1 University of Auckland Winter Week Lectures Second Lecture 3 July 2007 Associate Professor Ananish Chaudhuri Department of Economics University of Auckland

2 Back to the example of building a public park A public park is a public good non-rival in consumption benefits are non-excludable. A good is non-rival in consumption when A’s consumption of it does not interfere with B’s consumption of it. The benefits of the good are collective—they accrue to everyone. A good is non-excludable if, once produced, no one can be excluded from enjoying its benefits. The good cannot be withheld from those that did not pay for it.

3 Examples of Public Goods Fire Service Police National Defense Highways Public Parks Environment Hospitals Public Libraries

4 Problems of Cooperation Cooperative hunting and warfare (important during human evolution) Exploitation of common pool resources Clean environment Teamwork in organizations Collective action (demonstrations, fighting a dictatorship) Voting

5 Basic economic problem Cooperative behavior has a positive externality. Hence, the benefit to society exceeds the benefit to the private person providing it. Therefore private individuals are willing to incur the cost of providing this if and only if enough others do so.

6 A Public Goods Game Group of 4 players Each of them has $5 Each can contribute to either a “private” account or a “public” account Money put in the private account remains unchanged

7 A Public Goods Game Money contributed to the public account doubled by the experimenter redistributed equally among members of the group The question is – how much should each person contribute?

8 A Public Goods Game Total amount in the public account = Doubled amount = Divided by four each person gets back =

9 A Public Goods Game Analogous to a Prisoner’s Dilemma For maximum social benefit, each player should put all $5 into the public account A total of $20 which gets doubled to $40 Redistributed equally gets $10 for each player 100% return on investment

10 A Public Goods Game The self-interested strategy is to free-ride (i.e. not to put any money in the public account) Suppose I contribute $1, but no one else does $1 gets doubled to $2 Redistributed equally gets $0.50 for each group member I lose $0.50 while other players (who have not contributed anything) gain $0.50

11 A Public Goods Game Self-interest suggests that no player has an incentive to contribute Even though social benefit is maximized when everyone does so This game has been used extensively to look at issues of cooperation and selfishness in such social dilemmas

12 A few points to bear in mind Simultaneous decisions All players make contribution decisions at the same time One-shot game Finitely-repeated game

13 One shot game Players play the game once and only once We would expect self-interested players to free-ride

14 Finitely repeated game Players know that they will play the game a certain number of times – say 5 times. Players know with certainty when the game will end. We would still expect self-interested players to free ride on the basis of backward induction

15 Backward Induction You already have an idea of what backward induction is You start with what will happen at the end and work your way backwards Where I want to end up often dictates where and how I should start

Finitely repeated game - what would happen in the fifth and last play of the game? All self-interested players would free-ride If players anticipate that then they should also free-ride on the fourth play of the game If players anticipate that then they should also free-ride on the third play of the game And so on So they should free ride from the very start of the game

17 A few points to bear in mind Anonymity Participants never learn the decisions made by other participants Single-blind protocol experimenter can see decisions made by participants Double-blind protocol Even experimenter cannot see decisions made by each individual

18 10% 20% 30% 40% 50% 0% Rounds Percentage Contributed 60% 70% Pattern of contributions when the game is played ten times with a known end-point

19 Why do people do what they do? Not everyone contributes in the middle to start with Some people contribute everything at the beginning while others contribute less Some contribute nothing from the very beginning

20 Why do people do what they do? A number of puzzles here Why do people cooperate at the beginning and free-ride later? If they are going to free-ride why do they not start to do so immediately? Why do contributions start around 40% - 60%?

21 Why do people do what they do? We have already argued that free- riding is the self-interested course of action So maybe that is easier to understand But how about the ones who contribute a lot? Are they being purely altruistic? That is – do they contribute because they care about the welfare of others?

22 Why do people cooperate? It turns out that the motivation behind cooperation is far more nuanced than pure (unconditional) altruism People are conditional cooperators Beliefs regarding the actions of fellow group members play a crucial role

23 Conditional Cooperation - Fehr, Fischbacher and Gächter Players are asked to choose An unconditional contribution A conditional contribution, i.e., for every given average contribution of the other members they decide how much to contribute. A selfish player is predicted to always choose a conditional contribution of zero.

24

25 Chaudhuri and Paichayontvijit (2006), n = 88

26 Chaudhuri and Paichayontvijit (2006)

27 Source: Chaudhuri and Paichayontvijit (2006)

28 Source: Chaudhuri and Paichayontvijit (2006)

29 Source: Chaudhuri and Paichayontvijit (2006)

30 Results Unconditional cooperation is virtually absent. Heterogeneity: Roughly half (or more than half) of the subjects are conditional cooperators. Only a minority are free-riders (selfish).

31 Role of Beliefs Participants have very different beliefs about the contributions to be made by group members And they choose their contribution levels based on those beliefs

32 What if participants could not see what others are doing?

33 What if participants could not see what others are doing?

34 What if participants could not see what others are doing?

35 Role of beliefs Those with optimistic beliefs might start out with high contributions But over time as they see the average contributions fall they start to reduce their contribution

36 Questions?