Behavioral Game Theory

As the Russian economy heads towards tough times Putin seems to be pulling up the drawbridge. If Russia is going to prosper then, so the logic goes, it needs to rely less on foreigners and more on itself. This is a familiar nationalist argument that long pre-dates Putin. But it is one that economists have long tried to counter with the logic of comparative advantage.         Simply put comparative advantage says that a country should produce what it is relatively good at. To give an example suppose that both a barrel of oil and a tablet computer sell for $100 on international markets. If it costs Russia $40 to produce a barrel of oil and $100 to produce a tablet then Russia should produce oil because this is where it has a comparative advantage. Crucially this logic holds even if Russians only want tablets. For instance, with $400 of cash they can produce 10 barrels of oil and trade these on the market for 10 tablets. Or, they can produce 4 tablets themselves. Clearly 10 tablets is

Stamp duty is a tax on house purchases. And it will surely go down in history as one of the most badly designed taxes ever. Why? Because, until last week, the tax operated in bands that applied to the full purchase price. For example, if a house sold for £249,999.99 then it was taxed at a rate of 1% meaning a tax of £2,500. If the price increased by two pence to £250,000.01 then it was taxed at a rate of 3% meaning a tax of £7,500. So, a two pence rise in purchase price meant a £5,000 increase in tax!          Clearly such a tax is highly distortionary. No one was going to buy a house for £251,000. House prices, therefore, inevitably clustered at the bands of £125,000, £250,000 and £500,000. There was also the clear incentive to circumvent the tax. For instance, to buy a house for £249,999 but then agree to pay £10,000 for the living room curtains.          In the Chancellor's Autumn Statement stamp duty was finally reformed . The current slab system was replaced with a syste

The death of Australian cricketer Phillip Hughes shocked everyone. It serves as a powerful reminder that safety at work, whether it be the sport's field or a gold mine, is not something that should be left to the discretion of individual workers. This point has been most powerful made in recent years by Robert Frank whose argument rests on the notion of positional externalities.              To illustrate the point consider the game below where two cricketers have to independently decide whether to wear a helmet. The best joint outcome is for them to both wear a helmet (and get a payoff of 10 each). There is, however, an advantage - this is the positional externality - from not wearing a helmet when the other cricketer does (and get 12 to his 0). The advantage comes from increased performance or, in economic speak, from increased productivity and the consequent higher wage. This incentivizes neither player to wear a helmet. Which is a bad outcome for everyone.          

This week's edition of the economist had an interesting article  on the knock-on effect the Ebola outbreak is having across Africa. Safari bookings, for instance, are dramatically down on previous years. This seemingly makes no sense: the traditional safari hotspots are further away from and less connected with the effected areas than most European capitals. Through the lens of bounded rationality, however, such an 'ignorance epidemic' is much easier to explain.        To explain, consider the Jackson family deciding where to go on holiday this year. Suppose that a safari in Tanzania is the best. Then, in the world of the economic textbook, a safari maximizes utility and the Jacksons would set off for Africa. And reality?         Deciding where to go on holiday is undoubtedly going to be a difficult choice because of the almost limitless possibilities to choose from. So, the Jacksons are not going to maximize utility. The best they can realistically aim for is satisfic

I recently attended a conference session that ended with a debate on whether social preferences should be taken into account when measuring social welfare. That might not sound like a particular exciting issue but I think it's an interesting and important one. So, lets look at the issues.          We can all agree on the idea that social welfare should guide policy. A policy can be considered good if and only if it improves social welfare. The difficulty is measuring social welfare. How can we reconcile the differing desires and preferences within a population? How can we take into account the desires and preferences of future generations who will be influenced by a policy? And so on.            The presence of social preferences, such as envy and altruism, muddies the waters even more as the following example illustrates. Robinson and Friday are the only people living on a desert island. Robinson is selfish and envious. Friday is altruistic and generous. You arrive with a boa

The prisoners dilemma is probably the most well known product of game theory. Typically, the game is used to illustrate the difficulty of sustaining mutual cooperation. But, as the name may suggest, it also raises questions about justice and the legal system. A recent article in the economist suggested that power has swung too much in favour of the prosecution in the US justice system. The prisoners dilemma can help us understand how easily this can happen.        Suppose that Fred and William are arrested by the police in regard to a serious crime. The two are put in separate rooms and questioned. There is clear evidence that they committed a minor crime but the evidence regarding the serious crime is weak. The basic options open to the two suspects are to deny the serious crime or confess but blame the other suspect. If they both deny then they will receive one year in jail for the minor crime. If both confess then they will receive ten years in jail for the serious crime.     

The Scottish independence referendum has finally taken place with a comfortable majority voting no to independence. The result is, however, somewhat bizarrely being interpreted as a 'clear call' for greater devolution. Why bizarre? We have gone from four million Scots being asked a yes, no question 'should Scotland be an independent country' to the conclusion that a majority of the sixty million people in the UK want greater devolution to the regions, and they want it before March 2015! Surely there is not a better way to judge the 'will of the people'?        The answer, unfortunately, is 'probably not'. And the main reason why is the difficulty of making inter-personal utility comparisons. What we have here is a problem of collective choice. A single decision has to be made, e.g. Scotland becomes independent or it does not, but that decision will affect many . Some people stand to benefit a lot from independence and some stand to lose a lot from in

The recent killing of journalist James Foley has reignited the debate over paying hostage ransom demands. The US, British and many other governments have a clear policy of not paying ransom demands. Does that policy make sense?         The policy has a clear rationale in game theory. To see why consider the very stylized game below. The game begins with the kidnappers deciding whether or not to kidnap. If they kidnap then the hostage's representatives have to decide whether or not to pay the ransom. The numbers give the payoffs to the hostage takers and the hostage's representatives. If the hostage takers do not kidnap then payoffs are 0. If they kidnap and the ransom is paid 100 is transferred from the hostage's representatives to the hostages. If they kidnap and the ransom is not paid then the hostage takers pay some small cost of 10 while the hostage's representatives pay a big cost of 200.                The payoffs in the game are clearly somewhat arbitr

Petrol prices are one of the more interesting and accessible examples of demand and supply at work. With prices written in bright luminescent letters by the roadside it is a simple task, while driving along, to appreciate the variety of prices on offer. And an interesting economic problem to try and explain that variation in price.          A recent road trip gave us chance to compare prices  in a few European countries. It was pretty obvious that prices were higher in Germany than in Austria or Switzerland and higher in Austria and Switzerland than in Luxembourg. These broad differences primarily reflect differences in tax . What I found interesting, however, was that German prices appeared to be squeezed near the borders with Austria and Luxembourg. Anecdotally, at least, it seemed that prices got lower the closer we got to the border. If true, that would be a very nice example of tax incidence at play.         Tax incidence is a fantastic economic concept. But it is also very p

The UKs National Institute of Health and Care Excellence has a basic remit of evaluating the costs and benefits of medical treatment. Last week, it emerged that NICE will change its guidelines so that more people with Type 2 diabetes will have access to gastric bypass surgery. I think it is fair to say that the reaction to this news was not particularly positive. So, has NICE got its sums wrong?        Evaluating the costs and benefits of medical treatment is always going to be a controversial and thankless task. Just about any decision is likely to upset someone. For instance, telling a cancer patient that her treatment is not 'cost effective' is clearly not going to be popular. But, from the other side, saying that gastric bypass surgery is 'cost effective' did not go down well with taxpayers. So, keeping everyone happy is impossible. That does not mean, however, there are not right and wrong ways to measure costs and benefits. And, there seems to be an increas

We were recently passing Stonehenge and so stopped off to see what the new visitor's center was like. Given that we are members of English Heritage it was free for us to visit. Most visitors, though, were stumping up the standard entry fee of £13.90. And, to put it bluntly, £13.90 seemed like a bit of a rip-off.          Why a rip-off? Stonehenge is a truly remarkable site. It is arguably best seen, however, from the many paths in the surrounding countryside - and these are completely free for anyone to walk. The entry ticket only gets you a 'little bit closer' to the stones. And I'm not sure that's worth £13.90. To put things in context I would make the comparison with Dover Castle (another English Heritage site). Dover Castle is more expensive at £19.30 but you get a whole lot more for your money - castle, wartime tunnels, museums, sea views etc. I would guess the average visitor to Stonehenge probably spends around 30 minutes at the stones while the average vi

The Lochaber Mountain Rescue team in Scotland recently had to rescue someone who fell after setting off up one of Scotland's highest mountains in flip-flops. This looks like a textbook example of moral hazard. Moral hazard arises whenever someone (the principal) 'employs' someone else (the agent) to do a job and the agent takes 'more risk' than the principal would like. In this case mountain rescue essentially 'employs' people to not be dumb in the mountains, but too many of us are dumb in the mountains.           But, here's an interesting issue: In the textbook story of moral hazard the agent takes proper account of incentives. So, a person takes greater risk in the mountains because he knows  that mountain rescue will save him. On this account, scrapping mountain rescue might negate the need for mountain rescue.          I would be surprised, however, if the three men involved in this story knew a great deal about Lochaber Mountain Rescue. Inste

In the last month or so I seem to have come across a lot of discussion on how to reduce use of antibiotics. The basic claim seems to be that we are entering a worrying stage where antibiotics lose their power to stop common infections. Only by reigning back our use of antibiotics can we avoid falling into the abyss. But how do we reign back our use of antibiotics? It is typical to refer to the tragedy of the commons when exploring the options available to us. Personally, however, I feel the tragedy of the commons is a misleading way of looking at the problem with antibiotics. Let me explain.            The tragedy of the commons can arise whenever there is a resource that is limited in supply (rivalrous in the jargon of microeconomics) but that can be harvested by anyone (non-excludable). Water, fish, clean air and grazing land are the textbook examples. The tragedy is that we end up overusing the resource because each individual harvests as much as he wants, ignoring the negative

Recently I read the book Climate Change Begins at Home by David Reay. It makes for an entertaining read and persuasively argues that every family can substantially cut its greenhouse gas emissions. I particularly liked how the book puts the focus of tackling climate change on individual behaviour. Way too much climate change debate is about governments making agreements, even though such agreements are basically worthless. Governments can do little: it's individuals that pollute, and it's individuals that need to pollute less!         The arguments Reay put forward in his book did, however, seem a bit naïve when it came to economics. He made the case, which one often sees, that cutting back on emissions is a win-win scenario. If a family uses the car less, uses the air conditioning less, goes for a local holiday rather than flying half way around the world, buys less plastic gadgets, and so on, then they benefit the environment and save money. At the level of the family th

A recent issue of Nature had a special report on obesity. One of the articles looked at the merits of  behavioural interventions in tackling obesity and came to a somewhat pessimistic conclusion. In particular, the article pointed to evidence that behavioural interventions produce only short term gains - weight loss over the first 6 to 12 months but creeping weight gain thereafter. This is bad news for anyone wanting to tackle obesity. It also raises questions about the general benefits of behavioural interventions.         And this second point is especially interesting given that behaviour change is very much a buzz idea at the moment. Richard Thaler and Cass Sunstein have done most to publicize the idea with their book Nudge , but they are by no means the only advocates. The popularity of behaviour change stems largely from its seeming simplicity and cost effectiveness: people's decisions are effected by the way choices are framed and so framing choices in a particular way

Recently, in the Premiership football, Crystal Palace beat Cardiff City 3-0. Nothing particularly unusual about that. But it subsequently came to light that Crystal Palace had used underhand means to obtain the Cardiff team line up ahead of schedule . Cardiff, obviously, cried foul play. This incident reminded of the 2008 Ryder Cup golf when Nick Faldo was photographed with a set of team pairings. In that case there was no foul play. There was, though, the notion that the US gained from knowing the European pairings.        To make sense of why it may, or may not, be useful to know an opponents strategy we need to look at mixed strategies. To illustrate, consider the simple matching pennies game below. Europe can choose two possible team line ups, A or B, and the US can also choose two possible line ups, X or Y. If Europe chooses Team A and the US Team X then Europe wins (which is why Europe gets payoff 1 and the US payoff -1). If Europe chooses Team A and the US Team Y then the US

In the UK budget a week or so ago the Chancellor surprised most by announcing a radical shake up of the UK pension system. According to the old system retirees, with a private pension plan, were essentially forced to buy an annuity that would smooth income over their remaining life. Under the new system retirees can withdraw the money and spend it as they wish. So, if they want to splash out on a Lamborghini sports car then fine (according to the pensions minister).             What has interested me most about the pension changes is the public reaction. Immediately, people began questioning whether it made sense to let retirees have freedom of choice. Are pensioners capable of make informed rational decisions about how to spend their savings? Will they not blow it all and be left to live out their lives on state support? To most people it seemed obvious that some might make dumb, inappropriate choices. And, for me, this illustrates how divorced from reality economic theory has be

Saturday morning I heard a somewhat intense debate on the radio about whether a mother should breast-feed in public. The debate was sparked by an incident in a restaurant where a breast-feeding mother was asked to ' use a blanket '. Views were completely polarized. Some, like me, thought it outrageous to criticize someone for breast-feeding in public. Others, thought it outrageous to breast-feed in public! This polarization of views is a perfect illustration of the reciprocal nature of externalities, first pointed out by Ronald Coase.         The 'textbook' picture of an externality is typically one of good and evil, like a factory polluting the water that local people drink. The clear suggestion is that the evil doer, the factory in this case, should take account of the effect they have on others. Often, however, externalities do not lend themselves to a simple good and evil. That's the case in the breast-feeding example: Some would place the breast-feeding mot

One of the most basic and intuitive ideas that has come out of the behavioural change literature is the opt-in versus opt-out distinction. Essentially, because of psychological bias, people are likely to end up 'choosing' the default option. So if, for example, the default option is to not be opted into a pension savings plan a person is likely to end up not saving enough for retirement. This simple observation partly motivated the save more tomorrow plan that stands to revolutionise retirement saving.         A context where default options are often used strategically is check boxes on online (or hard copy) forms. Suppose, for example, you want to travel from London to Birmingham and go to book your ticket online. If you are going by train then once you've sorted out the times of the trains etc. you will be offered the chance to buy basic travel insurance. In this case the box is not ticked and so the default option is no travel insurance - you have to click a mouse bu

Every four years, as the Winter Olympics hits town, a sizable proportion of the British population falls in love with the sport of curling. And that offers the chance to look afresh at game theory's 'first big result' - the Minimax Theorem.         Curling is often called 'chess on ice'. But, that analogy only goes so far because chess is a game of complete information and curling is not: If a chess player intends to move a bishop to E4 then we can be pretty sure he will move it to E4. He is not going to mistakenly move it to D3, and a gust of wind is not going to move it F5. Curling, by contrast, involves both skill and luck. Skill is required to put the stone where it was intended. And luck is needed because debris on the ice can deflect a stone, and so on. So, while chess is a pure game of strategy, curling is a game of strategy, skill and luck.            The fact that chess is a pure a game of strategy makes it relatively easy to analyze. It is no surprise

The last few decades have seen a huge rise in testing and performance monitoring within the English education system. The latest installment is a call for testing of four year olds when they enter the school system. The objectives of such policies are fine enough - this one, for example, will supposedly allow teaching to be more tailored to students needs. There are, however, two big problems with testing in schools. In short these are that: (i) Tests are often poor measures of what is being assessed. (ii) Tests change incentives. Let me elaborate on each of these problems in turn.        How can you measure ability? Exams and tests provide a simple to administer measure. They provide, however, a very, very noisy measure - in other words they often give the wrong impression. And the earlier one does testing the more noisy it is surely going to be because children naturally develop at different speeds. The fact, though, that tests can be wrong is not, in itself, a problem. The probl

Over christmas I had chance to read the book Running with The Kenyans by Adharanand Finn. In short the book is about a British guy's experience of immersing himself for six months in the Kenyan running culture. A recurring theme throughout the book is the question of why Kenyan's have come to dominate long distance running. The answer clearly depends on a number of things like high altitude, running to school etc. But the main thing seems to be a culture of running. Kenyans run because that is what Kenyans do. So, what has that got to do with economics?        There can be no doubt that Kenyan athletes take running very seriously. In other words they put in hours and hours of training (and perhaps more importantly put in hours and hours of dedicated rest). An economist would think of this as human capital formation. All the hours of dedication to running are about the person improving their ability to run fast so that he or she can eventually win some races and make some mo