Self Interest & Ultimatum Games

[Musitant]

Introduction

           I'm happy to be the first to start off education in the University of the Glorious Revolution. I'm sure I will be the first in a tradition of informed, helpful teachers and students ravenous for knowledge. My plan with UGR is to give a series of short, interesting lectures on economic topics that are accessible to everyone. Hopefully, they will be able to be read in any order and without any prior knowledge of economics. Today's topic, as titled, is self interest and ultimatum games.

Self Interest
           
           Self interest is an underlying assumption in a lot of economic analysis, so it is incredibly helpful to spell out what exactly it is and what it means. When economists assume self interest, it means they assume agents will make decisions in order to maximize their own benefit, ignoring how their actions will affect others. For example, when you give money to a salesperson in exchange for a product, economists will assume that you are doing so because the product is worth something to you, not to keep the salesperson in business. Likewise, economists assume that the salesperson isn't charging you because she hates you and wants you to lose money. They assume that she is charging you because she benefits from the money you give her.

           For the most part, this assumption holds up pretty well. It isn’t often that people shrug off their own self interest, especially if we broadly define self interest to include the interest of the agent’s entire household. When we make decisions, we worry about how it will affect ourselves and those in our household, not our neighbors. But, obviously, there are situations in which self interest is not the sole motivator behind behavior. One of those situations is the Ultimatum Game.

The Rules of the Ultimatum Game

           The Ultimatum Game is an economic experiment with two players, a proposer and a responder. The proposer is given some amount of money to split. The proposer than proposes the split to the responder. This can be a split where the proposer gets all or almost all of the money, or a more equal proposal. The proposer can also propose a split where the responder gets all or almost all of the money. The responder then can either accept or reject the proposal. If the responder accepts the split, both get money as proposed. However, if the responder rejects the split, both players get nothing. To put it more succinctly, a proposer offers a deal to split income with a responder, who may reject the deal so that none benefit.

Self Interested Predicted Game

           In order to test the assumption that players act according to rational self interest, one would have to know what that assumption predicts in order to compare it to experimental results. If players act solely according to self interest, the responder will accept any positive proposal. This is because the responder realizes that walking home with a small amount buys you more than walking home with nothing. Proposers will realize this and maximize their take by proposing a split where they offer only the smallest possible amount to the responder.

The Game in Reality

           RESPONDERS REJECT UNFAIR PROPOSALS. Sometimes. Experimental evidence shows that proposals where the proposed offer is biased towards the proposer are rejected. People would rather forgo money in order to spite proposers who were unfair or taking advantage of their situation. Proposers also offer more fair offers than any other offer, unlike the self interest predicted unfair offers. This may be due to two reasons: proposers care about responders and want to give them a fair deal, or proposers want to maximize their chance of having the responder accept their offer.

Conclusion           

           So, does this spell woe for economics as a discipline? Not at all. Experimental evidence finds that fairness as a concept becomes less and less important as the stakes are raised, and that punishing unfairness has a strong cultural bias to it. And market experiments and experiments of different types that have the underlying assumption of self interest have been incredibly predictive to behavior. However, ultimatum games do make economists and those who study economics highly aware of the assumptions they make and how they might affect the validity of what they study.

Bonus comic:
Saturday Morning Breakfast Cereal

Bonus article:
Pacific Standard Magazine

Further reading:
Cultural Differences in Ultimatum Game Experiments: Evidence from a Meta-Analysis
Incorporating Fairness into Game Theory and Economics
Does Culture Matter in Economic Behavior? Ultimatum Game Bargaining among the Machiguenga of the Peruvian Amazon
Stakes Matter in Ultimatum Games
Avoiding the sharp tongue: Anticipated written messages promote fair economic exchange

[Myroria]

An excellent lecture! I think St. Oz in particular would have an interest in this.

[Delfos]

Can we use this with the ECB giving money to government that have to give money to national banks? In this case the government usually ends with way less than the banks. The system isn't broken because it's skewed towards "private" bank ownership of the economy? or is there no other or at all defensible aspect of this kind of Ultimatum?

[Musitant]

Thanks, Myroria! That means a lot to me!

Quick disclaimer Delfos: I'm not at all an expert on money and banking, and have only the most basic knowledge of the subject. Now that the disclaimer is out of the way, I want to clarify that you're speaking about having the governments give an ultimatum to private banks as a "take it or leave it" bailout? Or are you saying the ECB should give governments take it or leave it bailouts? You're also jumping into way more complicated and political issues about the structure of the eurozone and its political economy, so I really would like to unpack the question before answering completely.

For now, I'm going to skim the surface of your questions and focus on the ultimatum game side of them, because I want to give answers on things I'm well-read on and not mislead you on what the educated consensus is.

Right now, Greece is rejecting the eurozone bailout effectively acting as a responder in an ultimatum game. Because Greece is not an individual and this is not an experiment, it is difficult to completely explain their reasoning, but one could argue that it is a rejection of self interest in the strictest sense, and is done so in the name of independence on issues of fiscal policy and because politically it was the government's mandate.

I'd call this an example of an ultimatum game because the Greek rejection has the potential to be incredibly harmful for investment in Greece and future borrowing by Greece. However, it also hurts the proposer which is the rest of the eurozone because most of the money owed by Greece will not be paid back to the French and German banks it was leant from. However, this differs from ultimatum games in that the experimental ultimatum game is one shot, and with Greece there is the option of them renegotiating their bailout with the eurozone.

I hope this answers some of your question, especially about where one might see an ultimatum game in the real world.

[Delfos]

I'd put Greece as the one that receives an ultimatum from ECB/IMF/EU, has not much power to decide what to do with the money because such money have goals and receivers pretty much determined by the "bail out", such as we give you this money but you have to do what we tell you, give most of it to banks so we can benefit with what we call "private initiative" when in reality we just want banks to play our awesome game of debts...What about the Greeks? Oh I didn't thought of them, tbh they're not significant to our game.

anyway, yeah any take on the ultimatum works around the Greek problem.

[Musitant]

Looks like Greece isn't rejecting the bailout after all. They're doing a four-month extension pending a list of promised reforms.