More on this book
Community
Kindle Notes & Highlights
Bangladeshi economist Muhammad Yunus (b.1940) was awarded the 2006 Nobel Peace Prize for his answer to this problem – founding the Grameen Bank and pioneering the concept of microcredit to help the poor gain access to financial markets.
To allow access to credit markets, Yunus solves the problem of lack of a commitment device by giving the poor microcredit (small loans) in a pooled manner – loans to a connected group of people rather than to an individual. Each applicant in the pool then makes sure that the other applicants invest in safe projects.
One potential solution to this problem is to delegate the retaliation decision to someone who is likely to be motivated by revenge or by a duty to follow the prearranged procedure. This will ensure that retaliation is a credible threat.
A second way of making the threat of retaliation credible is to give many individuals the option of initiating an overwhelming strike. This is the proliferation solution. Then, when the enemy is contemplating an attack they must gauge the chance that at least one of these people is motivated by revenge. The more people who have the ability to launch a retaliatory strike, the more likely it is to happen. If retaliation is likely, then there will be no attack in the first place.
Hollywood has suggested a third option to solve this problem: the retaliation decision could be completely automated, guaranteeing a counterattack. This is the premise of the “Doomsday Device” in Dr. Strangelove, the “War Operation Plan Response” in WarGames and “Skynet” in the Terminator films.
In all walks of life people make decisions where their information is either imperfect or incomplete, or both. This has important implications for the strategic interaction between players, especially if one side is better informed than the other.
A manager may have imperfect information about an employee’s habits. If the employee doesn’t make progress in a task, the manager doesn’t know whether to blame the employee or to believe that it’s a particularly difficult task.
Persistent unemployment presents a puzzle for standard economic analysis: if there is unemployment, then for each job opening there are many applicants. In that case, firms can offer lower wages and still fill all vacancies. With lower wages, hiring is cheaper and firms employ more workers. It seems like wages should eventually adjust downward to the point where the number of people who want to work equals the number jobs.
If there is no unemployment and the firm offers the same market-clearing wage as other firms, then the worker will try his chances with shirking.
In order to encourage workers to work hard, a firm has to give them something to lose if they get caught shirking. It can do this by offering higher wages than workers could get elsewhere. These high efficiency wages can induce efficient output from the workforce.
If it can’t provide believable, direct information about product quality, a high-quality firm may need to find a device to signal its quality to the consumer. For this to work, the signal must be some observable action that a high-quality firm can take but that would not be worthwhile for a low-quality firm.
Advertising may also serve as a quality signal if the firm is selling a repeat-purchase product, such as shampoo. This is because the return on investment from advertising is different for products of different quality.
the benefit from advertising is much higher for a firm producing a high-quality product since new customers will make repeat purchases. For the same advertising expense, a firm selling a low-quality product can get only one-off purchases from first-time customers. Therefore, a high level of advertising can only be profitable for a firm with high-quality goods.
Consumers observing an expensive advertising campaign can infer that the firm would only have advertised if it knew that its product would generate repeat purchases. Hence consumers use advertising as a signal for high quality.
Rational decision makers have transitive preferences. This means that if a decision maker prefers alternative A over alternative B and prefers alternative B over alternative C, it must be that he or she prefers A over C (the symbol “>“ means “preferred to”): So A > B and B > C implies A > C However, even when all group members are rational, group preferences can be non-transitive. That is, for groups, A > B and B > C does not necessarily mean that A > C!
“Arrow’s Impossibility Theorem”. It shows that, for groups which are not run by a dictator, there will always be the possibility of some situations where group preferences are non-transitive, where we reject a choice that may be better for everybody or where irrelevant options change our choice. These problems are inherent in group decision making.
