Monday, October 20, 2008

*** Game Theory at Work by James Miller

This is a fun, enlightening exploration of game theory with practical applications that you can use both in and out of the office. Among this book’s lessons are the following:
  • Never hire/date someone too eager to work for/go out with you
  • Have less trust in smokers; and more in exercisers
  • Many business people exhibit honesty not because they are moral, but because they are greedy
  • Eliminating choices can increase your payoff
  • Burning money can increase your wealth
  • Exposing yourself to potential humiliation can help you get a raise
Game theory is an approach that is rational, but that doesn’t mean that is how people do and should behave. You’ll discover that sometimes when we are irrational this leads to better outcomes, and evolution has used this fact to help you overcome a rational prisoner’s dilemma. So give yourself some credit, start playing hard to get, but keep exercising, and put out that cigarette. Read on, and you'll soon learn why.

Is it better to be loved or feared?
Imagine you fear your teenage daughter becoming pregnant . First you try to reason and urge her to be more careful. But when reason fails, parents resort to threats of disowning. Should the daughter believe you? Not if you love her… If your daughter became pregnant, she’d need you more than ever…. It would not be in your loving interest to actually carry out the threat. The manifest love thus weakens your negotiating strength. Interestingly if the daughter suspected that her parents didn’t love her, then she might believe their threat, and all of them may be better off. P9

One way trip
Cortez, conqueror of the Aztecs, employed the boat burning tactic, shortly after landing in Mexico, thus showing his enemies and potential allies that he would not be quickly driven back to Europe… No tribe would want to ally with Cortez if it thought that he might abandon his fight against the Aztecs… His promise to stay, by itself, was not believable… By burning the ships and eliminating the option of quickly retreating, Cortez guaranteed that he wouldn’t leave. P11
Another way to get a raise is to tell everyone in the firm that you will definitely quit if you don’t obtain it, and put yourself in a position where you would suffer complete humiliation if you were denied and stayed on the job… By effectively eliminating your choice to stay, your boss may find it in her self interest to give you the raise because she knows you will have to leave otherwise. P12

Out of control
Telling others that you have given up control is a common negotiating tactic… Broadcasting your lack of decision making authority makes it easier to turn down unwanted requests. P13

Giving up control by cutting off communications is another way to improve your position. You could first order your troops to fight to the death, and then leave your troops behind on an island to fight the enemy. If the enemy sees you leave and believes no one else has the authority to call of the attack, then they will think that your troops will fight to the end. P14

Brick wall
If an employee constantly pesters you for a salary increase, refusing to even listen to her demands credibly signals that she has no chance of prevailing. P15

Hey blackmailers should you go pro or remain an amateur?
Before paying a blackmailer you should examine her incentives to reveal the information. If they hate you, and would enjoy seeing you suffer, then they would likely release the information regardless of whether you pay or not… A one time blackmailer (who has no track record) would have a strong incentive to make further demands if given an initial payoff… The best way to deal with a 1 time blackmailer is probably to take your chances and not pay, or pay her off with small sums for the rest of your life… By paying the blackmailer throughout her life, you turn her into a professional and make it in her interest to be honest. P16

Motivating the workers
How could you motivate all employees with just one threat? First put all employees in some arbitrary but announced order. You tell employee 1 that if she doesn’t work hard, you will fire her. This would obviously make her work harder. Next, you tell employee 2 that if employee 1 works hard, and he doesn’t, you will fire him. Since employee 2 expects employee1 to work hard, he must work hard too. Does this again with employees 3 through N. Your employees can’t circumvent your system by colluding to be lazy because employee1 would never agree to slack off. .. The key lesson is that when you assign responsibility randomly, all might accept the chance to be punished and choose not to work hard. It’s much better to have a clear chain of punishment. P31

Survival of the vigilantes
Exhibiting insanity can enhance your threat’s credibility. Some forms of insanity in this regard are a thirst for revenge even at your own demise or detriment… Interestingly evolution may have made humans precisely irrational because of the benefits it can bring… To see the benefit of being vengeful consider a small village from prehistoric times. Imagine a group of raiders steal food from this village. A rational community would hunt down the raiders only if the cost of doing so was not too high. A vengeful group would hunt down the raiders regardless of the cost. If the raiders know of this reputation, they would rather find another village. Thus vengefulness confers an evolutionary advantage. P34

The optimal strategy to adopt with respect to legal vengeance is to convince people that you are insanely attached to vengeance when if someone did violate your legal rights you would really sue them even though lawyers are expensive. P34

Price Obscurity
Contract complications reduce the damage of price competition for similar items. When every firm uses complicated pricing schemes the benefits of undercutting your rival diminish since customers will be challenged to find the low cost provider amongst all of the complications. P48

Dominate your strategy
Is stopping at red light, and going on green a dominant strategy? Actually no it isn’t. You only want to do that if all the other drivers do the same. Same issue with driving on the right side of the road. Only works in countries where all other drivers agree to do the same. A dominant strategy is one you employ regardless of what others do. If everyone else holds their breath to the point of passing out, your dominant strategy is to breath freely, and you should do it regardless of what they do. P54

Why SF has so many gays
Most humans prioritize being able to find a sexual partner. This task can be more challenging for homosexuals since they make up only a small percentage of the population. Consequently when a homosexual decides where to live, the percentages of gays will rationally play a large part in this decision… The consequence will be that a few cities will become known for having a large gay population, gaining a reputation as a gay haven, and accelerating the process further. P93

Why money has any value
Money only has value because other people want it (it has no intrinsic value). Because so many people want it, it’s useful to have it because you can trade it for goods and services. Thus our use of money is based upon a massive coordination game. P98

Why high sunk costs can hurt you
Industries with high sunk costs are extremely vulnerable to price competition because it is rational for companies to ignore their sunk costs when setting prices… Imagine your airline always has 1 flight daily from NYC to Paris. Assume that if the plane were always full, you would need charge $400 per passenger to break even. What if your flight was only ½ full, but you could sell additional seats for $300 each? Should you fill the extra space? Yes, you’re better off with $300 than leaving it empty. Of course, since everyone in the industry will feel the same way, the market price could easily be driven below $400. P109

Balance of spam power
We have currently reached an email spam equilibrium in this country, if American spammers spam less (because we outlaw or regulate it), some users would get less sick of spam, and actually read more of it, thus increasing the benefits of foreigners (who are beyond US legal jurisdiction) to start spamming us. This would of course cause users to again ignore spam at the same rate. P110

Career criminal? Consider joining a union
Joining the Mafia would allow criminals who are arrested to overcome their prisoner’s dilemma (of ratting out their colleagues), because of the mafia code of killing rats. This added punishment changes the prisoner’s dilemma… In an effort to avoid the mafia death penalty, both criminals should now not cooperate and will thus get a lenient sentence. So Mafia membership clearly has its privileges since such membership will clearly lower your sentence if caught, and we can thus expect mafia members to commit more crimes. This gives the mafia a significant competitive edge in the market for crime. P118

Why some freak who can shoot a ball will make in 1 year more than you in your lifetime
A professional athlete like a basketball player has a very specialized talent. His skill in basketball can’t be transferred to other sports or professions. As a result, he won’t make anywhere near his basketball salary in another job… If a team offered lowered salaries, they would still attract top talent since this talent would have no other place to go. Indeed offering multi-million dollar salaries might shorten their careers because it makes it easy for them to retire early. But individual teams face a prisoner’s dilemma with respect to salaries. If all the teams offered a low salary, your team could greatly benefit by paying a higher wage and attracting the best talent. But once you do that, the others teams must counter. Offering high salaries is a dominant strategy for each team, even though they are all worse off because of it… Teams have tried to limit this dilemma with salary caps, and player’s unions fight against such caps. P125

All for 1, and 1 for all
As a soldier the best way avoid harm is to run away only if all of your fellow soldiers stayed and fought. But if everyone on your side runs with you, it will be easy for the enemy to hunt you all down and kill you. Thus, you all might be better off if everyone stayed than if you were all cowards… Armies solve this coward’s dilemma much as the mafia solves the prisoner’s dilemma – cowards are court marshaled and executed. P131

Why you should trust exercisers over smokers
Game theory teaches that when 2 people play a finitely repeated prisoner’s dilemma game, they should always be mean… Unfortunately for game theory, when real people play this game, they are often nice to each other. Why do they do this?... Many people outside of game theorists are nicer than they should be, but still don’t like to be taken advantage of… You suspect that if you play mean, your opponent will be mean back to you [the golden rule].
Like smoking, betraying someone in repeated game, helps you today, but harms you in future periods. The less someone cares about the future, the more likely he is to betray you… People’s actions thus betray how much they care about the future relative to today. You have limited trust in smokers because they obviously care far more about the present than the future. Conversely someone who exercises is willing to make sacrifices today for future benefits, and is thus less likely to betray you for a short term gain. P138

In a fixed sum game (your loss is my gain), there is no benefit to cooperating, and players will always be trapped into a mean dominant strategy. P139

Green with envy, means a red light for trust
Just as you should be less trusting of smokers, you should be less trusting of envious people. Consider how envy affects the cost/benefit calculation… Envious people enjoy a further benefit of betrayal in seeing you get a lower payoff. Since envious players benefit even more greatly from betrayal, they are more likely to engage in it. Therefore you should be less trusting of envious people, and others should trust you less if they perceive you as envious. P139

Why nice guys finish last
Having a reputation for swift and harsh retaliation is vital to being able to sustain a good outcome in a repeated prisoner’s dilemma game. Wimps can never achieve a nice/nice outcome (optimal) for their rivals will always exploit them. If others fear your wrath, the nice/nice outcome becomes obtainable since others will grasp the consequences of betraying you. P141
Imagine you buy 1000 widgets each at $10 from 2 firms, and that both firms refuse to lower their price to $6. What would happen if you started buying all of your widgets from just 1 firm and you still pay them $10 each? Firm 2 might suspect Firm 1 is giving you a discount, even if Firm 1 promised (violating anti-trust) that they wouldn’t lower prices… To add to the mistrust, you may even want to ask Firm 2 to match the new price of $6. Firm 2 would almost certainly lower its price. P146

How guaranteed lowest price can actually work against you
If a supplier gave all of his customers most favored customer status, it would be much harder for him to secretly lower his prices, because he’d have to lower prices to all of his customers. He wouldn’t be able to lower prices to just those customers he wants to steal from a rival… When one supplier issues most favored customer agreements, its rival can have much more confidence that it is not being betrayed. So even though most favored customer agreements sound like they favor customers, they really help producers by reducing price competition. P148

Don’t bother trying to find a win/win outcome if you find yourself in a one period prisoner’s dilemma. In repeated games with no last period, you should strive to cooperate. P150

So why do we tip when we travel?
I think evolution has prepared for repeated interactions amongst a small group of people where cooperation would lead to the best outcomes. Travelling amongst strangers is not the environment that you were built for. It goes against your instinct to stiff the waiter, even though that is rational.

If you want them, then they don't want you
The person a company would most want to hire would probably not even bother applying because they would be so talented that they could easily make more than the offered salary. To combat the appearance of adverse selection, a candidate should then avoid appearing overeager, and play hard to get, letting the company believe that he has many attractive offers. If a candidate is really hard to get, then a company doesn’t have to worry about adverse selection. P152 Is the same true of dating? I suspect so. If you appear too eager, your suitor may fear adverse selection, and your appeal may diminish in their eyes. So playing hard to get, yet still being gotten in the end is the way to go it seems.

Why are most used cars lemons?
Adverse selection often creates a vicious cycle. Here’s an example in the used car market… As adverse selection lowers the price of used cars, fewer used cars of excellent quality are sold, which reinforces the adverse selection, further lowering the price, which causes even more quality cars to be withheld, which causes more adverse selection…How do you break this cycle? An inspection removes the hidden information that causes adverse selection (the fear of a lemon). An owner could also provide a warranty reducing the harm of hidden information. p155
If you have to cut corporate costs by 10% is it better to lower everyone’s wages equally by 10% or to fire 10% of the workforce? Adverse selection shows you why it is better to fire. If you cut everyone’s wages, the most productive workers will probably leave to higher paying jobs. Thus because of adverse selection you’ll encourage the worst workers to stay on board. If you fire your worst 10%, you’ll be better off. P156

Why everyone pays a big deposit
If over 95% of prospective tenants in your area are honest and responsible, you may figure there is no reason to inconvenience them with a security deposit. Unfortunately if you become the only landlord to not require a deposit, then adverse selection will cause you to get all of the deadbeats. P156

Why we don't always settle a lawsuit
Adverse selection should cause me to question why you would want to settle a legal suit. You would most want to settle when your case is poor… Consequently your signal to settle is a signal that I should go to trial…Only if I learn of the strength of your case would I be amenable to your offer. P157

Why we must screen for offenders
Organizations that work with children need to be especially concerned about adverse selection even if a very small percentage of the population sexually abuses children because these abusers are attracted to such jobs that allow them to interact with children. P158

Why dictators are usually big dickheads
To gain power in a dictatorship, one must be willing to kill. It’s not surprising therefore that almost dictators have been evil scum, for most dictators would have never risen to power if they had been nice… Adverse selection also explains why most revolutions go bad, producing narcissistic, brutal regimes as in the French, Russian, and Chinese examples. The only types of people capable of acquiring power in these revolutionary environments were people skilled at murder and betrayal… Monarchies are usually superior to dictatorships because of adverse selection. A man is born king, and is therefore average in morality, while dictators are exceptionally morally bankrupt. P158

What’s the purpose of a college education?
Most people attend because it increases their lifetime earning potential. How does it do that? The standard answer is that it teaches you useful things. Signaling theory shows that college could do the same thing without teaching you a thing…. It’s somewhat hard to be accepted and graduate from a decent college… Graduating thus signals to an employer that you have a decent level of intelligence, even if you didn’t learn anything. P165

Why is race used so often to judge
Using race as a signal can be rational if race is correlated with less visible characteristics – that you can’t easily measure… Signaling theory shows that if a college discriminates against some race (like Asians) then employers might desire to discriminate in favor this race. Alas, the reverse also holds true. Affirmative action can harm racial groups to the extent that a college sends a signal of quality… Tragically, even high performing members of the protected group will be hurt affirmative action because employers could more easily judge their race than their intelligence. P166

One hand tied behind my back strategy
What if, when a rival enters your market, you stop all advertising? If your rival has any chance at long term survival, this strategy would be disastrous. If however you are so confident that no one would buy your rival’s product even when you cease your ads, then you might want to stop. Your rival will realize that if he can’t beat you when you’re not even trying, that he has no hope when you do advertise. This is similar to how a gazelle will jump 18 inches vertically when seeing a cheetah. This is a signal of fitness by displaying conspicuously an outrageous feat. P167

A warranty implies quality
A free warranty signals quality. If the product is of high quality, the warranty will not cost the seller much. The seller of a lemon would be reluctant to offer such a warranty that would impose expensive obligations. P168

Why guys are stuck buying flowers on Valentines day
Game theory forces almost all men to give flowers to their women on Valentine’s Day… Men who don’t care about their women won’t spend the money. Could a man convince his girlfriend that he didn’t need to buy flowers? Yes, but it would be like a smart person convincing his employer that he’s intelligent even if he didn’t go to college. So no flowers from your man, will leave most women thinking that their boyfriend is disinterested in them. Plus men who don’t buy flowers and are not actually interested, will often lie and claim interest. Consequently it’s extremely difficult for men who care but don’t buy flowers to convince their girlfriends that they are devoted. P170

Why playing hard to get works
If you express extreme desire to date someone, she may question why you can’t do better than her.. The strategy to adopt is to convince her that you can date better women, but you are willing to make an exception with her. Ideally, she thinks that you’d barely consider dating her. Of course if she’s a supermodel, this strategy no longer works. Expressing intense interest in that case is normal for every male regardless of your worth, so feel free to express your desires, but be coy when pursuing ordinary mortals. P171

Single women sometimes pretend not to recognize available men whom they have previously met. This is a brilliant strategy for it signals that they have so many options that they need not keep track of them all. This feigned ignorance will impress not only the men they pretend not to know, but also people who find out about their deed. And the better looking the man they pretend not to know, the higher the opinion others will have of them. P171

It’s entirely rational to lose interest in someone who responds favorably to your advances. After all this means they can’t do better than you. If they’re too eager to accept, then perhaps you should look elsewhere. P172

What’s more important – looks or personality?
Beauty may be skin deep, but it conveys information far more quickly than personality does. We are also judged not just by our appearance but the company we keep. How can you then convince someone that you are a deep, caring person? The best way is to be completely superficial in your choice of mates. What would you think of a below avg man with a strikingly beautiful woman? He must be smart, sensitive, funny and/or rich. Now what you think of the same man with a below avg woman? Probably nothing. So if you want to trade up in the dating market, be superficial. P172

If you don't label it, then they won't believe you
When a product is not labeled for a particular characteristic (lowfat, organic, safe, etc.) you should assume that either most people don’t care about this trait, or that product’s trait is bad. Even if it were average it would be labeled. If it is not labeled, it must be below average. P174

How to get out of jury duty
Juries are supposed to irrational and forget that defendant who doesn’t testify is signaling that his testimony would hurt his case (want to get out jury duty in a jiffy, just say that if a defendant doesn’t testify it must mean he has something to hide). In business you don’t have to be held to this irrational standard and you are free to assume that silence signals the worst. For example a job applicant’s resume has holes, and he is not willing to fill them in. p174

Cracking under the stress
When an interviewer asks you hostile, stressful questions he is seeing how you handle it without breaking. Or if a manager asks if anyone has free time for a new project. An unthinking person eager to the please the boss will signal their idleness. Acting quickly can reveal more about you than you want. P175

Tell your supplier that the next batch is really important, and if there are zero defects you will pay him double. If the supplier is not too sharp and complies, then you’ll have proof of his true capabilities. P175

How affirmative action backfires
It would much harder to fire a minority worker because of the threat of discrimination, thus it might be more rational to hire a white worker because he can be more easily fired. It would be worth taking a chance on the white employee, but you would only hire a minority if you are almost certain that the would be productive… Similarly it is much harder to fire workers in Europe than in the US, consequently unemployment rates are lower in the US because American firms have a greater willingness to hire and fire workers. P180

You can often use the financial aid package from one school to get a better offer from another. Make the college believe that your choice will depend upon aid; have the college believe that you are price sensitive. P185

A price for everyone, and everyone has their price
Coupons seem silly, however they effectively separate the price sensitive customers by giving them a discount by trading time for money. P187

For $130, Universal studios will sell you a pass that lets you move to the front of the lines. Supermarkets could do the same thing. They could have an express lane where you pay 10% more for faster service. They could also charge different prices during rush hour (5pm to 8pm). P189 Dept stores use this tactic by offering sales prices during working hours. Same goes for happy hours.

Company boy
Employees should always be cautious of working for a business where the experience they gain would not be transferrable to other companies. Of course, the flip side is that that you are harder to replace. P203

Credit Crisis
A governmental guarantee to banks would mean that the bank needn’t worry about lending me the money, even if you knew I would squander it, since the gov’t will pay it back. Similarly deposit insurance for a bank allows the bank to attract deposits even if the bank makes extremely risky investments. P217

Beware the hidden price of test results
If there were genetic tests that could determine when someone would get cancer or heart disease, then insurance companies would be reluctant to cover anyone how had not been tested by the company because they would fear that these folks may have been tested without disclosing the results to the insurance company. P220 Thus not having the tests makes the system work like it does today. If the tests become prevalent, and private, then insurance premiums will most likely go up to cover the adverse selection.

The most important person in the world, and why Marx was wrong
100,000 people die in an earthquake in a faraway land and it is all over the news. At the same time, you cut off the tip of your pinky finger. A close friend calls you and asks “How’s your day been?” What are you most likely to mention, the earthquake or your finger?...Communism failed because it didn’t take account this fact, that humans are self interested. P231

How the not so good, make the good even better
Imagine that Bill is better than Jane at everything at work (Bill can produce 2 widgets or 7 sprokets in 1 day, Jane can only produce 1 widget or 1 sprocket in 1 day). If you fired Jane and only had Bill what would this cost your firm? Quite a bit actually, much more than 1 widget or 1 sprocket per day. How? Through trade. Imagine your firm had to create 2 widgets, and you only had Bill left. If you had kept Bill, during that 2 day period, you could have had Jane create 2 widgets, while Bill created 14 sprockets. So the lose of Jane cost you 14 sprockets, even though she could never product at that level. Her value is that she frees up a productive resource. P238

Why art can't become too expensive
Most everyone would rather have a nice painting or art work instead of a stock certificate as an investment. Consequently if art and stocks performed equally as well, no one would buy stocks. The market automatically adjusts the return on stocks and art, such that stocks out perform. P262

More on this subject:
Thinking Strategically by Avinash Dixit
Evolution of Cooperation by Robert Axelrod
Sex and reason by Richard Posner


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