Lecture Notes for Game Theory and the Pareto Criterion

Lecture Overview

• Unit Topics:
  • Game Theory and the Pareto Criterion
  • Impact of economic interactions on decision making
• Instructor: Dr. James O’Mahony, Assistant Professor, School of Economics
• Contact: james.omahony1@ucd.ie

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Key Concepts from Previous Lecture

• Labour-Leisure Model: Explains the shift in hours worked during the Industrial Revolution.
• Income Inequality: The relationship between hours worked and income inequality.
• Gender Differences: Variations in hours worked based on gender roles.
• International Hours Worked: Differences in hours worked across countries.

Overview of Today's Lecture

• Topics Covered:
  1. Social dilemmas and externalities
  2. Game theory terminology
  3. Examples of dominant strategies
  4. The Pareto criterion

Social Dilemmas

• Definition: Situations where individual actions lead to collective suboptimal outcomes.
  • Example: Climate change, traffic congestion, overuse of common resources.
• Tragedy of the Commons:
  • Concept by Garrett Hardin referencing overuse of common resources.
  • Originates from agricultural practices and resource management.

Game Theory Fundamentals

• Strategic Interaction: Awareness among players that their actions affect one another.
• Game Components:
  • Players: Individuals or groups in interaction.
  • Strategies: Possible actions players can take.
  • Order of Play: Sequence in which players make decisions.
  • Pay-offs: Outcomes resulting from the combination of actions.

The Rice Farmers Example

• Scenario: Two farmers producing rice and cassava, with independent production decisions.
• Payoff Matrix: Illustrates various outcomes based on each farmer's strategy.
• Best Response: Optimal strategy for a player considering the opponent's choice.

Nash Equilibrium and Strategy Dominance

• Nash Equilibrium: Situation where no player can benefit by changing their strategy while others keep theirs unchanged.
  • Example in rice-cassava game illustrates interdependence of decisions.
• Dominant Strategy Equilibrium: Occurs when both players have strategies that lead to the best overall outcome without requiring cooperation.

Externalities and Self-Interest

• Challenges: Individual self-interest can overlook external impacts, leading to less optimal outcomes.
• Possible Solutions:
  • Consideration of mutual interests, social norms, contracts, or regulatory policies.

The Pareto Criterion

• Definition: An allocation is Pareto superior if at least one individual is better off without making others worse off.
• Pareto Efficiency: No further reallocation can make one party better off without hurting another.
  • Multiple Pareto-efficient allocations can exist.

Game Outcomes and Policies

• Social Dilemmas: Arise across various economic interactions; game theory clarifies decision-making strategies.
• Policy Implications: Understanding game outcomes can guide the formulation of interventions to enhance efficiency and cooperation.

Summary of Key Takeaways

1. Social dilemmas exist in many economic scenarios.
2. Game theory is essential for understanding decision-making in social interactions.
3. Strategies can yield varied outcomes; interventions may be needed to improve collective welfare.

Next Lecture

• Topics: Public goods, repeated interactions, and cooperation
• Units Covered: 4.6 - 4.10