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December 2, 2019 - January 22, 2020
SCREENING AND SIGNALING
Economists usually argue that cash is superior to transfers in kind, because the recipients can make their own optimal decisions to spend cash in the way that best satisfies their preferences, but in the context of asymmetric information, in-kind benefits can be superior because they serve as screening devices.5
Signaling by Not Signaling
Everything you do sends a signal, including not sending a signal.
Their insight is that in some circumstances, the best way to signal your ability or type is by not signaling at all, by refusing to play the signaling game.
The very fact that they are signaling is a signal that they are trying to differentiate themselves from some other type that can’t afford to make the same signal. In some circumstances, the most powerful signal you can send is that you don’t need to signal.*
BODYGUARD OF LIES
As Churchill famously said (to Stalin at the 1943 Tehran Conference) “In wartime, truth is so precious that she should always be attended by a bodyguard of lies.”
When playing mixed or random strategies, you can’t fool the opposition every time. The best you can hope for is to keep them guessing and fool them some of the time. You can know the likelihood of your success but cannot say in advance whether you will succeed on any particular occasion. In this regard, when you know that you are talking to a person who wants to mislead you, it may be best to ignore any statements he makes rather than accept them at face value or to infer that exactly the opposite must be the truth.
Actions do speak a little louder than words. By seeing what your rival does, you can judge the relative likelihood of matters that he wants to conceal from you. It is clear from our examples that you cannot simply take a rival’s statements at face value. But that does not mean that you should ignore what he does when trying to discern where his true interests lie. The right proportions to mix one’s equilibrium play depend on one’s payoffs. Observing a player’s move gives some information about the mix being used and is valuable evidence to help infer the rival’s payoffs. Betting strategies in
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PRICE DISCRIMINATION BY SCREENING
Cooperation and Coordination FOR WHOM THE BELL CURVE TOLLS
THE ROUTE LESS TRAVELED
Then in 1873 Christopher Scholes helped design a “new, improved” layout. The layout became known as QWERTY, after the letter arrangement of the first six letters in the top row. QWERTY was chosen to maximize the distance between the most frequently used letters. This was a good solution in its day; it deliberately slowed down the typist, and reduced the jamming of keys on manual typewriters.
bandwagon effects,
The adoption of QWERTY, gasoline engines, and light-water reactors are but three demonstrations of how history matters in determining today’s technology choices, though the historical reasons may be irrelevant considerations in the present.
The important insight from game theory is to recognize early on the potential for future lock-in—once one option has enough of a head start, superior technological alternatives may never get the chance to develop. Thus there is a potentially great payoff in the early stages from spending more time figuring out not only what technology meets today’s constraints but also what options will be the best for the future.
what this suggests is that short but intense enforcement can be significantly more effective than the same total effort applied at a more moderate level for a longer time.10
The impeccably conservative economist Milton Friedman made the same logical argument about redistribution of wealth in his classic Capitalism and Freedom: I am distressed by the sight of poverty; I am benefited by its alleviation; but I am benefited equally whether I or someone else pays for its alleviation; the benefits of other people’s charity therefore partly accrue to me. To put it differently, we might all of us be willing to contribute to the relief of poverty, provided everyone else did. We might not be willing to contribute the same amount without such assurance. In small communities,
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When actions are taken in a piecemeal way, each step of the way can appear attractive to the vast majority of decision makers. But the end is worse than the beginning for everyone. The reason is that voting ignores the intensity of preferences. In our example, all those in favor gain a small amount, while the one person against loses a lot. In the series of ten votes, each junior associate has nine small victories and one major loss that outweighs all the combined gains. Similar problems tend to plague bills involving reforms of taxes or trade tariffs; they get killed by a series of
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There is a second, quite different moral to the Justin-Case story. If you are going to fail, you might as well fail at a difficult task. Failure causes others to downgrade their expectations of you in the future. The seriousness of this problem depends on what you attempt. Failure to climb Mt. Everest is considerably less damning than failure to finish a 10K race. The point is that when other people’s perception of your ability matters, it might be better for you to do things that increase your chance of failing in order to reduce its consequence. People who apply to Harvard instead of the
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Consider three people all looking for a taxi in Manhattan. Though they start waiting at the same time, the one at the most uptown position will catch the first taxi going downtown, and the one located farthest downtown will catch the first uptown cab. The one in the middle is squeezed out. If the middle person isn’t willing to be usurped, he will move either uptown or downtown to preempt one of the other two. Until the taxi arrives, there may not be an equilibrium; no individual is content to remain squeezed in the middle. Here we have yet another, and quite different, failure of an
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First we looked at games in which each person had an either-or choice. One problem was the familiar multiperson prisoners’ dilemma: everyone made the same choice, and it was the wrong one. Next we saw examples in which some people made one choice while their colleagues made another, but the proportions were not optimal from the standpoint of the group as a whole. This happened because one of the choices involved spillovers—that is, effects on others—which the choosers failed to take into account. Then we had situations in which either extreme—everyone choosing one thing or everyone choosing
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Turning to situations with several alternatives, we saw how the group could voluntarily slide down a slippery path to an outcome it would collectively regret. In other examples, we found a tendency toward excessive homogeneity. Sometimes there might be an equilibrium held together by people’s mutually reinforcing expectations about what others think. In still other cases, equilibrium might fail to exist altogether, and another way to reach a stable outcome would have to be found.
Inferior standards may be behavioral rather than technological. Examples include an equilibrium in which everyone cheats on his taxes, or drives above the speed limit, or even just arrives at parties an hour after the stated time. The move from one equilibrium to a better one can be most effectively accomplished via a short and intense campaign. The trick is to get a critical mass of people to switch, and then the bandwagon effect makes the new equilibrium self-sustaining. In contrast, a little bit of pressure over a long period of time would not have the same effect.
Sometimes creating a price can solve the problem, as with congestion on the Bay Bridge. Other times, pricing the good changes its nature. For example, donated blood is typically superior to blood that is purchased, because the types of individuals who sell their blood for money are likely to be in a much poorer state of health. The coordination failures illustrated in this chapter are meant to show the role for public policy. But before you get carried away, check the case below.
Bidding in an auction requires a strategy—though many people think all they need is a paddle. That leads to problems when people bid based on emotion or excitement.
They live to regret it. To do well in an auction setting requires a strategy. Should you bid early or wait until the auction is almost over and then jump in? If you value an item at $100, how high should you bid? How do you avoid winning the auction but then regretting that you’ve over-paid? As we have discussed before, this phenomenon is known as the winner’s curse; here we’ll explain how to avoid it.
The only hard part is determining what is meant by your “value.” What we mean by your value is your walkaway number. It is the highest price at which you still want to win the item. At a dollar more you would rather pass, and at a dollar less you are willing to pay the price, but just barely. Your value might include a premium you put on not having the item fall into a rival’s hands. It could include the excitement of winning the bidding. It could include the expected resale value in the future. When all of the components are put together, it is the number such that if you had to pay that
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Values come in two flavors, private and common. In a world of private values, your value for the item doesn’t depend at all on what others think it is worth. Thus your value of a personalized signed copy of The Art of Strategy doesn’t depend on what your neighbor might think it is worth. In a common value situation, the bidders understand that the item has the same value for all of them, although each might have a different view as to what that common value is.
VICKREY AUCTION
second-price auction,
The winner doesn’t pay his or her bid. Instead, the winner only has to pay the second highest bid.
REVENUE EQUIVALENCE
Buyer’s Premium
ONLINE AUCTIONS
Sniping
Bidnapper
BIDDING AS IF YOU’VE WON
A powerful idea in game theory is the concept of acting like a consequentialist. By that we mean to look ahead and see where your actions have consequences. You should then assume that situation is the relevant one at the time of your initial play. It turns out that this perspective is critical in auctions and in life. It is the key tool to avoid the winner’s curse.
Our point is that you should presume the answer will be yes at the time you pop the question.
This idea of presuming you’ve won is a critical ingredient to making the right bid in a sealed-bid auction.
In a sealed-bid auction, you are supposed to bid as if you’ve won. You’re supposed to pretend that all of the other bidders are somewhere below you. This is exactly the situation you are in when competing in a Dutch auction.
The way we describe a preemption game suggests a duel and that analogy is apt. If you fire too soon and miss, your rival will be able to advance and hit with certainty. But if you wait too long, you may end up dead without having fired a shot.*
THE WAR OF ATTRITION
your bidding strategy all depends on what you think they are doing, which in turn depends on what they think you are doing. Of course you don’t actually know what they are doing. You have to decide in your head what they think you are up to. Because there’s no consistency check, the two of you can each be overconfident about your ability to outlast the other. This can lead to massive overbidding or massive losses for both players.
Our suggestion is that this is a dangerous game to play. Your best move is to work out a deal with the other player. That’s just what Murdoch did. At the eleventh hour, he formed a merger with BSB. The ability to withstand losses determined the split of the joint venture. And the fact that both firms were in danger of going under forced the government’s hand in allowing the only two players to merge.
CASE STUDY: SPECTRUM AUCTIONS
When Fuji entered the U.S. film market, Kodak had the opportunity to respond in the United States or in Japan. While starting a price war in the United States would have been costly to Kodak, doing so in Japan was costly to Fuji (and not to Kodak, who had little share in Japan). Thus the interaction between multiple games played simultaneously creates opportunities for punishment and cooperation that might otherwise be impossible, at least without explicit collusion.
Bargaining
