6.6 Conclusion

Chapter 1 and Chapter 2 introduced game theory and sequential games to explain how people bargain over the gains from cooperation, and how the rules of the game determine how those gains are shared.

Chapter 3 and Chapter 4 showed how interdependence and specialization create the conditions for mutually beneficial exchange. Chapter 5 equipped us with the evaluative tools of efficiency and fairness, demonstrating through the ultimatum game that people are motivated not only by self-interest but also by social preferences. In this chapter, we built on these foundations by introducing a new class of interaction—simultaneous games—and new analytical tools: the game table, best-response analysis using the dot-and-circle method, and the concept of a dominant strategy.

Applying these tools, we found that self-interest does not always lead to bad outcomes. In the corn–soy game, Ana and Ben, each pursuing the highest payoff, independently specialized in the crop their land was best suited to produce. This is the invisible hand game: by following their self-interest without communication, the players arrived at an outcome that was also best for them jointly. Adam Smith argued that people pursuing their own advantage in market interactions nonetheless serve the needs of others. This insight captures an important truth about market economies, and we return to this idea throughout the book.

But self-interest is not always so cooperative. In the pest control game, both Ana and Ben had a dominant strategy: use Toxic Tide regardless of the other person’s action. When both followed the dominant strategy, they reached an equilibrium in which each earned less than they would have earned if they had both chosen integrated pest control. Each player’s decision imposed an external cost on the other: the costs of water contamination fell partly on the neighbor, not only on the person choosing to spray. Because neither player accounted for the harm their decision caused the other, self-interest led them to an outcome they would have wanted to avoid. This is the prisoners’ dilemma, a model of social dilemmas that recur throughout economic and social life, from overfishing to antibiotic resistance to climate change.

In Section 6.5, we used the efficiency and fairness framework from Chapter 5 to evaluate the outcomes of the pest control game systematically. The dominant-strategy equilibrium—both players choosing Toxic Tide—is inefficient: the cooperative outcome, in which both choose integrated pest control, offers greater gains from cooperation for everyone. At the same time, the equilibrium is fair in the sense that both players receive equal payoffs and neither has been coerced. The equilibrium combination, fair and inefficient, is the hallmark of the prisoners’ dilemma and the reason it is a genuine dilemma: the players are not being irrational or unfair when choosing Toxic Tide, but their choices while doing the best they can jointly produce an outcome that is worse for both of them than it needs to be.

Adam Smith’s invisible hand describes market interactions in which the pursuit of self-interest tends to align private incentives with social well-being. Smith was not describing social dilemmas. When external effects are present—when my actions impose costs or confer benefits on others that I do not take into account—self-interest systematically leads away from the socially best outcome. Social dilemmas of this kind are not rare anomalies. They arise whenever people share resources, contribute to public goods, or make decisions whose consequences spill over onto others. Understanding why social dilemmas arise and what can be done about them is one of the central tasks of economics.

In Chapter 7, we extend the analysis in three directions. First, we move from two-player games to public goods games with many players. We ask why people often contribute to collective projects even when free-riding would give them a higher immediate payoff. Second, we introduce the coordination game—a type of game with more than one best-response equilibrium—and show how governments and communities can use fines, subsidies, and regulation to steer players toward the efficient equilibrium. Third, we examine the mechanisms people adopt to overcome social dilemmas: altruism, reciprocity, social norms, the opportunity to punish free-riders, and repeated interactions. These mechanisms can sustain cooperation in small communities, but they become harder to sustain when the number of players grows and interactions become anonymous, which is why global social dilemmas like climate change remain so difficult to resolve.

Throughout Chapters 6 and 7, “doing the best you can” has meant choosing the action that gives you the highest payoff, given what you expect others to do. In Chapters 8 and 9, we apply the same logic to a different kind of decision: the choices you make as an individual, facing constraints imposed by the time you have available, your limited budget to buy things, the prices you encounter in markets, and the technology available to you. Instead of asking “What is my best response to my opponent’s strategy?” you will be asking “How much should I consume, or produce, to do the best I can given my constraints?” The tools of marginal benefit and marginal cost will give you a precise and general way to answer that question.

References

Flavelle, Christopher. 2022. “The Great Salt Lake Is Drying Up. Soon It Could Be a Disaster”. The New York Times. 7 June.

Nash, John F. 1950. “Equilibrium Points in n-Person Games”. Proceedings of the National Academy of Sciences 36(1): pp. 48–49.

Smith, Adam. 2008. The Invisible Hand. London: Penguin UK.