium?
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What can self interest not explain?
• Interesting set of experiments in the 1980s
and 1990s using game theory and other
sorts of tools.
• Ernst Fehr and Simon Gachter
“Ultimatum Game”
Version of Take it or Leave it Bargaining
• Player 1 moves first and proposes a division
of $1.00. Suppose there are just 3 possible
divisions, limited to $0.25 increments.
• Player 1 can propose x=$0.25, x=$0.50, or
x=$0.75 for himself, with the remainder, 1-x
going to Player 2.
• Player 2 can then accept or reject Player 1’s
proposal.
• If Player 2 accepts, the proposal is
implemented.
• If Player 2 rejects, both players get $0 each.
The $1.00 gains from trade vanish.
What happened?
• Check out chapter 2
• Paves the way for reconsideration of homo
economicus
Findings from the Ultimatum game
• Most common offer: 50,50
• Offers lower than that were often rejected
• Different findings from arbitrary differences
such as in the dictator game.
Some findings
• proposers can be said to have altruistic
preferences—preferences that lead them
to act to benefit others at some cost to
themselves (even with no expectation that
reciprocal benefits will be received later).
• Notion that is increasingly approved of:
homo reciprocans (reciprocal behavior)
• Otherwise- ‘rational fools’
Other findings
• Anthropologists have studied this game
with many different regions.
• Offer goes up with:
• 1. Cooperation
• 2. Market Integration
Human Behavior and Economics
• Self interest assumption gives us a lot of predictable
outcomes which gives insight into social regularities
• 1) Difficulty of maintaining cooperation and the
persistence of socially suboptimal outcomes.
• 2) Free Riding and the difficulty of maintaining public
goods
• 3) The need for regulation to help with certain
coordination activities
• But Self-Interest is a limited notion to understand the
range of human behavior: now, more and more, people
are trying to understand the behavior of homo
reciprocans