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An Equilibrium Point in Decison-Making

People prefer more money when faced with a choice, so they accept whatever they’re offered. That’s how decision-making works.

Suppose that a responder the ultimatum game is completely rational, they prefer more money, so they accept whatever they’re offered. A proposer can take advantage of them and offer the smallest amount possible knowing that though except. That’s the rational equilibrium point for the ultimatum game.

Less choices more decision-making power

But, if the responder might not be rational, if they might turn down money then the proposer can’t just assume that they’ll accept any amount offered. The proposer needs offer something it seems more fair. So, the threat of irrational behavior of acting as one’s own self-interest pushes the proposer to offer more money.

How can the threat of rejection be credible in the decision-making process?There’s no contract in this case. In many experiments the proposer and respond or interact via computers, so they never even see each other. So there’s no way that an individual responder can send a signal of threat. There is a solution and it’s related to the first of my recommendations for today’s article: limiting your ability to make choices can give you power.

A Nobel Prize Idea for Decision-Making

I used this example in a previous article. You and your friend want to meet at a restaurant and you rather have her come to your side of town and she’d rather have you come to her side of town. She gets her way by calling you telling you where she’s going and then turning off her phone.

She’s purposefully limited herself to a single choice, she can only go to one restaurant and she can’t communicate with you anymore. By limiting her own options she shapes what you will do, she knows that he’ll come either. Thomas Shelling won the Nobel Prize in economics for this basic idea: that limiting your own ability to make choices can give you power.

A credible threat, to discourage unfair offers

So let’s apply this idea to the ultimatum game. When responders are given an unfair offer $2 dollars or $20 they get angry, they want to retaliate against the proposal, they are willing to sacrifice their own earnings if it teaches the proposer a lesson and importantly they can’t just turn off that emotion even if they wanted to.

That willingness to sacrifice one’s own potential earnings to behave irrationally and against our own self-interest, provides a credible threat we need to discourage unfair offers. Emotion limits our choices, but it can also give us power over others. I’ll revisit this idea at the very end of the article we talk about pre-commitment.

Emphasize a focal point

My second recommendation is that cooperation doesn’t always require communication. You can coordinate your secure choices with someone by exploiting the structure of the world, by looking for focal points. I want to emphasize that focal points like cooperation itself aren’t necessarily good or bad for decision-making.

Focal points can help us reach consensus in group discussions and can help us negotiate to a mutually beneficial outcome, but they can also lead to unwanted collusion as in the example of payday lenders. Focal points provide a potential tool for increasing the efficiency with which we collaborate for better or worse.

Disrupt unwanted equilibrium

My final recommendation is that institutional actions are often needed to disrupt unwanted equilibrium. In many competitive markets, say consumer electronics, businesses would often prefer to upgrade their products to take advantage of some new technology, like a better plug that connects devices to computers, but they can only change their own production if everyone else also changes their production.

That’s exactly the sort of situation where institutional actions are most valuable. Industry groups can collectively come up with a new standard that then becomes adopted more widely. Similarly as soon as the National Hockey League adopt a regulation enforcing helmet usage the undesirable equilibrium was disrupted and players moved collectively to a more desirable equilibrium with everyone wearing helmets.

Regulations are often criticized because they limit our freedom of choice and there are surely situations in which those criticisms hit their mark, but the idea that we are free to choose is based on the idea of a single decision-maker acting in isolation. As the game theory shows sometimes we are better off by restricting our own choices, counterintuitive as that may seem.