Detailed summary based on unit 4 of The
Economy CORE textbook. Analysis includes in-depth explanation using diagrams for game theory. Summarises the important concepts (those covered by lectures necessary for exam purposes) namely 4.1, 4.2, 4.3 and 4.13.
§ Game
§ Best response
§ Dominant strategy equilibrium
§ Social dilemma
§ Altruism
§ Inequality aversion
§ Nash equilibrium
§ Prisoners’ dilemma
Context:
§ Previous models of choice (unit 3) did not depend on others’ decisions
§ 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 (create social dilemmas)
→ why do these problems arise? what can we do about it?
4.1 SOCIAL INTERACTIONS: GAME THEORY
• Social dilemmas
= a situation in which actions taken independently by self-interested individuals
result in a socially suboptimal outcome
e.g. traffic jams, climate change
> Occur when people do not fully account for the effects of their actions on others
1. Tragedy of commons → common property or common resources are often
overexploited
2. Free riding → one person/party bears all the costs while everyone enjoys
the benefits
• Solutions to social dilemmas
How can altruism and government policy resolve social dilemmas?
> Humans have faced – and attempted to solve – social dilemmas for millennia
> Social dilemmas can sometimes be resolved by:
§ Social preferences (like altruism)
§ Repetition (that harnesses reciprocity)
§ Institutions (that punish bad behaviour or reward good behaviour)
e.g. Fines in Finland are determined relative to income
• Social dilemmas and game theory
> Devising policies to promote people’s wellbeing requires an understanding of
the difference between
§ Situations in which self-interest can promote general wellbeing AND
§ Situations in which self-interest leads to undesirable results
, > We can use the tools of game theory – a way of modelling how people
interact
– to model social interactions and explain social dilemmas
• Game theory
> Game theory = study of strategic interaction among ration decision-makers
> Games are models of players’ strategic interactions
> Types of games:
1. Co-operative VS non-cooperative
→ co-operative = players are able to form binding commitments that are
externally enforced
→ non-cooperative = players cannot form alliances or agreements are
self-enforced
2. Simultaneous VS sequential
→ simultaneous = players move simultaneously, or if they do not move
simultaneously, are unaware of the other player’s
actions
→ sequential (or dynamic) = later players have some knowledge about
earlier actions
e.g. the ultimatum game or labour discipline model → information
doesn’t have to be perfect
3. One-shot VS finitely played VS infinitely played
4. Discrete VS continuous
> Normal form of a game:
§ Matrix form
§ Shows:
- Players (2)
- Feasible strategies = an action that a person may take when they are
aware of the mutual dependence of the results for
themselves and others
- Payoffs = the outcomes depend on both players’ actions
> Strategic interaction = when, in a social interaction involving two or more
people (players), people are aware of how their actions
affect both their own and other’s outcomes, and vice
versa
> Strategy = an action that a player may take in a social interaction i.e. when
they are aware of the mutual dependence of the action on
themselves and others
> A game states the payoffs earned by players for every possible combination of
strategies
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