Wednesday, October 12, 2005

Game Theory

I'm not a big game theory guy, but the reactions to this years Nobel Prize in Economics seem to be really positive -- so good. (In contrast, giving the peace prize to a bureuacracy that has done nothing to halt nuclear proliferation is a joke -- on the Nobel committee. Folks are laughing all the way to the bank).

I thought I would share my favorite game theory experiment though, and it involves behavior economics as well. The game is called the ultimatum game, and basically two people try to split a dollar between them. One person suggests a split and the other person can either accept or reject the offer. If they reject the offer, both participants get zero.

Game theory would suggest that a 99%/1% split would be optimal, since 1 cent is better than 0 cents and that's all the offer acceptor/rejector can choose between. In reality, outside of economics students, people reject that offer (picking zero over 1 cent). The optimum seems to be a 60/40 split -- people don't like taking 40 cents instead of 50 cents, but they will settle for it. So remember -- be sure to hold out for your fair 60%


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