1. Game Theory & The Public Sector Principles of Microeconomics 2023 Boris Nikolaev

2. Pacal’s Wager
Should I believe in God?

3. What is Game Theory? Games Players (actors) Strategies (actions)
Strategic interaction between people.
E.g. Stalin & Hitler, Kruschev & Kennedy.
Assumptions (rationality, self-interested).
Players (actors)
Strategies (actions)
Payoffs (associated with the strategies)

4. Example: The Prisoner’s Dilemma Game
review

5. Solving the Game payoffs for B when A stays “silent”
A “betrays” B

6. Strict Dominance

7. Nash-Equilibrium

8. Economics in Dilbert & the Classroom
Dilbert gets caught in a prisoner’s dilemma
He mistakenly believes that his coworkers will deviate from the dominant strategy
[watch here]

9. Advertising Advertising Costly Purpose: increase product demand
If both firms advertise, expenses go up, but demand increases; each cancels other out
“Arms race” of advertising

10. Cigarette Advertising on TV
In 1970, Congress enacted a law making cigarette advertising on TV illegal
Reasoning: too many ads being seen by children and teens
Goal: reduce smoking among all ages
Unintended consequence
This actually increased the economic profits of cigarette makers
The law ended their prisoner’s dilemma of advertising
Before the law was passed manufacturers spent $300 million on advertising—$60 million more than they spent the year after the law was enacted. Much of this saving in advertising expense was reflected in higher profits at the end of the year.
But if eliminating advertising made them more profitable, why didn’t they do it on their own? Once again, because advertising was a dominant strategy.

11. Weak Dominance
Game Theory in the Dark Knight [watch here]

12. Split or Steal
[watch here] and [here]

13. Trust Games

14. Escaping the Prisoner’s Dilemma
The Nash equilibrium in prisoner dilemma games may give the best short run payoffs
However,
Many games are repeated
This repetition occurs over a longer time span
Dominant strategies may not consider long-run benefits of cooperation

15. Tit-for-Tat
- A long run strategy designed to create cooperation among participants
Strategy: mimic the decision your opponent made in the previous round.
Changes the incentives and encourages cooperation
Useful because interactions in life occur over the long run. Relationships between people and businesses involve mutual trust.

17. Paper, Rock, Scissors
[ watch here ]
[ how to win?]

18. The Penny Game We will simultaneously choose H or T
If I pick H and you pick H, then I win.
If I pick H and you pick T, you win.
If I pick T and you pick T, then I win.
If I pick T and you pick H, you win.
What is the solution of this game?

19. Mixed Strategy vs Pure Strategy
Pure Strategy – specific action that the player follows in every possible attainable situation of the game (it’s not random).
Mixed Strategy – possible moves and a probability distribution which corresponds to how frequently each move is to be played. (use mixed strategy only when indifferent between several pure strategies, and when keeping the opponent guessing is desirable)

20. Practice Question
How can a pure strategy Nash equilibrium be accurately described?
It is always the overall best outcome
It’s an outcome in which neither player wants to change strategies
It can only be reached by collusion
One exists in all games

21. The Chicken Game
[watch here]

22. Provision of Public Goods
2 self-interested players that have two strategies: steal or not steal.
simultaneous game (players don’t know how the other person will act)
steal
not
A / B I II 1
steal 1 5
III IV 5 3
not 3

23. Results/ Implications
Dominant Strategy
Nash-Equilibrium
Is it Pareto efficient?
3. Which is the optimal solution? And how do we get there?
ONE REASON TO HAVE A GOVERNMENT IS ALLOCATIVE EFFICIENCY

24. Results/ Implications
5. System of property rights + procedures to enforce them is a type of SAMUELSONIAN PUBLIC GOOD = is one that is non-excludable in consumption. A PURE PUBLIC GOOD is one that is both (1) non-excludable in consumption, and (2) non rival (e.g. National Defense). 6. What happens if we repeat the game (have a SUPERGAME)? Axelrod computer (real) simulations  the cooperative solution emerges. Why do we need a government then? 7. When you expand the game it becomes virtually impossible to detect the cheater. This gives incentive for FREE RIDING. 8. DEMOCRACY as an institution for collective choice is needed only in certain communities by size, impersonability.

25. Coordination Games R L I II 1 R 1 III IV 1 L 1 A / B
2 drivers on a narrow dirt road are approaching each other. They have one of two options: go right (R) or left (L).
A / B R L I II 1 R 1
III IV 1 L 1

26. Results/ Implications
Dominant Strategy: NO DOMINANT STRATEGY.
MULTIPLE Nash-Equilibriums (no solution of the game).
GOVERNMENT AS A COORDINATION MECHANISM.
The building of the manhatan bridge 1909

27. Class Demonstration
How does this activity demonstrate the concept of externality?
Is this a positive or a negative externality?
Why?

28. Gulf of Mexico Oil Spill (2010)

29. The Pacific Gyre Garbage Patch
[see here]

30. The Aral Sea
Once the 4th largest freshwater lake. Today it’s mere 10 % of its original size (lost 23 meters.)

31. Pollution in China
[see here]

32. Externalities negative positive
Definition: unintended side-effects from actions that are otherwise useful (non-market exchange).
Externalities could be negative or positive. For example:
Air pollution
Overfishing
Nuclear waste
Education
Vaccination
Pollination
negative
positive

33. Graphical Analysis (- externality)

34. Graphical Analysis (+ externality)

35. How to correct this market failure?

36. Problems with Pigovian taxes
How do you measure the external cost/benefit?
Political influence [money in politics]
Can externalities solve themselves?

37. The Coase’s Theorem
In the absence of transaction costs, an efficient outcome will be achieved regardless of how property rights are assigned.
Coase’s theorem gave rise to the field Law and Economics.
Sparks from railroad trains setting wheat fields on fire. Two ways to solve problem: (1) spark catching attachments or (2) don’t plant next to railroad. The outcome?
Bee keepers and farmers.

38. The Race for Candy 50 pieces of candy is the sustainable population.
The population will double every round up to its sustainable level
The person who collects the most candy will get 5 extra credit points on their final exam.
If you collect more than 3 pieces of candy you will get 1 point.

39. The Tragedy of the Commons
"That which is common to the greatest number has the least care bestowed upon it." Aristotle
(Scientific evidence suggests that we are fishing at 50 percent above the limit for sustainable exploitation of oceans).
(The Aral sea – the cost of cotton)

40. The Common Pool Problem
Common pool goods are rivalrous but non-excludable (e.g. irrigation systems, forests, fish, hunting game, water, etc…)
If you can take as much as you want without paying anything you have the incentive to free ride.
Common pool resources are subject to the problem of congestion, overuse, pollution, and potential destruction.
Government as a mechanism to prevent “the tragedy of the commons.”
Elsinore Ostrom (she won the Nobel Prize in 2009) observes that local communities come up with solutions to this problem via different institutional arrangements (i.e. there is no need for government).

41. Redistribution The diminishing marginal utility of income
Social insurance
Stabilize the economy

43. The Public Sector

44. Federal Debt
Real time debt clock [see here] [debt clock breaks]

45. At a reading rate of 4 minutes per page, 2
At a reading rate of 4 minutes per page, 2.6 people would have to read for 40 hours per week for a year just to keep up with the new rules and pronouncements.

46. Where do we go from here?
Juan Enriquez on mind boggling science [watch here]