Unit 4 - Strategic interactions and social dilemmas

4.1 - Climate negotiations: Conflicts and common interests

  • The Stern Review examined both scientific evidence and economic implications of climate change

    • The benefits of early actions would outweigh the cost of neglecting the issue

    • Early actions: significant cut in greenhouse gas emissions, reducing consumption of energy intensive goods, etc.

    • Changes could not happen under ‘business as usual’ - everyone were free to pursue their own interest without taking its effects on others into account

  • Governments disagree on policies and costs - different interests

  • The problem of the climate change is an example of the social dilemma

    • Social dilemma: A situation in which actions taken independently by individuals in pursuit of their own private objectives result in an outcome that is inferior to some other feasible outcome that could have occurred if people had acted together, rather than as individuals.

  • The Tragedy of the Commons

    • ‘The Tragedy of the Commons’ - Garret Hardin, 1968

    • Resources are not owned by anyone and can be easily overexploited, unless taking actions against it

    • Free-riders: Someone who benefits from the contributions of others to some cooperative project without contributing themselves is said to be free riding, or to be a free rider.

  • Resolving social dilemmas

    • Altruistic motivations can help to address social dilemmas

    • Forming institutions, laws

4.2 - Social interactions: Game theory

  • Social and strategic interactions

    • Social interactions: Situations in which the actions taken by each person affect other people’s outcomes as well as their own

      • Strategic interaction: A social interaction in which the participants are aware of the ways in which their actions affect others (and the ways in which the actions of others affect them).

      • Strategy: An action (or action plan) that a person may choose, while being aware that the outcomes for themselves and others depend on their own strategy and the strategies chosen by others.

      • Game: A model of strategic interaction that describes the players, the feasible strategies, the order of play, the information that the players have, and their pay-offs

      • Game theory: A branch of mathematics that studies strategic interactions, meaning situations in which each actor knows that the benefits they receive depend on the actions taken by all

      • Simultaneous game: A game in which the players choose their strategies simultaneously

      • Pay-off: The pay-off for an individual player in a game is the benefit that the player receives as a result of the joint actions of all the players

4.3 - Best responses in the rice–cassava game: Nash equilibrium

  • Best response: In game theory, a player’s best response is the strategy that will bring about the player’s most-preferred outcome, given the strategies adopted by the other players.

  • Nash equilibrium: A Nash equilibrium is an economic outcome where none of the individuals involved could bring about an outcome they prefer by unilaterally changing their own action. More formally, in game theory it is defined as a set of strategies, one for each player in the game, such that each player’s strategy is a best response to the strategies chosen by everyone else.

    • Invisible hand game: A game in which there is a single Nash equilibrium that is Pareto efficient may be called an invisible hand game

4.4 - Dominant strategy equilibrium and the prisoners’ dilemma

  • Dominant strategy equilibrium: A dominant strategy equilibrium is a Nash equilibrium in which the strategies of all players are dominant strategies

    • Beneficial for all of the players

  • The pest control game

    • A particular example of the prisoners’ dilemma

  • External effect: An external effect occurs when a person’s action confers a benefit or imposes a cost on others and this cost or benefit is not taken into account by the individual taking the action. External effects are also called externalities.

4.5 - Evaluating outcomes: The Pareto criterion

  • Allocation: In an economic interaction, an allocation is a particular distribution of goods or other things of value to all participants

  • Pareto criterion: The Pareto criterion is a way of comparing two allocations, A and B. It states that A is an improvement on B if at least one person would be strictly better off with A than B (in other words, would strictly prefer A to B) and nobody would be worse off. We say that A Pareto dominates B.

    • The Pareto criterion is cautious

    • Pareto efficient: An allocation is Pareto efficient if there is no feasible alternative allocation in which at least one person would be better off, and nobody worse off

      • There is often more than one Pareto efficient allocation

      • The Pareto criterion does not tell us which Pareto efficient is the best

      • Even by the Pareto criterion, a Pareto-efficient allocation is not always better than a Pareto-inefficient one

4.6 - Public good games and cooperation

  • Public good game: A public good game is a game in which individual players can take an action that would be costly to themselves, but would produce benefits for all players (including themselves)

    • Each player can free-ride on the contributions of others

  • Is this a good model?

    • People do cooperate, but the degree of cooperation varies

4.7 - Social preferences: Altruism

  • Social preferences: An individual is said to have social preferences if their individual utility depends on what happens to other people, as well as on their own pay-offs

  • How altruism can change preferences in the prisoners dilemma

    • If people care about one another, social dilemmas are easier to resolve

4.8 - Repeated interaction: Social norms, reciprocity, and peer punishment in public good games

  • A public good experiment

    • Usually people would be better off if they not contribute

  • The role of social norms

    • People make decisions according to their own individual preferences, but their preferences can be influenced by social norms

    • Social norm: An understanding that is shared among most members of a community about how people should behave towards each other in particular circumstances

      • In the situations modelled by public good games, many people are happy to contribute when they observe others contributing

      • Reciprocity: A preference to be kind to or to help others who are kind and helpful, and to withhold help and kindness from people who are not helpful or kind.

      • If people care strongly about social norms, they may wish to punish those who violate them, even if the cost to themselves is high

4.9 - Using experiments to study economic behaviour

  • The nineteenth century scientist (and monk) Gregor Mendel used controlled experiments to discover the laws of genetic inheritance

  • The way people behave in experiments can predict how they react in real-life situations

  • Field experiment

    • Economists also conduct experiments ‘in the field’: deliberately changing the economic conditions under which people make real decisions, and observing how their behaviour changes

4.10 - Cooperation, negotiation, and conflicts of interest

  • Cooperation: Participating in a common project that is intended to produce mutual benefits

  • Reasons for cooperation:

    • Having social preferences

    • Behaviour driven by social norms

    • Repeatedly interaction

  • People commonly resort to negotiation to solve their economic and social problems

    • Not always successful - benefiting each player more than others

  • Sharing mutual gains: the role of social norms and social preferences

    • Conflict of interest: The situation that arises in an economic interaction if in order for one party to gain more, another party must do less well

4.11 - The ultimatum game: Dividing a pie (or leaving it on the table)

  • The ultimatum game

    • Ultimatum game: A game in which the first player proposes a division of a ‘pie’ with the second player, who may either accept, in which case they each get the division proposed by the first person, or reject the offer, in which case both players receive nothing.

      • Sequential game: A game in which players do not all choose their strategies at the same time, and players who choose later can see the strategies already chosen by the other players

  • Social preferences in the ultimatum game

    • In a community where many people cared about fairness, the Proposer might prefer to offer $50, otherwise he might offer $1 which can be accepted, if the responder accepts any positive offer

    • Minimum acceptable offer: In the ultimatum game, the smallest offer by the Proposer that will not be rejected by the Responder. More generally in bargaining situations, it is the least favourable offer that would be accepted

4.12 - Fair farmers, self-interested students? Experimental results of the ultimatum game

  • When pay-offs are uncertain, we can compare them by calculating the expected pay-off of each one

    • Expected pay-off = pay-off if accepted * probability of acceptance

  • The effect of competition

    • The outcome of a negotiation may be different if it is affected by competition

    • Consequently, even people with preferences for fairness will accept low offers to avoid the worst of both worlds

      • The Proposer knows this, so they will make low offers

4.13 - Coordination games and conflicts of interest

  • In case of more than one Nash equilibrium

    • Coordination game: A game in which there are two Nash equilibria, one of which may be Pareto superior to the other

    • The players can get ‘stuck’ in an equilibrium in which all players are worse off than they would be at the other equilibrium

  • Coordination games with conflicts of interests

    • A conflict of interest occurs in a coordination game if players in the game would prefer different Nash equilibria

    • The players will probably choose the equilibria providing a higher total pay-off

4.14 - Modelling the global climate change problem

  • Disagreement about cost sharing and technologies - negotiation may be able to improve the outcome

  • Hawk-dove game: A coordination game in which the players want to coordinate on the opposite action from their opponent, and in each of the Nash equilibria, (Hawk, Dove) and (Dove, Hawk), the Hawk obtains the higher pay-off; but both players choosing Hawk is the worst outcome for both.

  • Applying the hawk-dove game to the climate policy

    • Pay-offs may be different for these varied players

  • Using public policy to change the game

    • There is no court for carrying out punishment

    • Restrict must be in the interests of each of the parties