Unit 4

SOCIAL INTERACTIONS
OUTLINE

A. Introduction
B. Game Theory: Key concepts
C. Resolving social dilemmas
A. Introduction
 The Context for This Unit
• Previous models of choice did not depend on others’
decisions. (Unit 3)
• 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.

• Why do these problems arise?
• What can we do about it?
 Let’s play
• Public goods game
• Log in to ClassEx:
1. Go to https://classex.uni-passau.de/bin/ or use this link
2. Select: Università degli studi di Milano – Microeconomics IPLE – participant
3. Enter password: VwlI (copy and paste from here)
• Read the instructions
• Answer the comprehension questions
• Other quiz questions on Wooclap…
 This Unit
Use the tools of game theory to model social interactions
and explain social dilemmas
Carbon emissions from fossil fuels
10000

Social dilemma = a situation in 9000

which actions taken 8000

7000

independently by self-interested 6000

individuals result in a 5000

4000

socially suboptimal outcome e.g. 3000

traffic jams, climate change

2000

1000

0
1750 1800 1850 1900 1950 2000
 This Unit
Social dilemmas occur when people do not fully account for the
effects of their actions on others.

• Tragedy of the Commons: Common property or common

resources are often overexploited
• Free riding: One person/party bears all the costs while
everyone enjoys the benefits

How do societies resolve social dilemmas?

• Altruism, government policy, local informal institutions, or international
ones: examples?
B. Game theory: Key concepts
 Social and Strategic Interactions
• Social interaction: A situation involving more than one person/party,
where one’s actions affect both their own and other people’s outcomes.
• Strategic interaction: A social interaction where people are aware of the
ways that their actions affect others.
• Strategy: Action(s) that people can take when engaging in a social
interaction.
• Game theory: A branch of mathematics that studies strategic interactions.
 Game
• A game describes a social interaction:
1. Players – who is involved in the
interaction
2. Feasible strategies – actions each
player can take
3. Information – what each player
knows when choosing their action
4. Payoffs – outcomes for every
possible combination of actions
 Example: Crop choice
• Two farmers decide which crop to specialize in.
• They interact only once (one-shot game).
1. Players – Anil and Bala.
2. Feasible strategies – Rice or Cassava
3. Information – Each farmer does not know
what the other chose (simultaneous game).
4. Payoffs (represented in the payoff matrix) –
depend on market prices and quality of land
• When supply of a crop increases, its market price
decreases
• Anil’s land is suited for cassava, Bala’s land for rice
Question 4.1
 Optimal decision-making
• Best response: Strategy that yields the
highest payoff, given the other player’s
strategy
• Dominant strategy: A best response to all
possible strategies of the other player (does
not always exist!)
• Dominant strategy equilibrium: An
outcome of a game in which everyone plays
their dominant strategy
 Crop choice example
• Best response: If Bala grows rice, Anil’s best
response is to grow cassava. If Bala grows
cassava, Anil’s best response is to grow
cassava.
• Dominant strategy: Anil’s dominant
strategy is to grow cassava. Bala’s dominant
strategy is to grow rice.
• Dominant strategy equilibrium: When Anil
and Bala each play their dominant strategy,
the outcome is (Cassava, Rice).
 Crop choice example
• Dominant strategy equilibrium: each
farmer’s action does not depend on what
the other farmer does, although his payoff
does
• In this game, the pursuit of self-interest
results in an equilibrium that is:
• the best of the four possible outcomes for each
player
• the strategy that yielded the largest total
payoffs for the two farmers combined
 Nash equilibrium Different pay-offs

Nash equilibrium: A set of strategies

(one per player), such that each player’s
strategy is the best response to the
strategies chosen by everyone else.
In a Nash equilibrium, no player has an
incentive to deviate unilaterally.
NOTE: There may be more than one
Nash equilibrium in a game
 FIND THE NE OF THIS GAME
 Nash equilibrium Different pay-offs

Nash equilibrium: A set of strategies

(one per player), such that each
player’s strategy is the best response to
the strategies chosen by everyone else.
In a Nash equilibrium, no player has an
incentive to deviate unilaterally.
NOTE: There may be more than one
Nash equilibrium in a game.
Question 4.2
 Summary
1. Social interactions can be modeled as games
• Players choose best responses to others’ strategies

2. Social dilemmas e.g. prisoners dilemma, can be resolved by

social preferences, peer punishment, or binding agreements
• The rules of the game also matter for outcomes

3. Multiple Nash equilibria can cause coordination problems

• Economic and political institutions can help achieve socially
optimal outcomes
 Homework
• Watch Elinor Ostrom’s video on ‘Sustainable development and the
tragedy of the commons’ and read about her on CORE

• Watch the video on the show Golden Balls

• Readings: Unit 4.3-4.7 included