ECON 1020 Macquarie University Principle of Economics Worksheet

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Unit 1
THE CAPITALIST REVOLUTION
OUTLINE
A. Introduction
B. Inequality
C. “Hockey-stick” growth
D. Capitalism
E. Economics
A. Introduction
The Context for This Unit
Rapid, sustained growth in average living standards since 1700.
How did this happen?
This Unit
• Economic inequality and divergence
• The technological revolution and growth
• The role of capitalism in economic growth
• Importance of the government in capitalist economies
B. Inequality
How unequal is the world?
1980
1990
2014
In Singapore, the richest country on the furthest right, the average incomes
of the richest and poorest 10% are $67,436 and $3,652 respectively.
In Liberia, the furthest left, the corresponding incomes are $994 and $17.
Within and between country inequality
1,000 years ago, the world was “flat”. Today, there are large
differences both within and across countries.
While both types of inequality seemed to have increased,
differences in average income between countries are much
larger today than they were in the past.
We can link growing between-country inequality to the hockeystick diagram.
Inequality and growth
For a very long time, living standards did not grow in any
sustained way. When sustained growth occurred it began at
different times in different places.
• The countries that took off economically a century or more
ago—UK, Japan, Italy—are now rich.
• The countries that took off only recently, or not at all, are in
the flatlands.
Measuring income and living standards
Gross Domestic Product (GDP) = A measure of total income and output of
the economy in a given period.
• Usually expressed in per-capita terms (as an average income).
GDP per capita ? Disposable income
Disposable income = Total income – taxes + government transfers
GDP is an imperfect measure of well-being. However, it is highly correlated
with other measures of well-being, such as life expectancy at birth and the
infant mortality rate, both of which capture some aspects of quality of life.
Measuring income and
C. “Hockey-stick” growth
GDP growth rates
“Hockey-stick” curves represent the sustained rapid growth in
GDP per capita experienced by countries worldwide.
Timing of growth
Growth take-off occurred at different points in time for different
countries:
• Britain was the first country to experience sustained economic
growth. It began around 1650.
• In Japan, it occurred around 1870.
• The kink for China and India happened in the second half of the
20th century.
In some economies, substantial improvements in people’s living
standards did not occur until they gained independence from
colonial rule or interference by European nations.
The Technological Revolution
Technology = A process that uses inputs to produce an output.
By reducing the amount of work-time it takes to produce the things we
need, technological changes allowed significant increases in living
standards.
Remarkable scientific and technological advances occurred more or less
at the same time as the upward kink in the hockey stick in Britain in the
middle of the 18th century.
The Technological Revolution
The technological revolution is ultimately driven by the
scarcity of time:
• Time is a scarce resource
• Only 24 hours per day to allocate between work (and
hence enjoy consumption) and leisure activities
• Technological changes help to ease this trade-off
• Opportunity to spend less time working in exchange for
more leisure time, or to work the same amount of time
but get more consumption
The Industrial Revolution
Industrial Revolution = a wave of technological advances starting in
Britain in the 18th century, which transformed an agrarian and craftbased economy into a commercial and industrial economy.
For example, today the productivity
of labour in producing light is half a
million times greater than it was
among our ancestors around their
campfire.
A Connected World
Technological progress also greatly improved the speed at which
information travels, making the world more connected.
Environmental consequences
Increased production and population growth affects the environment
• Global impacts – climate change
• Local impacts – pollution in cities, deforestation
Technology may provide the solution
Environmental consequences
These effects are results of both
• the expansion of the economy (illustrated by the growth in total
output)
• the way the economy is organised (what kinds of things are valued
and conserved, for example).
The permanent technological revolution may also be part of the
solution, by making it possible to use less resources to produce more
output.
D. Capitalism
Capitalism
Institutions are the laws and social customs governing the
production and distribution of goods and services.
Capitalism = an economic system where the main institutions are
private property, markets, and firms.
Key Concepts
Private property = ownership rights over possessions
• an important type of private property is capital goods = the
non-labour inputs used in production.
• Does not include some essentials, e.g. air, knowledge
Markets = a way for people to exchange products and services
for their mutual benefit. Unlike other types of exchange, markets
• are reciprocated transfers
• voluntary
• usually there is competition
Key Concepts
Firms = business organisation that uses inputs to produce
outputs, and sets prices to at least cover production costs.
• Inputs and outputs are private property
• Firms use markets to sell outputs
• The aim is usually to make profit
This pursuit of profit provides an incentive for firms to innovate
and adopt new technologies, as witnessed during the Industrial
Revolution.
The Capitalist Revolution
Capitalism led to growth in living standards because of:
• impact on technology: firms competing in markets had strong
incentives to adopt and develop new technologies
• specialisation: the growth of firms and the expansion of
markets linking the entire world allowed historically
unprecedented specialisation in tasks and production
Together with the technological revolution, this increased worker
productivity.
The gains from specialisation
Specialisation increases productivity of labour because we
become better at producing things when we each focus on a
limited range of activities
• learning by doing
• taking advantage of natural differences in skill and talent
• economies of scale
People can only specialise if they have a way to acquire the other
goods they need. In a capitalist society, this is done via markets.
Comparative advantage
Production if 100% of time is spent on one good
Greta
1250 apples or 50 tonnes of wheat
Carlos
1000 apples or 20 tonnes of wheat
• Greta has absolute advantage in production of both crops
• Greta has a comparative advantage in wheat
• Carlos has a comparative advantage in apples = he is least
disadvantaged in production of apples.
Comparative advantage
All producers can benefit by specialising and trading goods, even
when this means that one producer specialises in a good that
another could produce at lower cost.
Markets contribute to increasing the productivity of labour by
allowing people to specialise.
Did capitalism cause the hockey-stick growth?
Natural experiment: the division of Germany at the end of World
War II into two separate economic systems, capitalist in the west
and centrally planned in the east.
Divergence in growth
Not all capitalist economies are equally
successful
• the right incentives must be in place
in order to promote growth
• economic conditions: firms, private
property, or markets may fail
• political conditions: capitalist
institutions are regulated by the
government
• the government also provides
essential goods and services
(infrastructure, education)
Political systems
Capitalism coexists with many political systems.
A political system determines how governments will be selected,
and how those governments will make and implement decisions.
In most countries today, capitalism coexists with democracy
• individual rights of citizens (e.g. freedom of speech)
• fair elections
But capitalism has coexisted with non-democratic systems, too.
E. Economics
What is Economics?
Economics is the study of how people interact with each other and
with their natural surroundings in producing their livelihoods, and
how this changes over time.
Summary
1.
•
•
•
Important trends in economic variables over time
Income inequality across regions has increased a lot over time
“Hockey-stick” growth in GDP
Technological progress helped bring about these trends
2. The adoption of capitalism was another key factor
• Capitalism = Private property + Markets + Firms
• Failure of these institutions can explain divergence in
economic growth across countries
• Political systems and the role of government also determine
the type of capitalist society
Unit 2
TECHNOLOGICAL CHANGE, POPULATION, AND
GROWTH
OUTLINE
A. Introduction
B. Economic models
C. Explaining growth
D. Explaining stagnation
A. Introduction
The Context for This Unit
The recent rapid, sustained increase
in income and living standards is
largely due to technological progress.
(Unit 1)
However, these major changes started very suddenly, 200 years ago
in Britain.
• Why did it not start earlier, or later?
• Why did it start in Britain, not anywhere else?
This Unit
Use economic models to explain the rapid growth in real wages
and population in the last 2 centuries, and the stagnation in the
centuries before that.
B. Economic models
Why do we need models?
What happens in an economy depends on the actions and
interactions of millions of people.
We use models to see the big picture.
Building a model
To create an effective model we need to distinguish between
• the essential features of the economy that are relevant to the
question we want to answer, which should be included in the
model
• unimportant details that can be ignored
Models necessarily omit many details. This is their feature, not a
bug.
Building a model
1. Capture the elements of the economy that we think matter for
our question
2. Describe how agents act, and how they interact with each
other and the elements of the model
3. Determine the outcomes of these actions (an equilibrium)
4. Study what happens when conditions change
Equilibrium of a model = situation that is self-perpetuating.
Something of interest does not change unless an external force is
introduced that alters the model’s description of the situation.
What is a good model?
• It is clear: it helps us better understand something important
• It predicts accurately: its predictions are consistent with
evidence
• It improves communication: it helps us to understand what we
agree (and disagree) about
• It is useful: We can use it to find ways to improve how the
economy works
Key concepts
• Less is more: Ceteris paribus = simplification that involves
“holding other things (in/outside the model) constant”.
• Incentives = economic rewards or punishments, which influence
the benefits and costs of alternative courses of action.
• Relative prices help us compare alternatives.
• Economic rent = the benefit received from a choice, taking into
account the next best alternative (reservation option)
? Forms the basis of how we make choices.
C. Explaining growth
Explaining the Industrial Revolution
Why did the Industrial Revolution happen first in the 18th
Century, on an island off the coast of Europe?
There are many alternative explanations
• Access to colonies
• Relatively high cost of labour
• Europe’s scientific revolution and Enlightenment
• Political and cultural characteristics of nations as a whole
• Abundance of coal
Modelling technology
Technology = A process that uses inputs to produce an output.
There are 5 different ways to
produce 100 metres of cloth, using
labour (number of workers) and
energy (tonnes of coal) as inputs.
E-technology is relatively labourintensive; A-technology is relatively
energy-intensive.
Firm’s choice: inferior technologies
Firms choose between technologies
(specific combinations of inputs) to
produce outputs.
Some technologies are dominated
by other technologies.
Firm’s choice: minimising cost
Firms aim to maximise their profit, which means producing cloth at
the least possible cost.
This is why the firms’ choice of technology depends on economic
information about relative prices of inputs.
Isocost lines
Isocost lines = combinations of
inputs that give the same cost
(slope = relative price of inputs)
We can derive it from the cost
equation by re-arranging it:
The firm will choose the least-cost technology.
Change in relative prices in Britain
Technology was labour-intensive
before the Industrial Revolution
(technology B).
Increase in wages relative to price of
coal in Britain create the incentive to
innovate more capital-intensive
technologies (technology A).
The benefits of innovation
Because relative prices of inputs changed, a firm that will switch
to the new cost-minimising technology will have an advantage
over its competitors.
The change in profit is equal to the fall in costs associated with
adopting the new technology. This is the innovation rent.
Creative destruction
The first adopter is called an entrepreneur. An entrepreneurial
firm is willing to try out new technologies and to start new
businesses.
The first adopters will enjoy Schumpeterian (innovation) rents.
Creative destruction = the process by which old technologies
and the firms that do not adapt are swept away by the new,
because they cannot compete in the market.
Technological change in Industrial Revolution
One of the first sectors to undergo technological change was
textiles
• Before the Industrial Revolution, making clothes for the
household were time-consuming tasks
• By the late 19th century, a single spinning mule operated by a
very small number of people could replace more than 1,000
spinsters
• These machines were powered by water wheels and later
coal-powered steam engines instead of using human labour
Why was Britain first?
English wages were higher than wages elsewhere, and coal was
cheaper in Britain than in the other countries in the chart (Fig.2.10)
Shift to a lower-cost technology
The combination of capacity to innovate and changing relative
prices of inputs led to a switch to energy-intensive technology.
D. Explaining Stagnation
Explaining economy before the Industrial
Revolution
We need a different model to explain the stagnation in population
and living standards before 18th century.
Diminishing average product of labour
Production function gives maximum
output for a given set of inputs.
If we hold one input (land) fixed,
and expand the other input (labour),
the average output per worker is
going to fall. This is the law of
diminishing average product of
labour.
Malthus’ model
Key ideas:
1. Population expands if living standards increase
2. But the law of diminishing average product of labour implies
that as more people work on the land, their income will
inevitably fall
In equilibrium, living standards will be forced down to
subsistence level.
Population and income will stay constant.
The Malthus’ Law
Model predicts a self-correcting response to new technology.
In the long run, an increase in productivity will result in increased
population but not increased wages.
Was Malthus correct?
The relationship between real wages and population in England
between 1280-1600 show evidence of this “Malthusian trap”.
But what about the subsequent “hockey-stick” growth?
Revising Malthus’ Law
3 conditions are required to stay in the Malthusian trap:
• Diminishing average product of labour
• Rising fertility in response to increases in wages
• An absence of continual improvements in technology to offset
the diminishing average product of labour
The permanent technological revolution meant that third
condition no longer holds, and explains why Britain was able to
escape the Malthusian trap.
Escaping the Malthusian trap
Summary
1. Introduction to economic models
• Less is more: use simplifying assumptions e.g. ceteris paribus
2. Used models for insights on the technological revolution
• Model of a firm: high wages (relative to capital, including energy)
motivated technological innovation
• Malthus’ model: the law of diminishing average product of labour
and population increases associated with increases in living
standards result in an equilibrium in which income is just sufficient
to allow a subsistence level of consumption
Unit 3
SCARCITY, WORK, AND CHOICE
OUTLINE
A. Introduction
B. Scarcity and choice: Key concepts
C. Decision-making under scarcity
A. Introduction
The Context for This Unit
(Unit 1)
• Labour is work.
• Labour is an input in the production of goods and services.
(Unit 2)
• New technologies raise the productivity of labour.
• How would that affect living standards?
• How would that affect the free time and working hours
chosen by individuals?
This Unit
Decision making under scarcity is a common problem because we usually
have limited means available to satisfy our unlimited wants
This unit examines how individuals do the best they can, and how they
resolve the trade-off between earnings and free time
•
•
•
•
Economists model these situations, first by defining all of the feasible actions, then
evaluating which of these actions is best, given the objectives
Opportunity costs describe the unavoidable trade-offs in the presence of scarcity:
satisfying one objective more means satisfying other objectives less
A model of decision making under scarcity can be applied to the question of how much
time to spend working, when facing a trade-off between more free time and more
income
This model also helps to explain differences in the hours that people work in different
countries, and the changes in our hours of work throughout history
B. Scarcity and choice: Key
concepts
Example: Grades and study hours
Source: Plant et al (Contemporary Educational Psychology, 2005).
• Students choose how many hours to study, which affects their
grade (GPA).
• We assume a positive relationship between GPA and the number
of hours studied (evidence that this is true, ceteris paribus).
Production function
Production functions show how
inputs (e.g. labour)
translate into outputs
(e.g. goods and services),
holding other factors constant
(e.g. production environment)
What can production functions tell us?
1. Marginal product
Change in output per unit change
in input (evaluated at a given
point, holding other inputs
constant)
2. Average product
Average output per unit of input
Slope = Marginal product
(4 hours of study)
Slope = Average product
(4 hours of study)
Studying example
Diminishing marginal product: Studying becomes less productive, the
more you study.
Indifference curves
Choices depend on preferences
Indifference curves show
all combinations of goods that give
the same utility (satisfaction)
The marginal rate of substitution is
the slope of the indifference curve,
and represents the tradeoffs that an
individual faces
Properties of indifference curves
• Indifference curves slope downward due to trade-offs: If
you are indifferent between two combinations, the
combination that has more of one good must have less of
the other good
• Higher indifference curves correspond to higher utility
levels: As we move up and to the right in the diagram,
further away from the origin, we move to combinations
with more of both goods
Properties of indifference curves
• Indifference curves are usually smooth: Small changes in
the amounts of goods don’t cause big jumps in utility
• Indifference curves do not cross
• As you move to the right along an indifference curve, it
becomes flatter
Opportunity cost
• Choices are limited by constraints and involve tradeoffs
(Studying example: higher grades vs. more free time)
• The opportunity cost of an action is the net benefit of the
next best alternative action
• Compare actions based on economic cost
Economic cost = monetary costs e.g. transport
+ subjective costs e.g. effort of work
Opportunity cost: Example
If the benefit from an action exceeds the economic costs, you
receive an economic rent from choosing it.
The Feasible Frontier
The feasible frontier shows the
maximum output
that can be achieved with a
given amount of input
The marginal rate of
transformation (MRT) is the
slope of the feasible frontier,
and represents the tradeoffs
that an individual faces
C. Decision-making under scarcity
Constrained choice problem
• Model of how individuals choose, given their preferences and the
constraints they face, when the things they value are scarce.
• Studying example: Free time and exam score are scarce because
they are both goods, each with an opportunity cost.
Optimal Decision Making
The utility-maximising choice is
where the amount of one good the
individual is willing to trade off for
the other good (MRS)
equals the actual tradeoff between
the two goods (MRT)
MRS = MRT
Optimal Decision Making
What happens when the feasible frontier changes?
• Technological progress makes it
feasible to both consume more
and have more free time.
• Choice of free time/consumption
depends on relative preferences
and willingness to substitute one
good for another.
Summary
Simple model of decision-making under scarcity
• Indifference curves represent preferences
• Feasible frontier represents choice constraints
• Utility-maximising choice where MRS = MRT
Unit 4
SOCIAL INTERACTIONS
OUTLINE
A. Introduction
B. Game theory and social dilemma
C. Resolving social dilemmas
A. Introduction
The Context for This Unit
• Previous models of choice did not depend on others’ decisions. (Unit 3)
• Individuals motivated by self-interest can produce outcomes that are
beneficial for society e.g. entrepreneurship, innovation. (Unit 1)
• However, self-interest can also be harmful to society.
• Why do these problems arise?
• What can we do about it?
This Unit
• Social dilemma occur when people do not take adequate account of the
effects of their decisions on others, whether these are positive or negative.
• Actions taken independently by self-interested individuals result in a
socially suboptimal outcome e.g. traffic jams, climate change.
•
•
Tragedy of the Commons: Common property or common resources are often
overexploited
Free riding: Benefiting from the contributions of others to some cooperative project
without contributing oneself.
• We look at situations resulting in social dilemmas and how people solve
them (or not solve them).
• We will use the tools of game theory to model social interactions and
explain social dilemmas.
B. Game theory and social dilemma
Social and Strategic Interactions
• Social interaction: A situation involving more than one person/party,
where one’s actions affect both their own and other people’s outcomes.
• Strategic interaction: A social interaction where people are aware of the
ways that their actions affect others.
• Strategy: Action(s) that people can take when engaging in a social
interaction.
• Game: A model of strategic interaction that describes the players, the
feasible strategies, the information that the players have, and their
payoffs.
• Game theory is a set of models of strategic interactions. It is widely used
in economics and elsewhere in the social sciences.
Invisible Hand Game (1)
• Two farmers decide which crop to specialize in.
• They interact only once (one-shot game).
• They decide simultaneously.
1. Players – Anil and Bala.
2. Feasible strategies – Rice or Cassava
3. Information – Each farmer does not know
what the other chose.
4. Payoffs – depend on market prices and
quality of land.
Invisible Hand Game (2)
• Best response: Strategy that yields the highest
payoff, given the other player’s strategy
•
If Bala grows rice, Anil’s best response is to grow
cassava. If Bala grows cassava, Anil’s best response
is to grow cassava. What are Bala’s best responses?
• Dominant strategy: A best response to all
possible strategies of the other player (does
not always exist!)
•
Anil’s dominant strategy is to grow cassava. Bala’s
dominant strategy is to grow rice.
Invisible Hand Game (3)
• Dominant strategy equilibrium: An outcome
of a game in which everyone plays their
dominant strategy
•
When Anil and Bala each play their dominant
strategy, the outcome is (Cassava, Rice).
• Although they independently pursued their
self-interest, they were guided ‘as if by an
invisible hand’ to an outcome that was in both
of their best interests.
The Prisoners’ Dilemma (1)
• All conditions of this game are the same as
the invisible hand game except for
strategies and payoffs.
• Anil’s dominant strategy is to use
Terminator. Bala’s dominant strategy is also
to use Terminator.
• The dominant strategy equilibrium is
(Terminator, Terminator), which is not the
socially optimal outcome.
The Prisoners’ Dilemma (2)
• The prisoners’ dilemma is a game in which
the payoffs in the dominant strategy
equilibrium are lower for each player, and
also lower in total, than if neither player
played the dominant strategy.
• In the prisoners’ dilemma, the socially
optimal outcome is not achieved.
• The contrast between the invisible hand game and the prisoners’
dilemma shows that self-interest can lead to either favourable or
unfavourable outcome.
Nash equilibrium
Nash equilibrium: A set of strategies (one
per player), such that each player’s strategy
is the best response to the strategies chosen
by everyone else.
In a Nash equilibrium, no player has an
incentive to deviate unilaterally.
NOTE: There may be more than one Nash
equilibrium in a game.
Why did we predict this outcome?
1. Players did not place any value on the other’s payoffs.
• What if the farmers also care about others’ payoffs?
2. Nobody could make players pay for the consequences of their actions on
others.
• What if games are repeated, or it is possible to punish free-riders?
3. Players could not coordinate their actions beforehand.
• Change the rules of the game (institutions and policies)
C. Resolving social dilemmas
Social Preferences: Altruism
• Social dilemmas arise when players only care about their own payoffs.
• However, in experiments, many players show altruism by choosing the
dominated strategy (e.g. IPC, Deny) in the prisoners’ dilemma game.
• Altruism is an example of social preferences, preferences that place a
value on what happens to other people, even if it results in lower
payoffs for the individual.
•
Spite and envy are also social preferences.
• What if Anil and Bala had altruistic preferences?
Altruism in the Prisoners’ Dilemma (1)
• If Anil does not care about Bala’s wellbeing, his indifference
curves are vertical, so (T, I) is his most preferred outcome.
Altruism in the Prisoners’ Dilemma (2)
• When Anil cares about Bala’s
wellbeing, indifference curves are
downward-sloping and (I, I) is his
most preferred outcome.
• If Bala feels the same way, then the
two would both choose IPC, resulting
in the outcome that both prefer the
most.
• If people care about one another, social dilemmas are easier to resolve.
• However, altruism may not be sufficient with a large group of people.
Social Preferences: Other Types
• Reciprocity: Being kind/helpful to others who are kind/helpful, and vice
versa.
• Fairness (inequality aversion): Disliking outcomes in which some
individuals receive more than others
• We evaluate whether others have been ‘kind’ or ‘helpful’ according to
social norms (common understanding of how to act in situations when
one’s actions affect others).
These motives affect outcomes in the public goods game and the ultimatum
game.
Learning about Preferences
Economists sometimes use experiments to learn about preferences.
1. Lab experiments:
• Can control participants’ decisions and their outcomes.
• Can create a control/treatment group for comparison.
• Results can be replicated.
• Can control for other variables.
2. Field experiments:
• Lab experiments may not predict real-world decision making.
• More realistic context in which people make decisions.
Public Goods Game (1)
• There are a group of farmers.
• Each farmer decides whether to
contribute to the public good
(e.g. irrigation project)
•
Public good is a good for which
use by one person does not
reduce its availability to others.
• Contributing has a personal cost ($10), but everyone benefits ($8 each).
Public Goods Game (2)
• If the farmer only care about their
own payoffs, free riding is a
dominant strategy for each
farmer.
•
If all contributed, each gets $22.
• There is a dominant strategy
equilibrium: no one contributes
and earns zero payoffs, which is a
social dilemma.
• Public goods game is a prisoners’ dilemma game with more than two people.
Repeated games
• Anil and Bala’s game is a one-shot game.
• But ongoing relationships are an important feature of social interactions.
• Behaving selfishly in one period has consequences in future periods, so it
may no longer be a dominant strategy.
• Better outcomes can arise in repeated interactions due to social norms,
reciprocity, and peer punishment.
• We will explore repeated interactions in the public goods game.
Public Goods Game: Experimental Data (1)
• The experiments were conducted in cities around the world.
• Participants are randomly sorted into small groups of four people.
• Participants play 10 rounds of a public goods game, where they decide
on a contribution from their $20 to a common pool of money (a public
good).
• For every dollar contributed, each person in the group receives $0.40,
including the contributor.
• For example, if you do not contribute, and the other three in your
group contribute $10 each, you will get $32 (the initial $20 + 0.4 x $30),
and the other three will get $22 ($32 – contribution $10).
Public Goods Game: Experimental Data (2)
• Contributions were high in the
first period, although they vary
across cities.
• But contributions remain
positive until the tenth period,
although they decrease over
time. People are not solely selfinterested.
• It appears as if participants are punishing free riders by decreasing
contributions. Reciprocity is a better explanation than altruism here.
Public Goods Game: Experimental Data (3)
• Now participants can identify
and anonymously make freeriders pay $3, which cost
themselves $1.
• With the punishment option
available, the contributions
increased in most cities.
• This experiment illustrates the way that, even in large groups of people, a
combination of repeated interactions and social preferences can support
high levels of contribution to the public good.
The Ultimatum Game (1)
• The most common tool to study
social preferences is a two-person
one-shot sequential game known
as the ultimatum game.
• Proposer is given $100 and is told
to give a part of $100 to Responder.
• Responder can accept or reject the
offer.
• This game is a strategic interaction.
The Ultimatum Game (2)
• The ultimatum game provides insights
about sharing the economic rents that arise
in an interaction.
•
e.g. sharing profit between employer/
employees
• In a world of people who only care about
their own payoffs, we can predict:
•
•
Responder will accept any offer because
something is better than nothing.
Knowing this, Proposer would offer the
minimum possible amount.
The Ultimatum Game: Experimental Data (1)
• However, this prediction does not
match the experimental data.
• Better offers, fewer rejections.
• Results differ across the two
populations.
• Proposer may be motivated by
altruism, fairness, social norms, or
reciprocity.
• Offers are consistent with social
preferences, but also with expected
payoff maximization.
The Ultimatum Game: Experimental Data (2)
• What if we introduce two Responders, instead of one?
• Proposer offers a two-way split of $100 to two Responders.
• If no one accepts, no one gets anything.
• If one accepts, but not the other, that Responder and the Proposer get
the split, and the other Responder gets nothing.
• If both Responders accept, one is chosen at random to receive the split.
The Ultimatum Game: Experimental Data (3)
• The Responder in a competitive
situation cannot be sure if
rejecting the offer will punish the
Proposer, because the other
Responder may accept the low
offer.
• Introducing competition
between responders moves
outcomes closer to the selfinterested outcome.
• Changes in the rules of the game matter.
Coordination Issues
• When there is more than one Nash
equilibrium and individuals choose
independently, the socially optimal
outcome may not be selected.
• Society co