Tag: Behavioral Economics

How to Split the Pie and Eat it Too! – A Game Theory Exercise

Bargaining is a very important concept in economics, most notably in game theoretical frameworks. A common problem which one comes across is how to split the pie between two players.  The question is as follows:

There are two players; A, and B. They are given by a pie which they must split between themselves. In Period 1, Player A proposes a division, and Player B accepts or rejects this division. If Player B accepts the division proposed by Player A, then the game ends at that time itself and both players walk away with their share of the pie. If Player B rejects, then Player B proposes the division in Period 2. Now Player A has the option of accepting or rejecting the division. Again the same conditions apply, and the game can continue or end in Period 2. However, for each Period the game goes on for, the size of the pie keeps diminishing by a certain amount. There are a certain number of periods the game can go on for, before the value of the pie becomes zero. 

So how should the pie be divided?

This problem is important, both as an introduction to bargaining games, as well as a introduction to thinking about ‘dynamic’ issues in economics — where agents think across time periods (as opposed to static frameworks where agents are only thinking about the current period of time).

 

I have made a small presentation about this problem and how to resolve it. To check it out, click here!

Price Discount Calculator

Most firms offer consumers one of two things during marketing campaigns and sales to boost sales -: i) Price discounts, like a 50% off on prices; ii) Extra Volume, like 50% extra volume for the same price. But, is a 50% increase in quantity equal to a 50% discount on prices? Actually, no! A 50% increase in quantity is only equal to about a 1/3rd or 33.333% discount on prices.

But according to an article in The Economist (2012) (Something Doesn’t Add Up), and research by behavioural scientists (Chen et al (2012)), people fail to realise the difference between the two and often end up viewing them as the same.

One of the researchers, Akshay Rao of the University of Minnesota’s Carlson School of Management, offered his undergraduate students a choice between two a deals when buying loose coffee beans – 33% extra for free, or 33% off on the price. While the discount on the price is the clearly better deal, the students viewed both deals as the same!

For equivalent deals (like a 33.33% price discount vs 50% extra quantity), researchers found that consumers mostly went for the extra quantity (about three quarters of them), even though the deals were numerically equivalent.

This tool helps you to not fall into this numerical blindspot by calculating what price discount (%) corresponds to extra quantity (%) and let’s you make informed decisions on purchases.

Please find below the link for the app:

https://sujanbandyo.shinyapps.io/price_discount_calculator/

Nudging People the Right Way: A Couple of Personal Anecdotes

Richard Thaler, the 2017 winner of the Sveriges Riksbank Prize in Economic Sciences, lists out several fascinating insights into the human psyche in his book – Nudge : Improving Decisions about Health, Wealth and Happiness.

The two systems of thinkings is perhaps the most significant contribution that behavioral scientists like Thaler and Kanheman. The simple concept elegantly explains how the human mind thinks. We have an automatic system which is instinctive and quick, and a reflective system that is that is slow and self-conscious. I would encourage everyone to read Thaler’s Nudge and Kanheman’s Thinking Fast and Slow, to better understand this concept.

But moving back to Nudges. Thaler and his co-author Cass Sunstein advocate a philosophy of ‘libertarian paternalism’ throughout the book. To them, freedom of choice is sacrosanct and they don’t want to impede on the liberty of people under any circumstance. Yet, they believe that ‘choice architects’ can drive people’s actions in subtle smart ways, through nudges, to improve outcomes. The authors define a ‘nudge’ as an activity that would alter people’s behaviour in a predictable way, while ensuring that people have the option of not altering their behaviour at little or no cost, if they so desire. An example used in the book is that if moving the arrangement of food in a school cafetaria encourages students to eat healthier, that would count as a nudge. However, banning the sale of unhealthy food items would not count as one.

Nudges can be especially useful in less developed nations. With states not having resources to impose mandates or bans, altering peoples’ behaviour through nudges can be an efficient way of achieving optimal outcomes.

Mumbai’s suburban railways experimented with nudges to prevent fatalities on its network. Mumbai’s rail network sees several deaths every day as trains and rail facilities are packed to the brim during rush hour and infrastructure is not enough to deal with such heavy crowds. Yet despite providing over-bridges to cross tracks people often resort to crossing the tracks of foot to save time or due to laziness. Despite being considered an illegal activity that attracts fines and a possible prison sentence, crossing tracks is a widely prevalent phenomenon.

In 2010, the rail administration decided to try and use nudge theory to prevent deaths by crossing tracks. Along with a behavioural economics think tank, they designed a set of posters that showed a person being a mowed down by a train with an emphasis on the person’s facial expressions of fear and shock. These posters were placed at locations which were prone to crossing in the eye-line of people who may contemplate crossing the tracks. Previous campaigns had been restricted to announcements, or written signs that contained information about fined people had to pay in case they were caught crossing the tracks.

This was a unique effort where the state was actually trying to impose a ban via a nudge. While preliminary results did show that the efforts had reduced fatalities, there has been no comprehensive report on the effect of the campaign. Yet, this exercise does show that in cases where governments are unable to impose their mandates, nudge theory may help them along the way.