Experimental Economics

Social Dilemmas

  • Definition: Situations where self-interested individuals' actions can lead to suboptimal outcomes for the group.
  • Key Examples:
    • Invisible hand: Self-interest leading to beneficial outcomes.
    • Tragedy of the commons: Resources are over-exploited when individuals act independently in their own interest.
    • Prisoner's dilemma: Cooperation can be undermined when individuals pursue personal gain.
  • Resolution Methods:
    • Social preferences: Factors like altruism, reciprocity, and spite can influence outcomes.
    • Repetition: Encourages cooperative behavior through reciprocal strategies.
    • Institutions: Rules or systems that penalize self-interested behavior to promote cooperative outcomes.

Economic Experiments

  • Limitations of Economists: Full experiments on economies are impractical.
  • Field Experiments: Increasingly used to test economic theories in controlled environments.
  • Types of Games Studied:
    • Public goods game: Examines contributions to common resources.
    • Ultimatum game: Analyzes negotiation and fairness in resource distribution.

Public Goods

  • Characteristics:
    • Non-excludable: No one can be effectively excluded from its benefits.
    • Non-rivalrous: One person's consumption doesn't reduce availability for others.
  • Challenges:
    • Susceptible to free riding where self-interested individuals limit their contributions knowing they will benefit regardless.

Public Goods Game

  • Scenario:
    • Four farmers deciding on an irrigation project.
    • Private Cost: $10 to contribute.
    • Benefit of Contribution: $8 per farmer.
    • Social Benefit: If all contribute, total is $32, leading to $22 each.
  • Dominant Strategy: Not contributing is the dominant strategy, leading to Nash equilibrium of zero contributions, which is a social dilemma.

Elinor Ostrom

  • Background: Political scientist and Nobel Prize winner in Economics (2009).
  • Contributions: Researched community management of common resources, highlighting conditions for successful governance without succumbing to tragedies.
  • Key Concepts:
    • Difference between common-pool resources and common property resources.
    • Principle: “A resource arrangement that works in practice can work in theory”.

One-shot Public Goods Game

  • Procedure: Players receive $20 each.
  • Dominant Strategy: Contribute $0; leads to a Nash equilibrium where average payoff is $20 per player versus a potential social optimum of $32 if all contribute.

Repeated Public Goods Games

  • Incentives to Cooperate: Players may contribute initially to foster a culture of cooperation for future interactions.
  • Tit-for-tat Strategy: Playing the strategy employed by opponents in the previous round may enhance contributions initially but may decline due to punishment for free-riding in later rounds.

Institutions and Punishments

  • Peer Punishment: Allowing players to penalize low contributors raises average contributions.
  • Social Norms: Motivation to punish can derive from social preferences and norms enforcement.

Sharing Economic Rents

  • Cooperation Outcomes:
    • Various cooperative scenarios: Invisible hand game, Prisoner’s dilemma, and Public goods game.
  • Negotiations: Cooperative agreements often collapse over perceived unfairness in sharing gains (e.g., Kyoto Protocol).

Ultimatum Game

  • Structure:
    • Two players agree to split $100; proposer makes an offer, responder can accept or reject.
  • Outcome Scenarios:
    • Acceptance = allocation of shares; rejection = no earnings.
  • Cultural Variations: Responses in ultimatum game vary across cultures; e.g., Kenyan farmers tend to reject lower offers compared to US students, due to differing expectations and social norms.

Field Experiments

  • Example: Late pickup fines for parents at schools; introduction of a fine led to increased tardiness due to crowding out of social preferences.

Multiple Equilibria

  • Concept:
    • Games can have multiple equilibria depending on player actions;
    • Nash Equilibrium: All players doing the best they can given other players' strategies.
  • Driving Example: Both left and right-driving conventions can serve as Nash equilibria.

Conclusion on Social Interactions

  • Game Theory Application: Helps model social interactions,
  • Outcomes: Individual self-interests may yield mutual benefits or losses based on cooperation potential.
  • Factors Influencing Outcomes:
    • Social preferences
    • Game repetition
    • Institutional frameworks informing behaviors.
  • Conflict of Interest: Can arise regarding equitable distribution of outcomes and chosen equilibria.