Tuesday, October 26, 2010

Reciprocity, Reputation and Trust: are they irrational?

I would like to begin by saying thank you. This is an article that has been on my “to read” list since Ms. Ostrom won the Nobel Prize last year. I must say though, I am glad I received some game theory study before reading this article. What is so very interesting about this topic is the divergence between theatrically sound models and empirical study. Common sense often tells us what ought to happen, however, common sense is only valid to those that share it. As economists, we like to make this grandiose assumption that people act rationally, it is common sense. However, we often fail to understand or appreciate that one can only act rationally on the information they have and their own expectations of the future. I posit that there is no such thing as perfect rationality; I believe this article validates that claim.

Now, if we restrict our conversation to competitive firms, we can make some pretty good (although not perfect) predictions about decision making strategies based on the premise of profit maximization. Nash equilibrium, competitive output and pricing schemes, the whole gambit of ideas based on self-interested action tend to loosely hold*. However, if we attempt to use the dual to this equation by projecting profit maximization onto individual consumers, we get paradoxical results. “Normal” people don’t usually do what we expect them to do. I think this article brings up some very valid reasons why. This topic is what got me hooked into economics, so forgive the gittiness. Here’s the one thing that I want to reiterate:

Altruistic behavior is generally a utility maximizing choice. Whether it is in the form of reciprocity, warm glow, or some other reason, people help because it makes them better off. I believe that this may be a genetic phenomenon. In the generations of even our great-grandparents, social cooperation was necessary for survival. Therefore, people with genetic pre-disposition to be non-cooperative proved to carry a lethal gene. If you don’t buy that, then call in a meme. The result still persists. In this case tradition and culture emblazon “fairness” onto us. In modern times, this gene is either no longer lethal, or the tradition is being lost. People are now able to defect without fear of death and have profited from it. Seeing that, the game has changed. What is unfortunate is that we are quickly becoming more individualistic, pessimistic, and opportunistic as a species. The cold-hearted, cut-throat reality of the world we live in is far below the potential social welfare that could be created through cooperation rather than competition. It is very sad that not only are we moving in that direction, we have moved so far as to base our entire study on that presupposition. I am always encouraged when I see social cooperation, reciprocal altruism, and generally nice behavior. It would be very hard to teach my son to only care about himself, because others only care about themselves. I firmly believe this is why our country has the highest rates of suicide and depression in spite of our wealth. I realize that government can’t force cooperation, but occasionally it can help. If only we could get back to helping each other without being in a state in which we would die otherwise.

*In my experience, I have found that there is a mutually higher maximizing solution that doesn’t rely on cost minimization or price fixing. It is a difficult solution to obtain, but even in a competitive market you can increase profits by cooperating with the buyers and employees. For a case study, read Henry Ford’s autobiography.

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