AM04 Duopoly

Under conditions of price competition, a duopoly leads to a perfectly competitive outcome. However, the assumptions are unrealistic. We consider different variations of assumptions and different types of outcomes that can result. There is a Prisoner's Dilemma involved in Duopoly price competition, which will study in greater detail.

. We will do an experiment with prisoner's dilemma in class at 8:30am -- half an hour before start of class. This is not required attendance, but it is very useful to experience the game first hand. Learning occurs when we relate personal experience to the theories we are studying. This is one reason why economic theory is so bad. It has no relation to our personal experiences of life.

2. I would like a few students who are computer-literate to come to me on Wednesday -- I have a little free time around 2:00pm. I would like to experiment with a new style of game using Google docs that I have never done before, but it seems to have potential to be very useful in the future, for running more experiments, as we will be doing later in the semester.

3. Next class, we will continue our discussion of game theory and prisoner's dilemma. We will study the theory which shows that dominant strategy is for both players to betray each other. We will show that this theory also holds in FINITE repeated games -- that is, even if the game is repeated for a fixed finite number of times, the unique dominant Nash Equilibrium strategy is for both players to betray each other.

4. The Theory is dramatically at variance with human experience. In actual games played by human beings under a wide variety of conditions, lots of cooperation is observed Even at extremely high stakes, where betrayal would lead to a huge reward, and people are playing against strangers, they tend to cooperate around 50% of the time, when theory predicts that cooperation would occur 0% of the time. BEHAVIORAL economics is drastically different from THEORETICAL mathematical economics. Then the question arises of UNDERSTANDING WHY this is so. Economists say that this is because humans are irrational -- but in fact, this just shows that economists are irrational. It is highly rational to cooperate, since BOTH people end up with more gain. The only thing necessary is to check your own individual greed in favor of promoting social welfare.

5. This general phenomenon is called the "SOCIAL DILEMMA" and it occurs in many different settings. This situation is exact OPPOSITE of the invisible hand theory -- the invisible hand says that everyone acts selfishly, but this leads to the best outcome for society. However, in social dilemma situations, if people act greedily, this cause social harm to everyone, ultimately even to themselves personally. Everyone is worse off when people act selfishly. So the person's greedy act hurst the whole society and EVEN his own self, though he does not realize it.

6. Economics texts are preaching greed, using INVISIBLE HAND model. They argue that everybody acts selfishly, but this selfish behavior helps society. This is a very WRONG message, which leads to corruption, immorality and loss of character. See for example, the following quote from MANIKIW's textbook:

"The reason for excellent functioning of decentralized market economies is that all participants are motivated by self-interest. This self-interest works better than love and kindness in terms of promoting social welfare" (GG: greed is good)

I am attaching two papers on prisoners dilemma as supplementary reading. These are NOT required, and are more detailed then necessary. I would summarize them if I had time (for next time around). I will discuss some key results from one of them in lecture tommorrow.

Sample Final Question:

• 1. Consider a real world situation which is characterized by a Prisoner's Dilemma. Describe the situation, and construct a plausible matrix of payoffs for this situation.

  2. Describe the solution which economic theory says is rational

  3. Provide empirical evidence that when people actually play this game, they do not behave according to the economic theory models.

  4. Explain why real world behavior does not correspond to theory. Also discuss which is "rational", the economic theory of behavior, or the actual behavior of human beings.