ECON 601: ADVANCED MICROECONOMICS

LECTURE 1: PRESENTATION

MICROECONOMCS ; Behaviour, institutions, and

evolution-Samuel Bowles

27/02/2023
 SOCIAL INTERACTIONS AND INSTITUTIONAL
DESIGN
• The meadow example illustrates the difficulties that arise when attempting to coordinate
and execute a complex collective action among a large group of people […the ease of
communication and mutual accountability between two individuals is not easily replicable
on a larger scale] - free riding increase with population size.

• On the hand, while people may have a general understanding of the importance of
cooperation [e.g. the case of seed planting in the palanpur region ], it can be difficult to
maintain commitment in the face of individualistic interests or distractions. - social
dilemma or coordination problem.

• Therefore, economists argue that by addressing these coordination problems may improve
individuals well-being in society.

• By understanding how social interactions can be structured; people are free to choose
actions while avoiding outcomes that none would? – classical constitutional conundrum.

• Avoiding outcomes that none would choose is known as pursuit of pareto efficiency
outcome.
 CONT’
• Due to externalities in society, uncoordinated activities tend to persist as the spill
overs are not usually taken care of by the owner. The ? Is what rules governing
interactions among people would ensure individuals pursue their personal
interests while being able to take care of their own external costs?

• Therefore, achieving socially beneficial outcomes in almost all social

interactions with coordination problems depends on the underlying structure of
the interaction, i.e., Factors and rules influencing interactions including level of
information asymmetry. Hence it becomes difficult to solve such problems as
assumptions of fundamental theorems may not apply.

• An adequate analysis of coordination problems is more elaborate by modelling

game theory as a general equilibrium analysis is not sufficient
 COORDINATION AND CONFLICT: AN EXAMPLE
• Tragedy of the commons and Smith’s invisible hand are metaphors that
counter argue on two important social interactions though very important.
• However, Garrett Hardin (1968);Tragedy of commons applied it to situation in
which externalities exists i.e. individuals are not responsible of their own spill
overs.
• An example is Tragedy of the Fishers: A Prisoners’ Dilemma case.

CHALLENGES OF THE
SITUATION

• If they have to agree to fish for 6hrs, they

may have no way of enforcing an
agreement, or even knowing if the
agreement has been violated-asymmetric
or unverifiable information.

• If they agree to fish less hours, they could

u1 divide 8 to 4 hrs. making it to 12, but the
problem would arise on allocations of
fishing time and distribution of the
benefits of fishing less hrs.
 CONT’
• opportunities and dilemmas of the fishers
• {1,1} are a feasible payoffs, any
agreement will be within the area
abcd
• Point d would be achieved if Jay
fishes 8hrs and Eye fishes 6, which
eye would not agree.
• Suppose Jay offers to fish 6hrs a
fraction of the time equal to u and 8
the rest, while requiring Eye to fish
6hras all the time.
• Eye may accept as he could gain 1
during u and u for the rest.
• Eye may only accept such offers for
the yield cf. Jay is 1st Mover
• Hence only fcg are pareto efficiency
or pareto improvement agreements.
 CONT’
• Given the possible large number of contracts (fcg), available, Eye may not agree
to any but could do if the 6hrs was the only contract possible.

• In this case, only a third party would settle such a problem, i.e. government to
imposes a limit on the hrs to fish and the fishers could bargain within their reach.
- …this may mean a change to the pay off matrix of the interaction.

• However, even bargaining becomes complex as the fishers may be face several
problems such as who to give offers, ownership of property rights, information
asymmetries, including norms that affect the conflict.

• Game theory brightens such social dilemmas or coordination problems.

 GAMES
• Games are a way of modelling strategic interactions, where the consequences of individuals’
actions depend on the actions taken by others.

• Every game has players, strategies or strategy profile, rules (order of play, information).

• Game theory contributes to the study of economic institutions and behaviour through :
a) Analysing individuals action influenced by one or more parties to an interaction.
b) provides a clear way of expressing insights for understanding the role of particular assumptions in a line of reasoning.

• Normal form of a game implies that there is an implicit sequence of actions to each player,
otherwise it is an extensive form of a game.

• While classical game theory stresses forward-looking cognitive evaluations by the players,
evolutionary game theory stresses rule-of-thumb behaviours updated by a backward-looking
learning process, based on players recent experience.

• Dominance and Nash equilibrium are solution concepts in CGT purporting; will not happen and
No incentives to deviate respectively - Based on he notion of a best response strategy.

• Pure strategies are actions in game chosen with certainty while mixed strategy a probability
distribution over pure strategy actions.
 CONT’
• Let n be the number of players, i = 1, 2…n and be a strategy set for each player.
If player chooses a particular strategy s , then represents all other strategies by
other players, then () is the payoff for player j under the ) strategy profile.

• Strategy s is the best response strategy of player j to other player's strategies if:
() (, ) , , , case of a weakly dominant strategy
() (, ) , , case of a strict dominant strategy

• A dominant strategy equilibrium is a one in which all players in the game have at
least a dominant strategy. A Nash equilibrium is a strategy profile in which all
players’ strategies are best responses to the other (no incentives to deviate).
Iterated dominance is a procedure by which a player may eliminate from
consideration any of the other players’ strategies that are strictly dominated.
 STRUCTURE OF SOCIAL INTERACTIONS
• Social interactions are in many ways described by game theoretical terminologies
eg:
a) cooperative and non cooperative games—refers to the institutional structure
governing the interaction. Cooperative games comprise of cases where agreements
are binding to players involved while non binding agreements are classified as non
cooperative games

b) common interest and conflict games—refers to the extent to which the game’s
payoffs exhibit conflict or common interest among the players. pure common
interest game is a case in which the outcome of the game can be parato ranked while
pure conflict game occurs when all possible outcomes are Pareto optimal (Zero sum
game & Division game)
Pure Conflict payoffs:
Machining pennies game
 CONT’
• For asymmetric games, there is a natural measure of common interest as opposed
to conflict. Given by assumuming the tragedy of the fishers problem. Where
represents conflict in interest, and represents common interest.
• The distinction and example's can be presented as below:
 CONT’
• Another important aspect of an interaction is whether it can be repeated in many
period with same players or not. (Repeated games or One –short games)

• Interactions (Games) can also be named after a number of players involved. [Two
player game (dyadic games) or n-player games]

END