Archive for the 'collusion' Category

Apr 20 2012

UPDATE: Golden Balls, Game Theory, the Prisoner’s Dilemma, and the cold rationality of human behavior!

In my original “Golden Balls” blog post (see below), written almost three years ago after I saw a clip of the finale in an episode of the British game show, Golden Balls, I analyzed the actions of Sarah and Steve, who  had to decide whether they would split or steal a jackpot of 100,000 British pounds. The contestants had one minute to try to convince one another that they would split the money; but when it came down to it Sarah stole and Steve split, meaning Sarah got to keep the whole jackpot and Steve went home with nothing.

In that original post, I proposed that Steve’s best chances for going home with any money would have been “for him to use the one minute of discussion time to convince Sarah that he would choose SPLIT, yet be willing to go home with something LESS THAN $50,000 and accept that Sarah was going to choose STEAL. He could have threatened to chose steal if she did not agree to share her winnings with him to some extent.”

In a recent episode of the same game show, a contestant followed a similar strategy to that I suggested Steve should have taken. Watch the clip below, from a February 2012 episode of Golden Balls.

In this episode, Nick immediately takes control of the negotiations by insisting that he is going to steal, which is a very unorthodox approach to this game, in which the traditional strategy is to try and convince your opponent that you are going to split. By establishing a credible threat to steal, Nick puts all the pressure on Ibraham to decide only one of two things:

  1. Does Ibraham trust that Nick will split the money with him after he has stolen the full jackpot, and
  2. Would Ibraham rather both of them go home without any money at all than Nick win the jackpot and possibly not split it with him later on?
Nick’s strategy is brilliant. By the end of the negotiation, Nick has convinced Ibraham 100% that he is going to steal the money. Ibraham may only have had a confidence level of 50% that Nick was honest about splitting the money with him after the show, but with a 50% confidence level, Ibrahim’s possible payoffs are:
  • Choose steal and go home with nothing.
  • Choose split and have a 50/50 chance of going home with half the jackpot (based on his level of confidence in Nick’s promise to split the money after the show).
In other words, with a jackpot of 14,000 pounds, the payoffs for Ibrahim became:
  • If he splits: 0 pounds or 0.5(14,000) = 7,000 pounds
  • If he steals: 0 pounds or 0 pounds (assuming his confidence level in Nick’s intention to steal is 100%).
Clearly Ibraham now has a dominant strategy: to split. In the typical version of this game, a player’s dominant strategy is always to steal (as explained below), since the possible payoffs are:
  • If you split: 0 pounds or half the jackpot
  • If you steal: 0 pounds or the whole jackpot.
But because Nick has convinced his opponent that he will steal, and then split the winnings, Ibraham’s dominant strategy shifted to split, since the possible payoffs have changed. Ultimately, Ibraham does what is most rational given his confidence in Nick’s threat to steal, and that is to split. Ibraham then chooses split (as he should), but then to everyone’s surprise, Nick chooses split, not steal as he had threatened to do throughout the negotiation. This a surprising twist, since from Nick’s perspective stealing is clearly now a dominant strategy! Nick had convinved Ibraham to split, which means Nick faced a greater payoff by stealing. But by splitting, Nick shows that he had intended to split all along, but first needed to convince Ibraham otherwise to establish splitting as Ibraham’s dominant strategy.
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What a thrilling game! I won’t even bother getting into how this relates to economics today, I’m still shaking with excitement over the outcome!
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Original Golden Balls post:
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Teaching the Prisoners’ Dilemma Will Never Be the Same Again « Cheap Talk

Rarely does such a perfect illustration of the Prisoner’s Dilemma come along for Econ teachers to use in their classroom:

The payoffs are clear:

Each player has a weakly dominant strategy, which is to choose to steal. By choosing to steal, the player has a chance at maximizing his own payoff, but will do no worse than he would if his opponent also chooses to steal and at least will have the satisfaction of thwarting his opponent’s attempt to steal the money.

There are three Nash equilibria in the game, which are outcomes at which a player can not do better on his or her own by changing his or her strategy. The outcome Steve was hoping for by chosing “split” (50/50) was not a Nash equilibrium because Sarah knows she can do better if she chooses steal when Steve chooses split. Steve doomed himself by choosing split because he should know that Sarah’s dominant strategy is to choose steal. However, Sarah would also have doomed herself by choosing split because she should assume that Steve would also chose steal since steal is a dominant strategy for him too.

John Nash, who pioneered the field of Game Theory, assumed that humans were coldly rational, self-interested, deceptive creatures that would not hesitate to stab one another in the back to get what was best for themselves. His theory of human behavior is only partially proven correct in this game, in which Steve is shown to be the sucker and Sarah the coldly rational self-interested player. The best chance for Steve to go home with any money would have been for him to use the one minute of discussion time to convince Sarah that he would choose SPLIT, yet be willing to go home with something LESS THAN $50,000 and accept that Sarah was going to choose STEAL. He could have threatened to chose steal if she did not agree to share her winnings with him to some extent. Then again, any promise Sarah makes she could later break, thus further empowering the players to choose steal.

Discussion questions:

  1. What in the world is going on here? Why did Sarah choose steal rather than collaborate with Steve and share the $100,000?
  2. Was Steve totally wrong to choose split? What would you have done in his situation?
  3. How do the choices faced by Steve and Sarah relate to the choices faced by firms in oligopolitic markets? Now that you’ve seen this video, can you explain why collusive agreements between oligopolists often fall apart? Why do cartels such as OPEC often fail to achieve the high price targets agreed upon in meetings of their leaders?

110 responses so far

Sep 14 2010

Bali’s Oligopolistic Scuba operators

A few summers ago, my wife and I spent three weeks travelling around the island of Bali in Indonesia. For six of those days we rented a jeep and circumnavigated the island. Our first stop was for two days of scuba diving in the northeast region of Ahmed. As we drove along the seven beaches near Ahmed, we observed there were around ten dive operators offering packages for the local dive spots (including one of Asia’s most famous dives, the WWII-era USS Liberty wreck). Based on our Lonely Planet recommendation, we settled on Eco-Dive, where we paid $60 a day for two dives and all our gear rental. We felt good about this rate and agreed that $60 was a fair and competitive price for a day of diving.Jukung- traditional wind powered trimaran used for fishing in Ahmed

Our next stop, Pemuteran, a remote and relatively undeveloped area on the northwest coast just across the straits from Java, is also known for its great diving. On our first morning in Pemuteran, my wife and I strolled along the beach and found that there were only three dive operators to choose from! And guess what, they all charged between $95-$105 for a day of diving. That’s around 60% more than the operators in Ahmed charged! In the end, we decided to do only one day of diving in Pemuteran, and elected to spend our second day there reading by the pool.

Discussion Questions:

  1. What was the difference between the scuba diving markets in Ahmed and Pemuteran? Which market was more competitive? Which of the four market structures did the two markets most resemble: perfectly competitive, monopolistically competitive, oligopolistic or monopolistic?
  2. How were the dive operators in Pemuteran able to charge 60% more than the operators in Ahmed?
  3. What do you think is keeping one of the three dive operators in Pemuteran from lowering their price to, say, $60 for a day of diving? How would the other two operators respond? Would this be good or bad for the dive operators of Pemuteran? Would it be good or bad for scuba divers?
  4. Assuming that the cost of opening a dive operation was relatively low, and there were no government or other barriers to doing so in Pemuteran, what do you suspect will happen in the Scuba diving market as the tourism industry continues to develop in the remote town of Pemuteran? Explain.
  5. Which village’s dive operators do you think were more “efficient” in their use of resources? Explain.

50 responses so far

Jun 26 2007

Bali economics: “thinking like an economist” on the Island of the Gods!

Legong: a traditional dance practice in the artisan community of UbudIF you’ve visited this blog in the last two weeks, you’ve probably seen the picture below of a beautiful sunset, a distant island and a wispy palm. Turns out I stayed two nights on the beach that picture was taken from, Ahmed in Bali’s remote northwest corner! What a beautiful island Bali is! Unlike many touristy places in Southeast Asia such as Phuket and Samui in Thailand, Bali is an island paradise that has managed to develop a thriving tourist industry while simultaneously maintaining its distinct Hindu culture and traditions that awe visitors and help them understand why it’s called the “island of the gods”. Not only do most Balinese outside the one or two major cities still live in the traditional style houses, but they actively practice their unique form of Hinduism (imported from India via Java in the 11th century), maintain the traditional forms of dance and religious ritual, and sustain themselves by practicing any number of artistic trades rooted in the island’s rich and colorful history. Indeed, in most villages we passed through, it was hard to tell which buildings were temples and which were houses. As much of Indonesia and the rest of Asia have rushed head-on into the age of globalization (often meaning westernization), Bali has thankfully held on to and even fostered one very precious and all too rare commodity: its own history.Art is everywhere in Bali. These statues look over Ahmed's fishing fleet and protect fishermen on their risky voyages to sea.

Certainly after a year in Shanghai, where the closest thing to religion among urban Chinese is the pursuit of wealth, a couple of weeks in the rich spiritual heart of an ancient Hindu island culture was just what I needed to remind myself what was important in life. But alas, once an economist always an economist, and even with a thousand years of rich cultural heritage to turn my attention from school and economics, I could not help but notice the intricacies of Bali’s economy and how tourism and globalization have affected this remote island culture. My next few posts will cover casual observations made during my 16 day trip to Bali about its local economy and how it has been shaped by the global economy and tourism.

5 responses so far

May 18 2007

Federal Price Gouging Prevention Act: aka the “STUPID” bill

Here’s a follow-up to the previous post about stupid Americans acting stupid. Looks like the stupidity is not limited to the idiotic idea of boycotting gas for a day, rather it is alive and well among America’s leaders. Here’s the Democrats’ solution to the high gas prices faced by Americans today:

Join the Campaign to Change America / John Edwards ’08 Blog

“The ENERGY PRICE GOUGING PREVENTION ACT will provide immediate relief to consumers by giving the Federal Trade Commission the AUTHORITY to investigate prices–focusing on the causes, the burdens they put on American families and businesses, and solutions.”

And here’s an insightful and entertaining critique of the Democrat’s proposed bill by economist Tim Haab:

Environmental Economics: All politicians are idiots and other obvious thoughts on high gas prices

“There are two possibile explanations for the Democrats proposal of the STUPID bill. 1) They think the public is too stupid realize they are trying to “do something” by proposing a STUPID bill, or 2) They are idiots. Since Env-Econ readers obviously represent a cross-section of the public, and since Env-Econ readers are smart enough to know that this bill is STUPID, I have to conclude that 1) is logically impossible and therefore, 2) must be true. So we’ve now proven that Democrats are idiots. We’re halfway there.”

The stupidity of this proposed bill lies in the fact that Democrats seem to champion environmental protection, reduction of greenhouse gas emissions, and a solution to the global warming problem, while simultaneously fighting for regulations that REDUCE the price of greenhouse gas emitting fuel, the repeal of gas taxes, the expansion of oil refineries’ capacity, and other measures that will assure the cheapest gas possible for American drivers. The two goals are incompatible, as the solution to the greenhouse gas problem requires HIGHER gas prices, not lower gas prices.

What policy makers don’t realize is that “high gas prices are NOT an economic or political problem.” Markets allocate resources efficiently when markets are allowed to work. Higher gas prices reflect the basic economic law of scarcity, supply and demand. With developing countries like China demanding a greater proportion of world reserves than ever before, American drivers preparing for their summer road trips and a war raging in the middle east, higher prices at the pump should come as no surprise. Intervention in the gas market will result in greater inefficiency, as prices kept artificially low by government interfere with the market mechanism, increasing the quantity of gas demanded, and further exasperating the depletion of this scarce resource (not to mention contributing to the nation’s greenhouse gas emissions). The shortsightedness of legislators may only postpone the inevitable price rises of this resource for tomorrow’s consumers, while work in the complete opposite direction as they desire on the global warming front.FPGPA supporter

Ultimately, higher gas prices are necessary and desirable if we are to transition to more environmentally friendly fuel sources. As petrol reaches $4.00 per gallon, consumers will think more seriously about buying more fuel-efficient automobiles, using public transportation, choosing to cycle to work and taking other such steps towards reducing their carbon footprints. This, after all, is the only way Democrats will ever achieve their other supposed goal of avoiding the catastrophe of global warming and achieving greater energy independence; and this can only happen if gas prices continue to rise.

So what about “price gouging”? Concentration of market power among a handful of firms in the oligopolistic oil market may indeed result in some degree of collusion and setting of prices above equilibrium. This is inefficient, yes, but it occurs in a market in which, unregulated, equilibrium output and price would also be inefficient due to the existence of negative externalities. In other words, even were oil companies competing directly, the price would be too low and output too high since the price of gas does not include the full social cost of gas consumption. In a way, the inefficiency arising from excess market power corrects the inefficiency arising from the existence of externalities. The catch is this: consumers end up lining the pockets of oil companies rather than filling their own national tax coffers, since the higher price is a result of collusion rather than taxation.

What policy makers should be discussing is the imposition of new gas taxes, which, rather than only increasing the price consumers would pay, would reduce the ability of oil firms to price gouge, taking a chunk out of their “record profits” and turning it into tax revenues. These revenues could then be invested into research of new fuel technologies, the subsidizing of which would increase their supplies, making them more competitive as a substitute for petrol and thus more attractive to consumers. This helps politicians achieve their goal of energy independence and reduction of greenhouse gas emissions. Lower gas prices NOW will only postpone this important transition.

Here’s another clear presentation of why politicians should not meddle with oil prices: Knowledge Problem: Price Gouging – Politicians vs. Economists

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