Freeriding+Game Theory=Disproves Adam Smith???

Economics Economics Questions
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1

I was in my “Urban Economics” class today, and my professor said that game theory disproves Adam Smith’s notion that competing firms are necessarily more efficient than cooperating firms or firms that are kept from competing.

He gave the example of the matrix with four possibilities. The subject was the upkeep of properties in a neighborhood. One possibility is that all of your neighbors keep up their properties well, and you keep up your property well too. The second possibility is that all of your neighbors keep up their properties well, and you don’t at all. The third possibility is that you keep up your property well, but none of your neighbors do. The fourth possibility is that no one keeps up their property. He assigned a value of 100 to Possibility 1. He assigned a value of 110 to Possibility 2, because you get the benefit of the high property value of that neighborhood without having to put in the work on your own property. He assigned a property of -10 to Possibility 3, because you’re putting in all this work on your own property, but because your neighbors don’t give a crap about their properties, the property value of the neighborhood sucks. He assigned a property of 0 to Possibility 4, because the property value of the neighborhood still sucks, but you’re not wasting all this time and energy trying to keep up your property.

My prof then said that because of this, it shows that the free market doesn’t generate the best outcome a lot of the time, since you have the freerider problem, and if you know how those around you are going to act, you can play them to your own benefit.

He also gave the example of the A Beautiful Mind scene where John Nash and his 2 friends are out drinking when 4 girls come into the bar, 3 of them being good-looking and 1 of them being exceptionally beautiful. If John Nash and his 2 buddies all went over to the girls’ table to compete for the best-looking one, the less-attractive friends would be offended and would make the best-looking one feel bad about leaving. So he decided they should not compete with each other and each settle for less than what he really wants, so each guy gets something rather than nothing.

And therefore this disproves pure free market competition being the best system?

Can anyone give me a simplified version of the Austrian take on this?

2

What I learned from your professor: If humanity were a hivemind it would function more efficiently.

3

It seems like the first example is more of one of collectivisation. No one’s actually competing to get the higher property value for themself in this case, but rather a higher property value for everyone in general. If I’m interpreting this correctly in this case, then either your professor apparently can’t tell the difference between Marxism and capitalism and is unqualified to teach, or it’s something far more sinister and he is unqualified to teach.

As for the second example, I suppose that the analogy isn’t parallel because the girls aren’t exactly searching for guys. If they were, they’d be competing with each other for the three men. Or, we could think of this as a situation analogous to a monopsony, where there is only one [de facto] buyer. So this situation isn’t really analgous to the free market at all.

In any case, I’m new to this game so if I’m wrong, blame the Marxists.

4

Yup, this is called a prisoner’s dilemma, tragedy of the commons, public goods problem, externality, collective action problem, etc. Take your pick, there are a million terms for it. Understand externalities, and you’ll understand them all. Wikipedia’s articles are good.

However, you can go back to your prof and tell him that markets do in fact provide in the cases he quotes. As Coase showed, when transaction costs are low, each actor can easily negotiate with the others to deal with the externality. The vast majority of externalities are delt with on voluntary basises, either through transaction (negotiation) or outright ownership of the “commons” (or a weird mix thereof; think of neighborhood associations).

The real problem comes when there are many actors, transaction costs can be huge. The atmosphere is a prime example of this. Its a commons whether we want it to be or not.

In theory, government could cheaply take care of these commons problems because it doesn’t have to negotiate with each individual. Unfortunately, public choice shows us that good government is in fact a “commons” in itself, so it really can’t be relied upon to do anything helpful in most cases. However, most economists don’t deal with the problem of bad government, instead looking at possible policies that can fix commons problems. I tend to think that democratic governments can do the really obvious things without a lot of incompetence (I don’t have much to complain about the local roads, for example) but expecting them to effeciently solve public goods problems is very unrealistic, IMO.

Adam Smith wasn’t “disproved” any more than Newton was. His ideas were simply a special case of a larger world of economics.

5

Well, to be honest I wouldn’t really care too much about Adam Smith being proven wrong. It wouldn’t be the first time. However, I must acknowledge the fact that to the mainstream Adam Smith somehow equals, or implies, division of labour, comparative advantage, competition amongst individuals, companies and nations, the invisible hand, anti-thrust etc.; in short, all one come to think about when mentioning the classical liberal notion of the “Free Market”. As a result, if Adam Smith is somehow challenged the mainstream suddenly thinks everything about the “Free Market” must be discarded; and so deconstruction begins! Thus, to prevent your professor to enlist any more into this lost cause, I will give it a shot at salvaging Mr. Smith’s reputation.

First off, I think I will try to employ the Iron Man Fallacy, although I never came to understand why it should be a fallacy. It is the act of strengthening your opponents claim, in the present case, Game Theory. I you haven’t already I would encourage you to look up Robert Axelrod, Tit for tat or, better yet, Richard Dawkin’s “Nice Guys Finish First” (YouTube, Wikipedia). As we can gather from this, Game Theory, in the long run, gives us insight into how Man, in a state of nature, comes to prosper when meeting a like-minded kinsman. In my mind this illuminates the explanatory strength Game Theory can have. However, we must always remember that the strength of a theory is not the amount of scientific fields it can span, but its greater applicability in one field compared to another.

Now, having strengthened the case for Game Theory somewhat, I will move on to your professor’s two cases.

Case I: In this case his solution space is not contained in any meaningful sense. What is the extent of a neighborhood? Also, what about Possibility 5: Some neighbors keep up their property? Possibility 6: Some neighbors do not keep up? How then would the individual strategies be? To be honest, the more I think about it, I do not even understand what he is trying to prove in this case. If it is just a cumbersome way to explain that each owner would enjoy short-term benefits from “defecting”, well then so be it, but this disregards precisely the reason why people choose to cooperate. Why wouldn’t the other upkeepers do something about it in cooperation? They are not blind are they? And now we arrive at the best means to do this? How do the upkeepers find the best way to increase their total property value with fewest possible costs?

  • The answer: Competition amongst competing means!

Case II: Here I could just mirror my comments to Case I, but instead I will just mention one strategy that seems to be considered a good one (don’t know if it is the best of course, since I know of no market, per se, in these matters):

In closing, Game Theory has moved on. It explains how cooperation does indeed arise amongst individuals, not that it lacks amongst individuals. Why should it be different when considering companies? Game theory does not explain this from an altruistic perspective, but from a “self-ish” perspective. In my mind, strengthening the case for Game Theory only affirms Adam Smith. John Nash also errored in thinking people wouldn’t choose to cooperate. For instance, look up Adam Curtis’ “The Trap” (YouTube, Wikipedia) - Just remember to cut through some of the crap about Friedrich von Hayek [;)]

Enjoy!

6

I’ve seen this several times lately - it’s “per se”, not “per say”, FWIW

7

Sorry, never got around to actually answering your question.

I think the true answer would be that there is no simplified Austrian version. The freerider problem or the tradegy of the commons are usually explained as a lack of properly understood property rights, i.e. you have no property right in the value of you property, since this is a subjective measure based on the valuation of prospective buyers or at least appraisal agencies. Nor do you have any positive right to coerce the non-upkeeper to suddenly be an upkeeper. So where is the problem? or rather, why would you even begin to contemplate the maximization of total property value?

That would be the simplified natural rights “austrian” version. If we move on to the utilitarian “austrian” version, well, then the question remains open, i.e. more fishy [;)]

I wouldn’t be able to represent this view properly, however, so I’d better end it at that.

8

I might be the perpetrator in many of these cases. FWIW to you, it is worth it to me, so thank you Paul for making me aware of it.

9

Why do professors repeat this crap, as if it’s actually true, and not a veil for their own biases? Hoppe deconstructed this “problem” in his article on “public goods”. Actors can always choose to resolve the problem via negotiation. If that does not work, tough luck; all it demonstrates is that some do not prefer to take this route. But your prof is free to be a fascist and force them to, contrary to their own demonstrated preferences. Who knew that the real world is a little more complex than what interventionist professors think it is?

-Jon

10

The prof will say it also does not work if the cost of negotiating is too high, and he’d be correct.

11

And?

-Jon

12

…and thats all I had to say :wink:

13

He’d be correct that transaction costs might be too high for it to be worth the while (i.e. individuals would prefer not to undertake the action), which is what I meant by “if that does not work”.

-Jon

14

Your prof’s nonsense is also an example of the nirvana fallacy.

15

Hoppe makes some exellent points in the article Jon was refering to in a previous post.

  1. There is no clear distinction between which goods are public and which are private. From page 3 “All goods are more or less private or public and can- and constantly do- change with respect to their degree of privetness/publicness as people’s values and evaluations change, and as changes occur in the compositions of the population”

  2. Historical evidence shows that all goods that the public goods theorists clame only can be produced by government have been produced privately (roads, security, courts, postal service, etc.)

  3. In order to prove that the state is needed to supply a public good, one would have to make a normative assumption. The assumption is according to Hoppe; “Whenever one can somehow prove that the production of a particular good or service has a positive effect on someone else but would not be produced at all or would not be produced in a definite quantity or quality unless certain people participated in its financing, then the use of aggressive violence against these persons is allowed, either directly or indirectly with the help of the state, and these persons may be forced to share in the necessary finacial burden.” This obviously wouldn’t be much of a ethical norm…

  4. The value of a public good would still be relatively lower then the competing private goods the consumer would buy unless forced to pay for the public good. Therefore, even if the so called public good is valuble what your professor forgott to mention is that there might be other even more valuable goods the consumer would spend his money on given a choice.

16

I like this reply!

17

This is a good point, though many neoclassical economists make it as well: the “public” and “private” distinction is as abritrary and subjective as the value of any good in an economy. However, I’m not sure if Hoppe takes this far enough. For example, if 99% of the population wants 1% of it erradicated (say, because of their ethnicity), is genocide a public good? Or for a less extreme example, lets say 80% of the population wants some minority press censored. Is that censorship a public good?

I think most sane non-anarchists draw the line at actual physical externalities for this reason.

I don’t think many economists would consider the postal service a public good, but the question is not whether these services can be provided at all. The question is whether or not they are underprovided or not. Taken along with your point #4, we can see there is a big calculation problem involved in state provision of public goods.

18

i think some others have replied along these lines, but I’ll restate it to see if I understand it.

The professor arbitrarily set the goal to be increased home value. An individual may value time spent hunting more than increased home value from time spent landscaping and painting the house. In that case, that individual isn’t competing with the one that is trying to sell his house. So one can’t conclude anything about competition at all from the example.

It would be very rare that bee hive mentality existed and everyone valued maximum home value over every other use of the time it takes to upkeep and improve their lot. So if you forced everyone to spend time making the neighborhood spiffy, then the people who valued high home values the most would be satisfied, but everyone else would be unsatisfied.

The free market, in this case, doesn’t maximize home values, but it DOES maximize the value scales of each individual actor according to their preferences. So in assigning point values to each square of the matrix, the professor took into account only one particular value scale (his), and didn’t consider the time and opportunity costs associated to get there.

19

You are right on the mark, in the sense that this would be the critique of the professor arbitrarily setting such a goal. However, I’m sure he would just retort and say that he merely posited an if statement which may or may not be true, i.e.:

If all the neighbors agreed to increase their property values, then, what would happen?

And so he sets up a scenario in which anyone who is pro free market, i.e. pro Adam Smith, would think competition amongst homeowners would be the best way to increase this agreed upon goal. Using Game Theory he then thinks he can counter this apparently silly idea of the free market being the optimum way to reach the goal. He does this by bringing up the free rider problem, essentially saying, because people are selfish they will not do what would be best for the neighborhood overall, but merely “piggyback” on the increased property value everyone else helped to bring about. That is, one selfish individual might gain 40%, but what if this gain has resulted in a 20% loss to each of the other neighbors.

The “trouble” is, he is right! He hasn’t made a value judgement, he has just stated that the homeowners have this goal. Also, he would be right in saying cooperation would help to get closer to this stated goal, i.e. better than “selfish” competition.

Going further than this, however, is a non sequitur. To imply Adam Smith is wrong, that the market has failed, that someone must direct the homeowners does not follow - at all.

To say such a thing is akin to sitting on top of the ivory tower surveying the world wearing blinkers. The market, if free, will see the problem and minimize the effects using the best means available, not install a professor to direct. Not even government would go that far up the ivory tower to find a such a director… but the Federal Reserve certainly would [:P]

20

Two points:

One, and this one has been mentioned somewhat already, is the arbitrary assignments made by the professor. How does he know what the relative value of each option would be? That’s what a market is for, to determine prices and values. And why are we limited to the four options he came up with? Just so it would fit in with his Game Theory exercise?

Two, game theory itself is rather suspect. For one thing, it assumes one decision to be made one time, and doesn’t really factor in changes over time. Just because you decided one way today, doesn’t mean you wouldn’t decide differently tomorrow. Circumstances change over time, and the set of circumstances are decidedly more complex than the professor’s game theory exercise.

Thus, all he’s really proven is that the real world doesn’t fit simple Game Theory ideas.