WINTER
WinterWEEK
Week
Kia Ora, Welcome
Thank you all for coming
I realize your time is valuable and I am
delighted that you have chosen to attend
this lecturer series
Centre for Continuing Education, Level 7, 58 Symonds Street, Auckland.
Private Bag 92019, Auckland Mail Centre, Auckland 1142
Phone 0800 UNICONTED (0800 864 266), (09) 373 7599 ext 87831/87832
Email: conted@auckland.ac.nz Web: www.cce.auckland.ac.nz
1
WINTER
WinterWEEK
Week
At this point I would like to request that you
either shut off your cell-phone or put it in silent
mode
Let me now tell you very briefly how the five
lectures are structured
Centre for Continuing Education, Level 7, 58 Symonds Street, Auckland.
Private Bag 92019, Auckland Mail Centre, Auckland 1142
Phone 0800 UNICONTED (0800 864 266), (09) 373 7599 ext 87831/87832
Email: conted@auckland.ac.nz Web: www.cce.auckland.ac.nz
2
WINTER
WinterWEEK
Week
Today I am going to introduce some ideas and
concepts that I will draw upon in later lectures
The lectures on Tuesday and Wednesday are
connected and deal with issues in cooperation
and selfishness
Centre for Continuing Education, Level 7, 58 Symonds Street, Auckland.
Private Bag 92019, Auckland Mail Centre, Auckland 1142
Phone 0800 UNICONTED (0800 864 266), (09) 373 7599 ext 87831/87832
Email: conted@auckland.ac.nz Web: www.cce.auckland.ac.nz
3
WINTER
WinterWEEK
Week
Thursday’s and Friday’s lectures are
again connected and will deal with issues
of fairness and trust
If you miss the first lecture of a topic then
the second lecture may make less sense
Centre for Continuing Education, Level 7, 58 Symonds Street, Auckland.
Private Bag 92019, Auckland Mail Centre, Auckland 1142
Phone 0800 UNICONTED (0800 864 266), (09) 373 7599 ext 87831/87832
Email: conted@auckland.ac.nz Web: www.cce.auckland.ac.nz
4
WINTER
WinterWEEK
Week
It might be convenient for everyone if you
hold questions till the end of the lecture
However if during the lecture you have a
question seeking clarification then
please feel free to ask that question
Centre for Continuing Education, Level 7, 58 Symonds Street, Auckland.
Private Bag 92019, Auckland Mail Centre, Auckland 1142
Phone 0800 UNICONTED (0800 864 266), (09) 373 7599 ext 87831/87832
Email: conted@auckland.ac.nz Web: www.cce.auckland.ac.nz
5
WINTER
WinterWEEK
Week
At times I might ask you to defer your question
till the end of the lecture
If I do so then it does not imply any disrespect
It simply means that trying to answer the
question may take me far away from what I am
talking about and it would be easier to answer it
later
Centre for Continuing Education, Level 7, 58 Symonds Street, Auckland.
Private Bag 92019, Auckland Mail Centre, Auckland 1142
Phone 0800 UNICONTED (0800 864 266), (09) 373 7599 ext 87831/87832
Email: conted@auckland.ac.nz Web: www.cce.auckland.ac.nz
6
University of Auckland
Winter Week Lectures
First Lecture
2 July 2007
Associate Professor
Ananish Chaudhuri
Department of Economics
University of Auckland
7
Game Theory and
Experimental Economics
• A large number of decisions in every
day life require strategic decision
making
• Economists have developed a broad
array of tools to understand how
people make decisions in such
situations
• These set of tools are called “Game
Theory”
8
What is Game Theory?
• Game theory is a language for
describing strategic interactions
when what happens to one person is
affected by another person
• A large number of situations that
confront us in our day to day lives
can be thought of as “games” with
us as “players”
• And they can be analyzed using the
tools of game theory
9
Games in everyday life
• Tennis players deciding whether to
serve to the forehand or backhand of
their opponent
• The local bakery offering a
discounted price on pastries just
before it closes
• Employees deciding how hard to
work when the boss is away
10
Games in everyday life
• Persian rug seller deciding how
quickly to lower the price when
haggling with a tourist
• Airline companies trying to decide
whether to cut prices or not
• Qantas and Air New Zealand trying
to decide whether to merge or not
• And the response of competitors to
a merger
11
Games in everyday life
• Lamalera man in Indonesia deciding
whether to join the group for the
day’s whale hunt or to fish on his
own
• Pharmaceutical firms investing in
research to develop a new drug
• People bidding for art or oil leases or
knickknacks on eBay
12
Pioneers of Game
Theory
• Economists have developed a large body of
theory which enables us to understand and
analyze the nature of the interaction
between players in such games
• A lot of what we know can be traced back
to John von Neumann and Oskar
Morgenstern
• As well as John Nash (played by Russell
Crowe in “A Beautiful Mind”) along with
Reinhard Selten and John Harsanyi
• The latter three together won the Nobel
Prize in Economics in 1994
13
Behavioral Economics
• Game theory is used extensively now in
economics, biology, sociology, political
science, and all branches of businessrelated disciplines such as management
and marketing
• My own research focuses on one part of
game theory that can be called “behavioral
game theory”
• I try to understand what the theory says
about how people would behave and how
they actually respond in many such
strategic situations – often by providing
monetary incentives
14
Contributing to a charitable
cause – a social dilemma
• I am going to illustrate some of
these issues with the aid of an
example
• You want to build a park in your
locality that would be open to
everyone
• You decide to approach the families
in the area and ask them to donate a
certain amount
15
Contributing to a charitable
cause – a social dilemma
• Not everyone has to contribute
for the park to get built
• As long as some of the families
contribute you will have enough
money for the park
• What are the chances that you
will be able to raise enough
money?
16
Contributing to a charitable
cause – a social dilemma
• Let us assume that by and large
people are self-interested and care
(mostly) about their own welfare
• Think about an individual trying to
decide whether to contribute or not
• If she does not contribute and the
park does not get built then she is
neither better nor worse off
• But suppose she does NOT
contribute but enough money is
raised to build the park
17
Contributing to a charitable
cause – a social dilemma
• This person cannot be
prevented from going to the
park once it is built
• She has not contributed
anything but still gets to enjoy a
walk in the park
• This person is then strictly
better off
18
Contributing to a charitable
cause – a social dilemma
• Seems like then that whether the
park gets built or not – for an
individual who cares primarily about
her own self-interest – the thing to
do is not to contribute any money
• We call this “free-riding”
• But if everyone reasoned along the
same lines then no one will
contribute!
19
Economic situations as
games
• A number of economic
situations in real life resemble
this scenario
• And they can be depicted as a
simple game played by two
players
20
The Prisoners’ Dilemma
• Economists refer to situations
like these as a “prisoners’
dilemma”!
• We can set up the situation on a
table, called a Payoff Matrix
21
The Prisoners’ Dilemma
• Here is how it goes:
• A crime is committed. The police
have no evidence but want to get a
conviction. So they arrest a couple
of likely characters, Ginger and
Rocky, and put them in different
cells.
22
The Prisoners’ Dilemma
• The police say to each suspect:
• “If you rat on your mate and finger
him for the crime and he doesn’t rat
on you, then we can convict him and
he will get 7 years in prison, and we
will let you go free.”
• “So what if I don’t rat and nor does
he?” asks Rocky (or Ginger). “ Then
you can’t convict, can you?”
23
The Prisoners’ Dilemma
• “No we can’t,” admits the
detective. “But then we’ll pin an
obstruction of justice charge on
both of you. One year in the
slammer each.”
• “And if we both rat on each
other?”
• “Then it gets a bit messy and
you both get 5 years,” says the
24
detective.
The Prisoners’ Dilemma
• So what will happen? Let us figure
out the options from Rocky’s point of
view.
• Being economists, we will assume
that Rocky is “rational” meaning that
he will do the best he can in his own
self-interest
• Rocky considers each possible
action by Ginger, and figures out his
best reaction in each case
25
The Prisoners’ Dilemma
• So if Ginger rats on Rocky, then
Rocky’s best move would be to
rat on Ginger (get five years
instead of seven)
• And if Ginger doesn’t rat, then
Rocky’s best move is……..
• again, to rat! (go free instead of
one year in prison)
26
The Prisoners’ Dilemma
• So Rocky’s rational decision must be
to rat on Ginger.
• And, similarly, Ginger’s best move is
to rat on Rocky
• So we predict this is what will
happen and they both will go to
prison for five years
• But if only both could have kept their
mouths shut, they would both be
better off!!!
27
The Prisoners’ Dilemma
Payoff Matrix
ROCKY
GINGER
Don’t Rat
Rat
Don’t Rat
Ginger: 1
year
Rocky: 1
year
Ginger:
free
Rocky: 7
years
Rat
Ginger: 7
years
Rocky: free
Ginger: 5
years
Rocky: 5
years
28
The Prisoners’ Dilemma
from Ginger’s perspective
ROCKY
GINGER
Don’t Rat
Rat
Don’t Rat
Rat
1 year
7 years
Free
5 years
29
The Prisoners’ Dilemma
• The problem is that even if one
prisoner does the right thing and
keeps quiet, the other has an
incentive to cheat on him
• Similarly in the case of the park it
would be better if everyone
contributes, but self-interested
individuals have an incentive not to
do so
• But if no one contributes then the park
does not get built
30
Experimental Evidence
• It turns out that people often choose the
cooperative strategy in Prisoner’s Dilemma
type situations
• People contribute to public charities
• People voluntarily save on electricity
consumption when asked to do so in the
face of a crisis
• The puzzle of course is why since that
behavior is not in accordance with
individual self-interest
31
Implications of Cooperation
• The issue of cooperation goes
beyond economics and has
ramifications for other disciplines
including theories of evolution
• Biological theories suggest that
those who act altruistically or
cooperatively in such situations will
lose out to those who act in their
own self-interest
• Over time the self-interested types
will come to dominate the population
32
Before I proceed
• Since this is a talk on experiments and
strategic decisions making, why don’t we
play a game?
• This will help to set-up the rest of my talk
• I will pick some volunteers in a minute
• Your job is to pick a WHOLE number
between 0 and 100
• Whoever gets closest to ONE-HALF of the
AVERAGE of all the numbers picked
33
WINS!!!
Before I proceed
• Each of you will write down a number
between 0 and 100 on a slip of paper and
hand it to me
• I will then calculate the average (and onehalf of the average) of all the numbers
chosen
• Then I will see whose number came
closest to one-half of the average and that
person is the winner
34
Before I proceed
• Please write your name or initials on
the slip of paper since we need to
identify you to give you your reward
• The reward is $25 (to be divided
among the winners in case of a tie)
• I will tell you the winner and the
answer to the game when we are
done
35
Answer to the Guessing
Game
• Suppose everyone chooses 100
• Then the average is 100
• Since I have to get closest to ½ of
100, I should choose 50
• But if everyone figured that out then
everyone will choose 50
• Then the average will be 50
• Then I should choose (1/2 of 50) = 25
36
Answer to the Guessing
Game
• But if everyone figured that out
then they will all choose 25
• Then I should choose 12.5 and
so on and so forth…till 0!
• But wait…how smart are my
group members?
37
Answer to the Guessing
Game
• How many levels of such
reasoning can they engage in?
• If they can think through only
two steps then maybe I should
stop at 25…
• In this case the answer turns
out to be…
38
Questions?
39