Unit 4

SOCIAL INTERACTIONS
Outline
A. Introduction
B. Game Theory: Key concepts
C. Resolving social dilemmas
A. Introduction
The Context for This Unit
• Previous models of choice did not depend on others’ decisions
• Individuals motivated by self-interest can produce outcomes that are beneficial
for society e.g. entrepreneurship, innovation
• Adam Smith stated that if everybody is motivated only by self-interest,
economic markets reach an efficient outcome:
• “He generally, indeed, neither intends to promote the public interest, nor knows how much he is
promoting it. […] he intends only his own gain, and he is in this, as in many other cases, led by
an invisible hand to promote an end which was no part of his intention.” Smith, 1776, The Wealth
of Nations, Book IV, Ch. II, §IX
• However, self-interest can also be harmful
• Why do these problems arise?
• What can we do about it?
This Unit

• Use the tools of game theory to Carbon emissions from fossil fuels
10000
model social interactions and explain 9000

social dilemmas 8000

7000
• Social dilemma = a situation in 6000

which actions taken independently 5000

by self-interested individuals result in 4000

a socially suboptimal outcome e.g.

3000

2000
traffic jams, climate change, COVID- 1000

19, … 0
1750 1800 1850 1900 1950 2000
This Unit
• Social dilemmas occur when people do not fully account for the effects of their actions
on others
• Tragedy of the Commons: Common property or common resources are often
overexploited
• William Forster Lloyd in 1833: applied idea to common parcel of land on which herders could let
their cattle graze  overgrazing
• Harding published article in 1968 in Science that further developed this idea
• E.g. fishing, climate change, common kitchen, …

• Free riding: benefiting from the contributions of others to some cooperative project
without contributing oneself
• How can altruism and government policy resolve social dilemmas?
8 Managerial Econ. - Equilibrium
B. Game theory: Key
concepts
Social and Strategic Interactions
• Social interaction: A situation involving more than one person/party, where
one’s actions affect both their own and other people’s outcomes

• Strategic interaction: A social interaction where people are aware of the ways
that their actions affect others

• Strategy: Action(s) that people can take when engaging in a social interaction

• Games are studied using game theory

• Applied in social sciences as well as biology
Game
• A game describes a social interaction:
1. Players – who is involved in the interaction
2. Feasible strategies – actions each player can take
3. Information – what each player knows when choosing their action
4. Payoffs – outcomes for every possible combination of actions
Example: Crop choice
• Two farmers decide which crop to
specialize in
• They interact only once (one-shot
game)
1. Players – Anil and Bala.
2. Feasible strategies – Rice or
Cassava
3. Information – Each farmer does
not know what the other chooses
(simultaneous game)
4. Payoffs – depend on market prices
and quality of land
Equilibrium of the Game
• Best response: Strategy that
yields the highest payoff, given the
other player’s strategy
• Dominant strategy: A best
response to all possible strategies
of the other player (does not always
exist!)
• Dominant strategy equilibrium:
An outcome of a game in which
everyone plays their dominant
strategy
Crop choice example
• Best response: If Bala grows rice, Anil’s best
response is to grow cassava. If Bala grows
cassava, Anil’s best response is to grow cassava
• Dominant strategy: Anil’s dominant strategy is to
grow cassava. Bala’s dominant strategy is to grow
rice
• Dominant strategy equilibrium: When Anil and
Bala each play their dominant strategy, the
outcome is (Cassava, Rice)
• Dominant strategy equilibrium is a strong concept
as this will be the outcome if both players just
follow their self-interest
• In this example, the equilibrium is as well the
desired outcome (namely the outcome that would
have been chosen when they would be able to
coordinate)
Nash equilibrium
• Often, there is no equilibrium in dominant strategies
Different pay-offs
• Nash equilibrium: A set of strategies (one per
player), such that each player’s strategy is the best
response to the strategies chosen by everyone else

• Named after John Nash (1928-2015, NP 1994)

• See as well ‘A Beautiful Mind’

• In a Nash equilibrium, no player has an incentive to

deviate unilaterally.

• NOTE: There may be more than one Nash

equilibrium in a game.
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16 Managerial Economics - Strategic

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• 1 2 3

• T 2 0 0
1 1 0
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1 0 2

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17 Managerial Economics - Strategic