Behavioral Game Theory

Travel agents have recently reported a new money making scam . The basic idea is to set up a bogus website selling chalet holidays in ski resorts, or to more simply sell a chalet holiday that does not exist. This scam particularly caught my attention because we often book online chalet holidays! And the emotions reading about it aroused were primarily ones of fear and mistrust - this could happen to us and so maybe we should not buy holidays online anymore. The costly-to-fake principle is a nice way to try and make sense of all this.        In any economic transaction there is an element of uncertainty, because you cannot have perfect trust in the person you are trading with. When we book a ski holiday we have to put some faith in the travel agent to deliver what is being promised. Similarly the travel agent has to put faith that we will pay on time and not trash the chalet. Ideally we would like to reduce uncertainty as much as possible by trading with people we think we can trust.

Depending on where you live the Sony PlayStation4 is either available or will be soon. Microsoft's Xbox One will follow shortly. Reviewers argue over which is best in terms of graphics, controller and the like, but the general consensus seems to be that they are pretty similar. They are not, however, similar in price! The PlayStation4 is around $100 cheaper than the Xbox. Of course, making like for like comparisons on price is difficult because Microsoft are offering things Sony are not and vice-versa. But, even so it is interesting to explore why Sony might want to come in with a lower price.       Let's start by supposing Sony has a monopoly - they are the only games console maker. Sony has to set a price to sell the console and a price to sell games. In the parlance of micro theory this is a two part tariff where the console is a fixed cost and the games are a user cost. To make the most money Sony should set the price of games equal to marginal cost and set the price of

A report published last week by the Waste and Resources Action Programme (Wrap) showed that British families are throwing away around £60 worth a food a month. This report comes hot on the heels of figures from supermarket giant Tesco showing it generated almost 30,000 tonnes of food waste in the first six months of the year. Apparently 68% of bagged salad ends up in the bin, and 20% of bananas. Clearly, this does not look like an efficient outcome. Which raises questions about why it happens and how we can stop it.       To most the answers seems obvious - consumers are making biased choices and need help to stop doing so. For example, food journalist Joanna Blytham is quoted as saying consumers are being 'ripped off' by supermarket promotions: "What we could say to consumers is 'wise up' ..... The minute you walk into the supermarket you may be able to get a few bargains but, more likely than not, you'll be nudged into buying stuff you didn't really

The median voter theorem is a workhorse of public choice and helps make sense of political manoeuvrings. Informally, the theorem says that if preferences are single peaked then the median voter will be on the winnings side of any majority vote. To say that preferences are single peaked essentially means that the vote is on a 'one dimensional issue' whereby that the closer is the outcome to a person's ideal then the happier they are. This naturally lends itself to talking of left wing, right wing and the centre ground. The median voter is then the person in the middle. And that is why the median voter will always be on the winning side: If the median voter prefers the 'left wing' option then the median voter and everyone to the left will vote for that option and it has a majority. Similarly, If the median voter prefers the 'right wing' option then the median voter and everyone to the right will vote for that option and it has a majority.       If the media

The anchoring effect recognizes that people's judgements (and choices) can be biased by things they come across before making the judgement. The most well known discussion of the anchoring effect is due to Ariely, Loewenstein and Prelec and their paper entitled 'Coherent arbitrariness: Stable demand curves without stable preferences' . Through six experiments they showed that valuations and experiences can be influenced by arbitrary anchors.     The first experiment that they discussed is the one that typically grabs the headlines. Subjects were shown six different products - a computer mouse, keyboard, average wine, fine wine, Belgian chocolates and a book. Having been introduced to the products, subjects were asked if they would buy each product for a dollar amount equal to the last two digits of their social security number. So, if the last two digits of your social security number are 52 you would have needed to say whether you wanted to buy the box of Belgian chocol

Labour leader Ed Milliband hit the headlines this week with his plans to freeze energy prices if elected into power in the 2015 UK general election. The response was pretty fervent. But can a price cap work?    The microeconomics textbook says that price caps are almost always a bad idea. To understand why it is interesting to see how labour defended the plan. Or, more properly, I should say how labour did not defend the plan. When questioned about the merits of the price freeze every shadow minister I heard reeled off a long list of reasons why the energy market is failing. What I never heard once was a minister argue that the price freeze will solve any of the market failures. And that's the problem, a price freeze will not solve any of the market failures! It will just make them worse.    For example, I heard several spokespmen bemoan the fact the market is dominated by only six firms. Put aside for the moment that six firms is more than enough for competition to work, will a

For those unfamiliar with cottage holidays, the ideas is pretty simple: You rent a house, bungalow, or beach hut for a week or more, make yourself at home, relax and enjoy. What I want to explore is how different the experience feels in the UK and Denmark.       When you arrive at a cottage in the UK you can expect ample supply of toilet rolls, kitchen towels and logs for the fire. There will almost certainly be a library of books, CDs, DVDs and local maps for you to enjoy. Bed linen is provided free of charge. At one cottage we recently went to there was a complimentary bottle of wine.      Contrast this with Denmark. Here you have to pay for any electric, water and gas you use. Don't expect any toilet rolls or kitchen towels, let alone a complimentary bottle of wine. There's no library. Bed linen, or anything else, comes with an extra charge.       Which system would you prefer? The economist in me says that I am supposed to prefer the Danish system. All the 'compl

   It is apple season for another year. The trees in the village where I live are packed full of tasty, fresh, organic apples. And, most of them are going to be left to fall to the ground and rot! Which I think is a great waste. I also think it is a great example of the sunk cost fallacy in action.     Here's the issue: Consider someone called Mark who goes out to the supermarket and buys some apples. He will almost certainly eat those apples and go out of his way to not waste them. Mark, however, ignores the apples growing in his garden and does not think twice about letting them go to waste. Why does Mark save the apples he bought and not the apples  growing in his garden?     You might say it is a difference in quality; but, the apples in my garden are easily as tasty as those in my local supermarket. You might say it is the difficulty of harvesting the apples; but, it takes seconds for me to harvest 20 apples from my garden. The difference, therefore, must be psychological

In recent work with Amrish Patel we model giving to charity using a signalling game. With this approach a person is assumed to give to charity in order to signal some desirable trait about herself such as generosity or wealth. To many this approach seems quite a cynical one. It seemingly paints a picture of very strategic giving. Do people not give to charity because they want to make the world a better place?       What I want to try and convince you of here is that a signalling game approach actually paints a nice picture of giving - strategic, but not overly cynical.       Here is how a simple signalling game works: There are two types of people - generous and not-generous. The generous want to make the world a better place. The not-generous do not care. Society likes generous people. It likes them enough that it is willing to reward them in same way. This could be through esteem, status, or a greater willingness to help them when they need help, etc.       Notice the 'n

A ring that once belonged to Jane Austen came up for auction recently and was bought by US singer Kelly Clarkson for £150,000. The UK government has, however, subsequently put a ban on the singer taking the ring out of the country . The Culture Minister said 'I hope that a UK buyer comes forward so this simple but elegant ring can be saved for the nation.'       This is clearly the kind of policy that will split opinion. Some are going to think its important to save our heritage, and some will think it stupid to stop the sale of a ring worn by an author who died nearly 200 years ago. What does amuse me, however, is that just about every spokesperson I have heard criticising the policy appeals to economic theory to back up their case. Listening to them talk you could easily get the impression that hard-headed economic logic leads to only one conclusion - sell the ring. This is wrong!       The basic argument I heard more than once goes something like this. Kelly Clarkson pa

I have finally got around to reading Daniel Kahneman's book Thinking Fast and Slow . It is a fantastic read. It brilliantly sets out how Kahneman and Tversky revolutionized the way we think about human judgement and decision making. But, here's the question I was left asking myself - why has the work of Kahneman and Tversky had so little impact in economics? That question might sound bizarre given that Kahneman won the Nobel Prize for Economics (Tversky had died). As far as I can see, however, the insights provided by Kahneman and Tversky have largely been ignored. So, what's gone wrong?         In his book Kahneman points to prospect theory as one idea economists have endorsed. True enough, their paper on prospect theory is one of the most cited papers in economics. Cites, however, are different to real impact. And very, very little research in economics has properly applied prospect theory. Indeed, given that the original paper is a pretty tough read, I would be surpr

It is the weekend of the British Open Golf Championship. And yesterday there was a fair amount of discussion about slow play. Slow play is annoying in golf because one player taking their time holds up everybody else on the course. The referees have the power to counteract this by putting a player on the clock. Which basically means the player will be timed and penalized for taking too long. Yesterday, the referees put lots of players on the clock and penalized Japanese golfer Hideki Matsuyama. A similar thing happened at this years Masters Championship where 14 year old Chinese Golfer Guan Tianlang was penalized .       What interested me about the slow play discussion was the reaction of the players and commentators. All were in agreement that play had been to slow and that 'something needs to be done about it'. But mention a name, such as Matsuyama, and all were also in agreement that 'he was treated very harshly'. That sounds contradictory. There were only 40 or

We have just got back from the PET13 conference in Lisbon. On the day of our arrival in Lisbon we were tired and hungry and desperately seeking food. A stroll in the vicinity of the hotel finally revealed a local corner shop selling fruit and essentials, and we were saved. We were also pleasantly surprised by the price. Our expectation was to pay a lot, because we'd bought a lot and because the shop owner was presumably going to rip off the unknowing tourist. It was pleasant surprise, therefore, when the bill came in well below our expectations.        In all likelihood the shop owner did add a bit of 'unknowing tourist profit' to the price. But who cares? We, as customers, were very happy to pay the price we did. And the shop owner was presumably happy to charge the price he did. Everyone is a winner. Indeed, this is a textbook story of exchange - a buyer and seller exchange goods for mutual benefit. From a textbook point of view, the really curious thing about this exc

A few months ago the Deputy Prime Minister Nick Clegg was expounding on the benefits of a security bond for visitors to the UK . The basic idea was that visitors to the UK would have to deposit some money with the government and they would get the money back when they left. I was hoping the plan would be quietly dropped, and it seemed to have been. But, unfortunately, the story is back and now looks worryingly likely to happen. Visitors from a select list of countries, including India and Nigeria, will be expected to deposit £3,000 with the UK government if they want to visit the UK. The government's policy on immigration has been a disaster for many years, but the idea of a security bond seems to be taking up a notch the level of stupidity.         To put this plan for a bond in context we need a bit of background. A large proportion of the UK electorate is anti-immigration. The current coalition government's answer is to bow to the electorate and promise a tough line on i

The UK's National Health Service seems to have been constantly in the news in recent months for the wrong reasons. One issue has been waiting times at Accident and Emergency Departments. The government's target is to treat 95% of patients at A&E departments within 4 hours. Whether or not the target is met has become a general indicator of pressure within the NHS. Recently the government missed the target . But, how useful are such targets?       Let us look at a hypothetical A&E department at 6pm on the 2nd July 2013. The waiting room is full of people. To be efficient we need to work out the benefit of treating each patient and compare that to the cost. The benefits and costs are shown in the diagram below. To illustrate how the benefit side works we can pick out two of the patients: David has had a heart attack and needs treatment or he will die, while Brian has sprained his ankle playing football. The benefit of treating David far exceeds that of treating Brian. O

The latest issue of the Hargreaves Lansdown Investment Times arrived in the post last week. As always it was full of advice on which investment funds are good bets for your money. Adherents to the efficient market hypothesis would suggest that such investment newsletters are basically a waste of time. But, I always enjoying reading through my copy of the Investment Times. So, why can investment newsletters be useful?        To answer that question let's start by explaining why investment newsletters are supposed to be useless. The efficient market hypothesis says that stock, commodity, bond, fund prices etc. should always reflect all the information available at that time. If, therefore, a freely available, published newsletter claims 'here's a great opportunity to invest' it shouldn't remain a great opportunity by the time you get the newsletter! The person writing the newsletter, for one, has an incentive to act on the advice. By the time you get the newsletter

I was flicking through a magazine yesterday when I saw an advert for the travel company Great Railway Journeys. The advert caught my eye because it guaranteed that 'you'll never pay more than last-minute bookers. If we reduce a holiday price for any reason, we'll give the same saving to anyone who has already booked'. To someone brought up on the microeconomics textbook this can sound a bit weird. The textbook tells us that price discrimination - charging different people a different price for the same good - is one of the main ways a company can increase profit. So, why would a company guarantee that it will not discriminate?      Last minute deals are an example of second-degree price discrimination. This is where a company knows there are different types of buyer but cannot tell them apart. By offering a menu of packages the company can potentially get customers to reveal their type and charge them accordingly. To illustrate: Holiday makers may differ in their wil

It is a year since Facebook launched shares on the Nasdaq. They were launched at $38 per share and now stand at a lowly $26. Anyone who bought a share would have lost 30% of their money.    At first sight this looks like a classic example of the winners curse. The winers curse captures the idea that the winner of an auction often loses money. IPOs (initial public offerings) are a textbook example of this. Here's the basic logic: If you ask 1000 investors to put a value on Facebook then the average valuation will probably be about right. But, shares are not sold to average investors. They are sold to the investors willing to pay the most. So, what really matters are the valuations of the most optimstic investors. And while the average investor will get the value about right, the most optimistic investors will not. They will overvalue the company and consequently pay too much. This is the winners curse: the investors who 'win the auction' to get Facebook shares would have

Earlier this week it the headlines that NICE (the National Institute for Health and Care Excellence) were recommending midwives use a carbon monoxide test to verify whether expectant mothers were smoking. Suitable fury from smokers followed. The proposal, however, is based on pretty sound economics.     The relationship between a child and parent is a principal-agent relationship. The basic idea of any such relationship is that a principal 'employs' an agent to do a 'job' for her. Its fine to interpret 'employs' and 'job' very loosely. In this case we can think of the unborn child as employing the mother to protect her growth and development. Clearly it is in the best interests of the child that the mother quit smoking, eat healthily etc. The mother, however, has different incentives. And, there were lots of mothers I heard on the radio this week determined to carry on smoking regardless. This is an example of a moral hazard problem: The agent, in thi

One of the big problems with US health care is the large number of uninsured people. A lack of insurance is costly for the state given that someone has to pick up the bill for all necessary treatment on uninsured patients. And its costly for society given that ill health can cause personal bankruptcy for anyone uninsured.    To fix the problem you need to know what is causing it. There are three basic causes. In looking through these its useful to have the following figure to hand. On the horizontal axis we plot the publicly observable health of the person, which might include things like weight, age, illness in the family etc. These are things the insurance company will take into account when assessing risk. On the vertical axis we plot the privately known health of the person, which also takes into account things like diet and exercise. These are things the insurance company would like to know but cannot, only the person knows. Each dot in the figure is a particular person. Most peo

Yesterday West Ham United Football Club were essentially given the London 2012 Olympic Stadium for the bargain price of £15 million. True, they will not own the stadium, and will have to pay rent. But, this does nothing to alter the basic fact that West Ham has been handed a bargain.    And its a bargain deal that has annoyed many. The Stadium cost around £500 million to build and converting it into a football stadium is going to cost at least another £100 million. Most of this funding has come from the taxpayer. So, on face value it looks like the UK taxpayer is giving a football club a very big gift - a £600 million stadium for £15 million. To make sense of this we need to think about sunk costs and bargaining.      Let's look at sunk costs first. The stadium was built for the London Olympics, and not the benefit of West Ham. Spending £500 million on the stadium was, therefore, arguably money well spent by the British taxpayer. But times move on: the London Olympics has long