Game Theory - Steal Away

Game Theory is one of those things almost all of us have heard of but very few have been able to learn about. It's hugely important in economics, especially the behavioural side of things. So, here is a very brief introduction to Game Theory...

Here is a typical two player 'game':

		Player 2
		Steal	Share
Player 1	Steal	1,1	4,0
	Share	0,4	2,2

Both players decide simultaneously, and without communication, what course of action to take in regards to a strawberry milkshake. They can either share it or steal it. The table shows the four possible outcomes, with the numbers representing what economists call 'utility' (the net benefit to each player).

The fair outcome is (Share, Share) as both get a utility of 2, but both players have an incentive to steal. However, if both try to steal it half the milkshake is spilt on the floor.

Imagine you're Player 1... What do you do? What is your strategy?

Economists use something called the Nash Equilibrium to define the likely outcome. A Nash Equilibrium is an outcome where no-one has an incentive to change their strategy. Thus it is stable. We can work out your best strategy as Player 1 by imagining what Player 2 could do.

If Player 2 steals your best response is to steal (as 1 > 0). If Player 2 shares, your best response is to steal (as 4 > 2). Hey presto, you should always steal!

Equivalently, Player 2 should also always steal. Therefore the Nash Equilibrium is (Steal, Steal).

There is clearly a better outcome for everyone involved (which economists call the Pareto-efficient outcome) but economists predict that without coordination it wont be reached.

Of course if we change the numbers we can change the 'game' and thus the outcome. Much more interesting games than this one (which is commonly called the Prisoners' Dilemma) will have to be covered in later blogs.

Recommended listening:
Steal Away by Ozzy Osbourne

The Monty Hall Problem - Fast Car

This is a probability puzzle named after the American quiz show host Monty Hall. Strictly speaking it's not a behavioural economics puzzle, but I'm interested in what you do...

There are three doors (1, 2 and 3) with one prize hidden behind each one. There is one car and two goats. Obviously, the idea is to get lucky and pick the car. Equally obviously, there is a one third chance of getting the car.

You can pick whichever door you like, for example door 1.

Monty knows where the car is. He has a think. He opens door 3 and reveals a goat.

He then offers you the chance to switch from door 1 to door 2 (or to stick with door 1).

Do you switch from 1 to 2?

When I first faced this problem I said no. I would stick with door 1. I reasoned that now there is a 50% chance of getting it right, and I might as well stick with what I put down first. It turns out that I was wrong.

If you switch to door 2 there is a higher probability of getting the car!

Wikipedia is full of differing explanations for the maths behind it, but I'll explain it in the way I reasoned it out.

At the start of the problem there is a one third chance of picking the car and you pick door 1. Thus there is a two thirds chance that one of doors 2 and 3 have the car. Therefore there is a two thirds chance that when Monty chose the door to open, he had no choice (he could not open the other door as that would have revealed the car).

There is only a one third chance that neither 2 or 3 had the car. In this case Monty could have picked either 2 or 3 to open.

Thus because there is a 2/3 probability that Monty had to open 3 and there is only a 1/3 chance he could have chosen either, we should switch to the one he did not open: door 2.

It took me a long time to work that out. Please let me know whether my explanation is adequate...

Recommended listening:
Fast Car by Tracy Chapman

How Much Would You Pay For Facebook? - Time Will Tell

In the first quarter of 2012 the average UK house price was £226,887 (BBC)

How much would you pay for Facebook?

• £1000 a year
• £500 a year
• £100 a year
• £10 a year
• £1 a year
• Nothing

Just £2 a week for one year is enough to equip two African villagers with the skills to work their way out of poverty (Tearfund).

How much would you pay for Facebook?

• £1000 a year
• £500 a year
• £100 a year
• £10 a year
• £1 a year
• Nothing

Now I'm guessing that as you're reading a blog about behavioural economics you're probably on your toes, but similar techniques are used by shops all the time. The next time you go shopping try looking out for them...

Recommended listening:
Time Will Tell by Bob Marley

Cucumber Pimm's - Drink Up Me Hearties

Picture the scene... It's summer. It's dusk. I'm in the garden surrounded by friends sipping Pimm's at a rather splendid birthday party. A friend observed all the fruit in the Pimm's. Cue jokes about it being one of our five a day. It was then that we noticed the cucumber. Why was there cucumber? Was it part of a liberal conspiracy to make us more healthy? Was it just a mistake? Don't get me wrong; the Pimm's tasted great, but why cucumber?

In their highly influential book Nudge: Improving Decisions About Health, Wealth, and Happiness Richard Thaler and Cass Sunstein talk about the potential for using behavioural economics to 'manipulate' people into making objectively better decisions like, for example, eating more healthily. We know that in a canteen placing fruit at eye-level dramatically increases the demand for it.

But surely sneaking cucumber into my Pimm's is immoral?

I'm sure Thaler and Sunstein would immediately point out that they do not advocate tricking or forcing people into eating more healthily. Rather, they propose 'nudging' people to make 'better' decisions. They still want there to be a an open and free choice.

In fairness, the birthday party in question had many drinks on offer. I did not have to choose the fruity Pimm's. I could clearly see there was cucumber present. Perhaps I was just 'nudged' into being healthy...

Shock Discovery - Make 'em Laugh

SHOCK DISCOVERY - GURUHOGG'S LAUGHTER CAUSES SCOTTISH ECONOMIC GROWTH

New research by the University of Life shows that the rate at which GuruHogg laughs is highly correlated with the rate of growth of Scottish GDP. Alex Salmond has already announced his intention to tickle GuruHogg constantly. GuruHogg has yet to respond.

Spot anything wrong with this news story?

Yes, that's right. Correlation is NOT the same as causation.

Just because two things are highly correlated does not mean that one causes the other. I suspect a large percentage of news stories are based on this misunderstanding.

So the next time you see a fantastic story about A causing the seemingly irrelevant B, read the story carefully and use some intuition to see whether it's good economics or not (this applies to all economics, not just behavioural stuff).

Recommended listening;
Make 'em Laugh by Donald O'Connor

Diamond Greed - Sweet Caroline

The recent Libor fixing scandal in the City of London just claimed its largest victim yet; the Barclays' CEO Bob Diamond. The scandal raises a wider question about the morality of greed...

The BBC coverage quoted two contrasting emails from members of the public:

C Abbott in Leeds emails: "It's a disgrace how the media and politicians are persecuting Bob Diamond and Marcus Agius for doing their jobs. We all live in a capitalist society where CEOs and chairmen are employed to make profits for their shareholders. If these regulations allow the rate fixing then the heads of Barclays and the other 20 banks under investigation are not to blame. The FSA and the politicians who set the rules and regulations should be held accountable. Instead of this self-righteous drivel that Cameron and Miliband are delivering to the public."

Neil Mcintosh in Worthing emails: "The right decision and about time. Too much mud has now stuck and all under his watch to allow him to stay and maintain the confidence of the market, shareholders and customers. Greed is not good and now it is being dealt with as it should have been since 2007. Now we need successful prosecutions with long prison terms and deterrent penalties such as seizure of profits made from such activities or all of this will have been for nothing. That in my view is the only acceptable course of action."

In other words:

Anything that legally makes profits for shareholders is justified.

or

Greed is not good.

How do you view greed? Is there such a thing as responsible capitalism? Is greed a virtue? If you were a banker, would you have fixed Libor? If you had the power, would you regulate in order to restrict human greed?

Recommended listening:
Sweet Caroline by Neil Diamond

Experimental Dishonesty - Love The Way You Lie

I recently partook in a really interesting experiment at the CeDEx lab at the University of Nottingham and thought I would briefly describe it...

If you would like to, please feel free to skip to the punchline at the end for some interesting thoughts on dishonesty...

There were 16 participants: 8 "buyers" and 8 "sellers". We were told that we were trading a notional good which started in the seller's possession. There were 8 periods for trades. In each period I, a buyer, would be paired with a different seller. We would meet in a room and were allowed 3 minutes of conversation, during which we could talk about anything. We would both then go back to our original rooms and write down our buying/selling price. These would then be collected by the experimenters.

If the stated buying price was lower than than the stated selling price no trade was done. If the buying price equalled the selling price, it was the final trading price. If the buying price was higher than the selling price then the final trading price was halfway between them.

So far, so straightforward.

The interesting bit was that before each period each buyers was told what "value" the notional good was worth to them that period. Buyers either valued the good at £3 or £9. Also before each period the sellers were told what it "cost" them to provide the good; either £1 or £7. The buyers' value and sellers' cost were both decided by drawing a ball out of a hat. Each value (£3 or £9) had an equal chance of being picked (50%), and each cost (£1 or £7) had an equal chance of being picked (50%).

So I, as buyer, always knew my valuation of the good (which was decided by the hat before each period). BUT I was not informed of the sellers' cost, and neither were the sellers ever informed of my valuation.

I kept the difference between the final trading price and my value as "profit". The sellers kept the difference between the final price and their cost a profit too. Thus everyone could benefit from a trade most of the time. But that does not guarantee that the profit would be shared equally (I could get very little profit and the seller could get lots, and vice versa).

By now you should be starting to grasp the the essence of the experiment. The following scenarios are possible:

Value: £9 Cost: £7 - Potential deal, somewhere in the region of £7-£9
Value: £3 Cost: £7 - NO DEAL
Value: £3 Cost: £1 - Potential deal, somewhere in the region of £1-£3
Value: £9 Cost: £1 - Potential deal, somewhere in the region of £1-£9

However, there is an incentive to be dishonest in your 3 minute conversation with the other party. If I had the value of £9, I could gain more by persuading the seller that I actually had the value of £3, because then the price would be lower.

If the seller has the cost £1 they have an incentive to persuade me that their cost is £7, because then the price would be higher.

But remember, if the buying price is below the selling price then no trade is done and no-one benefits.

--------------------------------------------------------PUNCHLINE-------------------------------------------------------------

In this experiment, dishonesty pays.

Would you be dishonest? (remember this is real money...)

I completed the experiment without telling a lie (I did, however, use negotiating tactics to get a better deal). Over the 8 periods I earned £17.20 (about average, I suspect). Some sellers were honest to me about their cost, but most were not (a seller's final trading price can be revealing about their true cost). I ended the experiment with less faith in humanity!

However, in real life people tend to interact more than once. If someone is dishonest I will not trade with them again. Thus the experiment does not necessarily translate to real life.

I'll finish with an interesting question...

Why do humans value honesty? Why, deep down, do we know that we are doing "wrong" when we are dishonest? Survival of the fittest would surely favour dishonest behaviour...

Recommended listening:
Love The Way You Lie by Eminem, Rihanna

How To Design A Wedding Gift List - Give Me Everything

I'm now at the age where my friends start getting married and last weekend I had the awesome privilege of being a Best Man. I must be very cool, because throughout the Best Man process behavioural economics kept on coming to mind.

Most couples now put up a wedding gift list online, which friends and family can use to guide their gift choices. I think this is a great innovation, allowing couples to easily communicate what would be useful as they embark upon married life together. As I perused these lists I got thinking about how to design them.

I'm going to make an assumption at this point: newlyweds would like their friends to be generous. So, how does one persuade one's friends to be generous?

One particular insight from behavioural economics called anchoring is likely to be useful (anchoring being the principle that people's opinions of what is a reasonable can be easily affected).

For example, say someone thinks £20 would be a reasonable wedding gift. How might one change that? I have two pieces of advice:

• Make the top item on the list uber-expensive. If the first gift people see is a £500 plasma screen, their opinion of what would be a reasonable gift may rise. Obviously not by £480, but some increase is not unlikely. No-one may actually buy the TV, but that's not the point, and hey it's no big disaster if they do!

• Create a way of communicating what previous people have given. For example, putting "bought" on an item that has been given already. Showing what others think is a reasonable gift is a surefire way of affecting what we think of as reasonable. Of course the risk is that if people give small gifts then this may decrease future gifts (if you were sneaky you could probably find a way of highlighting previous expensive gifts more).

Anyway, I would just like to say that when it comes to my wedding (which wont be anytime soon - all offers welcome...) I wont use either of the above methods. Why? Because manipulating my friends into giving me more is not something that I'm comfortable with. Thus I venture to suggest that the real lesson from this blog is that the use behavioural economics can throw up moral questions.

PS If I did see a friend trying to use behavioural economics to get me to give them more I would probably give them less out of principle!

PPS I hasten to add that the couple for which I was Best Man did not use any behavioural economics!

Recommended listening:
Give Me Everything by Pitbull