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 mark...

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.      ...

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 ...

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...

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. R...

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 t...

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 benefi...