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Managing Essentials

International Microeconomics Microeconomics and the game of life


Modesty resulted in Alvin Roth pretending surprise, but his Nobel Prize for economics was not completely unexpected because he ranked highly on a shortlist of candidates compiled every year by economic scholars. Roth shares the prize with Lloyd Shapley, a pioneer in microeconomics who in turn had worked together with Graham Nash, one of the founders of this discipline, father of the famous Nash-equilibrium and recipient of the Nobel Prize in 1994. Nash and Shapley further established the economic game theory, which was introduced some decades earlier in the seminal book by R. Duncan Luce and Howard Raiffa. Already its title, Games and decisions, pointed to their specific perspective on the world and its problems, together with theoretical solutions. They perceived the world as a universe of games and lotteries between which individuals have to choose, with the choice depending on the gains and losses incurred. This perspective seemed to offer a lot of advantages over a genuinely psychological understanding of the human individual. Firstly, games have a formal structure and this structure can be manipulated experimentally. This aspect set the beginning of experimental economics which became serious competition for classical psychological experimentation. Secondly, games, at least many of them, have a mathematically optimal solution. In fact, Luce and Raiffa hoped that based on the understanding of the structural properties of the games presented to humankind, many if not all of the worlds problems could be solved. It was against this background of optimal solutions in experimental games that the genuinely human characteristics of reasoning became exposed. Until today, in the sphere of social behavior the concepts of altruism and trust suffered from the severe blow they got from the famous prisoners dilemma game. In this game, two suspects are interrogated separately about their participation in a crime they committed jointly. Both would be better off cooperating by remaining silent but regularly, due to a lack of trust, the suspects blame each other. Graham Nash and Lloyd Shapley designed another game exposing human selfishness, which they called F*** your buddy and spent many evenings playing it. With regard to individual reasoning, biases and heuristics simplifying and coloring the world became evident. Risk aversion has probably become the most well known bias. In general, individuals value possible losses stronger than possible gains. Daniel Kahneman who received the Nobel Prize in 2002, was the principal investigator of this phenomenon, and he made the topic popular by writing books addressing the general public like his recent Thinking, fast and slow. However, risk aversion is only one of many biases and heuristics enabling the human being to think and act quickly at the expense of time consuming precision and correctness. Nevertheless, scientists in microeconomics seem to feel happy and honored to receive the Nobel Prize rather more than other economists. Microeconomics might be labeled as the black sheep of economics. Widely acclaimed historical economics gurus like Peter Drucker in management or John Maynard Keynes in macroeconomics outfitted us with the notions of control and successful interventions. To run a company successfully is a matter of applying adequate management techniques, and even macroeconomic phenomena like unemployment and inflation can, at least theoretically, be tackled if the right measure is taken at the right time.

Managing Essentials
International
In contrast, microeconomics demands modesty and points to the limitations of human information processing. Selfishness is not a complementary attribute and whilst to be biased may make the human being also more likable, there can be no doubt that its judgment is regularly surpassed by the cold application of mathematical models. Not only in chess human reasoning lost out confronted with the sheer computing power of machines, from clinical assessment in psychiatry to investment decisions at the stock exchanges, mathematical models have superseded what was perceived before as human ingenuity. In addition, experimental microeconomics elucidated what had been well known but was never modeled in this clear cut form, namely that many situations are structurally a dilemma. Sadly enough every action incurs inevitably opportunity costs, but, beyond that, many social interactions have a formal structure which in the end does not allow anybody to become a winner. Many of these games coming close to the heart of modern humankind, for example gaining social justice or achieving ecological conservation, cannot be won by one of the participating parties, but require compromises based on overcoming selfish interests. Of course, their compromising nature makes the pursuit of understanding such dilemma less likely to gain positive popular attention than win-win situations. Also the work by Roth and Shapley displays this dual nature of microeconomics. They developed an allocation algorithm which can be applied in many situations where goods cannot or should not be distributed over their prizing. The most prominent application is the mating game and you can playfully approach the algorithm in a simulation provided by the Mathlab from the University of California in Berkeley. The algorithm has proved its practical value allocating scarce goods like donated organs or sought for places to study at universities in a fair manner. However, whilst the best stable solution for all participants is achieved, not everybodys preferences can be completely satisfied. Evidently, solutions for such microeconomic problems help to solve problems concerning many individuals in a society. Macroeconomics is the result of the microeconomic universe and the success of macroeconomic interventions depends on regular considerations at a microeconomic level. The actual effect of a tax reduction to increase spending depends in fact on the willingness of the households to spend the money and not put it in a savings account. Candidate rankings indicate that several more Nobel Prizes for researchers in microeconomics are in the pipeline. The work of Roth and Shapley demonstrates that results do not necessarily have to be fascinating although a bit sobering insights into human nature only. Beyond such insight and explanations microeconomics can also provide useful tools and instruments. Thereby it will continue to take away illusions of control on some levels of human action, but also may give some more real control on other ones. Jon Elster from Columbia University titled an influential paper many years ago The sadder, the wiser. In fact, progress in economics and social welfare does not depend on the illusionary control of problems but on the wisdom to really cope with them. Analytically life can often be reduced to and viewed as just a game, but it is also much more than that.
Alvin E. Roth (Website) www.managing-essentials.com/2ly

Managing Essentials
International
Lloyd S. Shapley (Website) www.managing-essentials.com/2lz Profile: Lloyd Shapley and Alvin Roth (Laurence Knight) www.managing-essentials.com/2l1 Luce, R. D. & Raiffa H. (1957). Games and decisions: Introduction and critical survey. New York: Wiley. Flash demonstration of the mating game at the University of California at Berkeley www.managing-essentials.com/2l2 Kahneman, D. (2011). Thinking, fast and slow. New York: Farrar, Straus and Giroux Elster, J. (1985). Sadder but wiser? Rationality and the emotions. Social Science Information June 1985 24: 375-406.

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