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?
"Anticapitalist theories share in common an inability to take human nature as it is. Rather than analyzing man as a complex creature, anticapitalist theories tend to focus on what the theorist wishes man to be." - Isaac Morehouse
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.
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.
Grant: 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.
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.
I like this reply!
Schools are labour camps.
Magnus: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"
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.
Magnus: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.)
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.
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.
Greg: 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.
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
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.
macsnafu: 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.
I'm sorry to nitpick. It is not that I want to play the bully when it comes to Game Theory, but as a result of my sequence of replies on this matter I'm afraid I will come off as one.
With that said, there are a couple of points in your post that doesn't rest well with me.
One, he is not determining values, he asserts the presence of a group of individuals who agree to maximize a value, i.e. the total value. Think of a scenario of owners of a company, Neighbors Inc, increasing its total value. There is nothing to suggest he denies subjective value. Also, I disagree about your assertion that he is setting "the relative value of each option". Well, obviously I cannot know if that is what the professor thinks he is doing; however, I cannot see why it is necessarily wrong. The game setup allows for subjective valuation of each option, otherwise game theory would be void, i.e. if every player where supposed to always choose the most profitable option, "to desert". This is primarily why Nash got it wrong the first time. The main idea about giving each option a nominal value is to discern a trend, ex post. Nevertheless, just arbitrarily setting each nominel value, ex ante, seems silly. Obviously, for a game to give any robust results you would need to simulate many games using many different values, but for explanatory purposes, in the professor's case, one set of nominal values is fine. At this point I am well aware that my discussion so far is prone to invoke misunderstanding. When von Neumann and Morgenstern originally laid the groundwork to Game Theory they did it as a "revolt" against conventional mathematical marginal utility theory, who can blame them?, but unfortunately, probably owing to von Neumann, they "just" gave the world another constrained set of mathematical tools. Now, I might be wrong, but I think this is what Austrian economists normally revolt against; and seen in this light, I would probably agree with them if I knew more about it. But the moment you realize you aren't modeling reality, per se, and you do not use game theory to guide law making (thus causing injustice) but use the results to guide your own actions (as an individual, collective, firm, "nation" etc.) what is wrong with it? I know it comes close to positivism, á la Milton Friedman, but that is far from my position. I know the brevity of this reply is already in jeopardy, so I'll stop short here, and go on to my next point.
Two, I believe you are confusing changes in circumstances and changes in outcomes, or perhaps forgetting one. If you have spotted a "real life" situation where you know for certain that the set of possible outcomes cannot change over time (e.g. cooperate, not cooperate) it becomes possible to loop the game thus simulating changes in time, i.e. finding trends.
corpus delicti: 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
Ah, yes, I see, where I went wrong in my reply because of my unfamiliarity with game theoy. But the professor is still wrong and he has still made a value judgement. The game matrix correctly identifies a free rider issue, but his conclusion that cooperating is more efficient than free market is still untouched. That's because he's still had to define "more efficient". In this case, his only criteria is home value. That is his fallacy.
Say you have 4 houses in this neighborhood, essentially the same.
Possibility 1: All spend 200 hours improving the house and gain $20,000 in value.
Possibility 2: Three spend 200 hours improving, their houses gain in value $15,000. One person does no work but house still gains $5000.
Now I mix in some praxeology and stir. In possibility 1, does everybody value 200 hours of free time as being worth $100 an hour? If so, great. But what if one of the owners has a side business making $200 an hour (lucky stiff). He would gain $20,000 on his house, but lose $40,000 in opportunity costs. So the tally is 4x$20,000= $80,000 net gain for the neighborhood.
Obviously the dude making $200 an hour isn't going to play that game. That would be stupid. So he sits out and we get Possibility 2...the greedy selfish option. Here, we get 3*$15,000 +1*$5000 = $50000. So at first, the neighborhood seems to have lost out. But since the free rider was off making $40,000 that he didn't earn in possibility 1, we can add that to the total. Here then the neighborhood has really net $90,000. Better than possibility 1 by $10,000!
So, some individual neighbors did not do as well, but in aggregate, the neighborhood is richer in possibility 2. So for this specific case I would argue that possibility 2 is actually more efficient from a market standpoint. Especially if the first three still value $15000 more than 200 hours of free time. Everybody is satisfied. In my Possibility 1, the fourth guys house is $20,000 more valuable, but he had to give up $40,000 to get it...he is very unsatisfied. Even though the first three houses are MORE satisfied, it is impossible to measure their satisfaction against the 4th guys dissatisfaction.
Again the professor could come back and say that maximizing home values was the goal. Ok, fine, then only possibility 1 exists on the matrix. Because in order for possibility 2-4 to exist someone has to value their freetime more than maximum house value. If someone values their freetime more than the maximum house value then you have the possibility to get into my, more efficient possibility 2. If you limit the case to possibility 1, then you HAVE no game theory, so his arguement simply doesn't exist.
Which means that either the professor has to agree that he has no argument because game theory is not applicable, or that sometimes his argument is wrong...in which case he has proven nothing.
Nice one Greg
Essentially you are bringing in the broken window fallacy to the mix.
This is in fact what I fear about Game Theory. I still maintain, it can have great explanatory power, but your point is exactly why it must never be allowed to direct law making.
EDIT: Your reply also enforces macsnafu's reply, i.e. you cannot assign a real world evaluation to each option, since your are, in fact, in total disregard as to what else each homeowner could otherwise be doing if not trapped inside the professor's collectivist mind game.
Morgernstern was an Austrian, incidentally. Be that as it may, the problem with game theory is when it is used to establish the non sequitur that a state is needed to ameliorate some perceived "problem". The doctrine of demonstrated preferences also comes to mind when discussing whether the route chosen by the individuals is preferred or not by them, more so than any hypotheticals as to what they value most.
-Jon
To darkness I condemn you...
Freiheit: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.
Better? For who? Not for the blonde.
Of course, if you wait until your friends have picked up brunettes you can still score the blonde. So really cheating is the "best" outcome.
The benefit of conspiracy is not a new idea. But obviously these collisions never last because of the obvious advantage to cheating. Look at opec. They conspire to keep prices high, but each individual memeber stands to gain even more by cheating on their quotas.
Freiheit:Can anyone give me a simplified version of the Austrian take on this?
It doesn't prove anything that he claims it does.
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