Unit 4 - Social Interactions

Question 1

Game Theory

Answer 1

• Game theory models the way people interact
• Social and strategic interactions - situations in which there are two or more people, and the actions taken by each person affects both their own outcome and other people’s outcomes
  -Social dilemmas
  –> Occur when people do not take adequate account of the effects of their decisions on others, whether these are positive or negative

Question 2

Altruistic self-sacrifice

Answer 2

individuals that sacrifice themselves for others

Question 3

The invisible hand game

Answer 3

• Example posed in textbook: farmers Anil and Bala who must decide to produce either rice or cassava
• The farmers must determine the division of labour, who will specialise in which crop
• They determine this independently, no discussion over the course of action
• Diagram indicates the payoffs for both parties in all different situations
• Because the market price falls when it is flooded with one crop, they can do better if they specialise compared to when they both produce the same good
• When they produce goods they would both do better if each person specialised in the crop that was most suitable for their land

Question 4

Best response

Answer 4

gives the player the highest payoff, given the strategies the other players select

Question 5

Dominant Strategy

Answer 5

provides the highest payoff for one player, regardless of what the other does

Question 6

Dominant Strategy Equilibrium

Answer 6

• Indicates the outcome when both players play their dominant strategy
• The decision is not based on what the other does - but on what the payoff is

Question 7

Prisoners Dilemma

Answer 7

• A prisoner’s dilemma is a situation where individual decision-makers always have an incentive to choose in a way that creates a less than optimal outcome for the individuals as a group.
• The prisoner’s dilemmas occur in many aspects of the economy.
• The contrast between the invisible hand game and the prisoners’ dilemma shows that self-interest can lead to favourable outcomes, but can also lead to outcomes that nobody would endorse

Question 8

Social Preference

Answer 8

• When people generally do not only care about what happens to themselves, but also what happens to others
• These individuals have social preferences that are based of altruism

Question 9

Altruistic preference

Answer 9

A person who is willing to bear cost in order to help another person is said to have altruistic preferences

Question 10

Indifference curve according to social preferences (how it changes)

Answer 10

• An indifference curves alters in its shape when the individual has different social preferences
• A completely selfish individual will have a vertical indifference line that shifts vertically as they increase their own payoff with no regard for the other
• An altruistic person will have a convex indifferent line as this indicates their well-being being impacted by their consideration for the other person

Question 11

convex indifferent line

Answer 11

An indifference curve being convex towards origin means that slope of the curve declines as the consumer moves along the curve from left to right.

Question 12

Public good

Answer 12

when one individual bears a cost to provide the good and everyone benefits from the provision of the good

Question 13

Free Riding

Answer 13

assuming others will choose their dominant strategy, one relies on the actions of others to reap the benefit of the outcome without making any sacrifice themselves

Question 14

Free rider problem

Answer 14

Example: farmers buying into an irrigation system from which all would benefit.

• There is a dominant equilibrium strategy in which no one contributes and their payoffs are all zero.
• On the other hand, if everyone contributed, everyone would benefit from this.
• However, each farmers does better by free riding on the others (so they don’t invest into the irrigation themselves, the others do and they still benefit from it)
• This public goods game is a prisoners’ dilemma in which there are more than two players.

Question 15

How do economists learn about consumers’ preferences?

Answer 15

• Survey questions: used to determine political preferences, brand loyalty, degree of trust of others, or religious orientation

–> The problem with surveys is that people will not always answer honestly

• Statistical studies of economic behaviour: purchases of one or other goods when relative to price varies, to determine preferences for the goods in question

–> Statistical studies cannot control the decision-making environment in which the preferences were revealed, so it is difficult to compare the choices of different groups

Question 16

Cooperation

Answer 16

• Cooperation means participating in a common project in a way that mutual benefits occur
• Cooperative outcomes occur in instances with the invisible hand, the prisoner’s dilemma and the public goods game

Question 17

Negotiation

Answer 17

• People commonly resort to negotiation to solve their economic and social problems
• But negotiation does not always succeed because there is conflict of interest in the way that gains of cooperation will be shared

Question 18

Social norm

Answer 18

Dividing something equally is often a social norm, but some people act more selfishly

The effects of altruism, fairness and reciprocity are social preferences that heavily influence the way people act

Question 19

Ultimatum game

Answer 19

• a two-person one-shot game
• The subjects of the experiment are invited to play a game in which they will win some money.
• How much they win will depend on how they and the others in the gameplay
• There are two players - the Proposer and the Responder
• The proposer is given an amount of money and instructed to offer the responder a part of it (pie)
• The responder knows the proposer has been given that specific amount of money, and indicates the minimum amount they will accept
• If the offer is rejected, they both get nothing; if the offer is accepted, they split the money how the proposer wanted
• This is a sequential game - one choice happens after the other
• This is a game about sharing the economic rents that arise in an interaction.

Question 20

Nash Equlibrium

Answer 20

• if everyone is playing their best response to the strategies of everyone else
• Gives a prediction of what we should observe, that all players do the best they can given what others are doing
• There may be more than only one nash equilibrium
• Nash Equilibrium represents an action profile for all players in a game and is used to predict the outcome of their decision-making interaction.
• It models a steady state (i.e., a combination of strategies of all players) in which no player can benefit by unilaterally changing its strategy.

Question 21

Competition in the ultimatum game

Answer 21

• With competition responders are less likely to reject an offer
• their behaviours are more similar to what we would expect of self-interested individuals concerned mostly about their own monetary payoffs

-Even fair minded people will accept low offers to avoid having the worst of both world

Question 22

Cobb-Douglas production function

Answer 22

A Cobb-Douglas production function models the relationship between production output and production inputs (factors). It is used to calculate ratios of inputs to one another for efficient production and to estimate technological change in production methods.