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

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