Summary
A classroom game called "Cash and a Hat" serves as a practical illustration of economic concepts related to lending and borrowing. In the game, two players take turns deciding how much money to put into a hat, with the second player having the option to match the amount or take the money. This setup mimics real-world financial interactions between lenders and borrowers, highlighting the risks and incentives involved in such transactions.
The discussion evolves into a deeper analysis of the moral hazard problem, where borrowers may have incentives to act against the interests of lenders. The instructor emphasizes the importance of understanding sequential move games, where one player's decision influences another's. The concept of backward induction is introduced as a critical analytical tool, allowing players to anticipate the actions of others based on their choices.
Further exploration of the topic reveals strategies to mitigate moral hazard, such as implementing contracts that align incentives or requiring collateral to ensure repayment. The conversation also touches on historical examples, including William the Conqueror's commitment strategy of burning ships to eliminate retreat options, reinforcing the idea that commitment can influence the behavior of others in strategic situations. The session concludes with a reminder of the significance of backward induction in decision-making processes.
Show Notes
Game Theory (ECON 159)Uploaded 20-11-08We consider games in which players move sequentially rather than simultaneously, starting with a game involving a borrower and a lender. We analyze the game using "backward induction." The game features moral hazard: the borrower will not repay a large loan. We discuss possible remedies for this kind of problem. One remedy involves incentive design: writing contracts that give the borrower an incentive to repay. Another involves commitment strategies; in this case providing collateral. We consider other commitment strategies such as burning boats. But the key lesson of the day is the idea of backward induction.00:00 - Chapter 1. Sequential Games: Backward Induction17:57 - Chapter 2. Sequential Games: Moral Hazard29:50 - Chapter 3. Sequential Games: Incentive Design44:29 - Chapter 4. Sequential Games: Commitment Strategies01:01:06 - Chapter 5. Sequential Games: Backward Induction Is Really ImportantComplete course materials are available at the Yale Online website: online.yale.eduThis course was recorded in Fall 2007. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices
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