Welfare Economics. The Edgeworth Box. The Basic Theorem. Some Basic Assumptions

Transcription

1 Welfare Economics The Edgeworth Box The Basic Theorem The basic theorem in welfare economics: A market, exchange, economy will achieve efficient resource allocation. We intend to show the basics of that proof. Some Basic Assumptions A simple economy:harry and Sally. 1

2 Some Basic Assumptions A simple economy:harry and Sally. There are two factors of production, capital, K, and labor, L. L = L H + L S Some Basic Assumptions A simple economy:harry and Sally. There are two factors of production, capital, K, and labor, L. L = L H + L S These two factors of production can be used to produce either apples or bananas. Three Basic Questions How many apples and how many bananas should be produced? Three Basic Questions How many apples and how many bananas should be produced? How should the apples and bananas be allocated between Harry and Sally? 2

3 Three Basic Questions How many apples and how many bananas should be produced? How should the apples and bananas be allocated between Harry and Sally? How should capital and labor be allocated to the production of apples and bananas? The Edgeworth Box The Edgeworth Box The Edgeworth Box Sally Harry 3

4 The Edgeworth Box The Edgeworth Box Sally Sally Sally s a H b s a S Harry s b H Harry Harry s Sally s Harry The Edgeworth Box The Edgeworth Box Sally Sally Harry Harry 4

5 The Edgeworth Box The Edgeworth Box Sally Sally The Contract Curve C A B A B Harry Harry The Contract Curve The Contract Curve Sally Sally Points in yellow area (the Core) make Harry and Sally better off. Harry Harry 5

6 The Contract Curve The Contract Curve Sally Sally Points on black portion of contract curve are Pareto Optimum. Harry and Sally will move to the contract curve via voluntary exchange. Harry Harry Harry and Sally will move to the contract curve via voluntary exchange. Here, they will end up along the black portion of the line The Contract Curve Sally Pareto Optimality When they are on the contract curve, we say that they have achieved Pareto Optimality, the economist s equivalent of bliss. Harry 6

7 Pareto Optimality Pareto Optimality When they are on the contract curve, we say that they have achieved Pareto Optimality, the economist s equivalent of bliss. It is impossible to make Harry better off without making Sally worse off (or vice versa) When they are on the contract curve, we say that they have achieved Pareto Optimality, the economist s equivalent of bliss. It is impossible to make Harry better off without making Sally worse off (or vice versa) If they are not on the contract curve, it is possible to make one or both better off without making the other worse off. Marginal Rates of Substitution When they are on the contract curve, MRS S AB = MRSH AB Sally Marginal Rates of Substitution If not, trading is possible. Suppose MRS S AB = 4 MRS H AB = 3 Then trade Sally Harry Harry 7

8 Two Qualifications Consumer Sovereignty Two Qualifications Consumer Sovereignty Are we comfortable with welfare checks being spend on drugs and alcohol? Do we think children know what is best for them? Two Qualifications The Utility Possibility Frontier Consumer Sovereignty Do we have anything to say about the right point on the contract curve? Harry s Utility We construct the Utility Possibility Frontier by reading off the different levels of utility from the Contract Curve Sally s Utility 8

9 The Utility Possibility Frontier The Utility Possibility Frontier Harry s Utility Simply another way of stating the contract curve Harry s Utility Simply another way of stating the contract curve If we had social indifference curves for the various combinations of utility, we could find the best point along the contract curve Sally s Utility Sally s Utility The Utility Possibility Frontier The Core Harry s Utility Simply another way of stating the contract curve If we had social indifference curves for the various combinations of utility, we could find the best point along the contract curve The yellow area is the core. Harry Sally Sally s Utility 9

10 The Core The Core The yellow area is the core. If only Harry and Sally are involved, they will sit down and simply haggle with each other. Harry Sally The yellow area is the core. If only Harry and Sally are involved, they will sit down and simply haggle with each other. Suppose there are hundreds of Harry's and Sallies? Harry Sally Markets Markets The normal laws of supply and demand will get us to this point. Suppose that Harry and Sally start out with apples and bananas given by (a XH,b XH ) and (a XS,b XS ) respectively. We tell Harry that he can buy and sell apples and bananas at prices (1,p b ). The only constraint is that (a XH - a H ) + p b (b XH - b H ) = 0 (a XH - a H ) + p b (b XH - b H ) = 0 Revenue from Purchases of 10

11 The Contract Curve Sally Markets If Harry s budget line is the dotted line, he will want to move to Z Z If Sally is told that she can buy and sell apples and bananas subject to a budget constraint (a XS - a S ) + p b (b XS - b S ) = 0 she will be willing to buy and sell. Harry Markets If Sally is told that she can buy and sell apples and bananas subject to a budget constraint (a XS - a S ) + p b (b XS - b S ) = 0 she will be willing to buy and sell. However the price that persuaded Harry to move to Z, might or might not move her to Z. The Fundamental Theorem For any starting point there is a price p b which will lead both Harry and Sally to move to the same point on the contract curve. 11

12 The Fundamental Theorem For any starting point there is a price p b which will lead both Harry and Sally to move to the same point on the contract curve. That is, there is a price that equates supply and demand. It puts Harry and Sally on the contract curve Summary Normal trading gets Pareto Optimality in distribution. MRS(Harry ) = MRS(Sally) More to Come Some Basic Assumptions More Welfare Economics A simple economy:harry and Sally. There are two factors of production, capital, K, and labor, L. L = L H + L S These two factors of production can be used to produce either apples or bananas. 12

13 Three Basic Questions How many apples and how many bananas should be produced? How should the apples and bananas be allocated between Harry and Sally? How should capital and labor be allocated to the production of apples and bananas? What We Have Seen Markets get us Pareto Optimality in Distribution. MRS(Harry) = MRS (Sally) There is more to the story. Pareto Optimality in Production Labor Pareto Optimality in Production Labor The Production Frontier A B Capital A B Capital 13

14 Pareto Optimality in Production Labor The Production Frontier A B Capital Integration Production Possibility Frontier MRTS A KL = MRTSB KL Integration Integration Production Possibility Frontier Production Possibility Frontier Slope = MRT 14

15 Integration Integration Production Possibility Frontier Production Possibility Frontier Slope = MRT Slope = MRT Harry and Sally s Contract Curve and Indifference Curves Slope = MRS Some Propositions Some Propositions The ownership of capital determines where we end up. The ownership of capital determines where we end up. MRS = MRT 15

16 Some Propositions Some Propositions The ownership of capital determines where we end up. The ownership of capital determines where we end up. MRS = MRT MRS = MRT We are Pareto Optimal We are Pareto Optimal BUT we can change the initial endowment. Summing Up This is the basic proof of the efficiency of the free market. Summing Up This is the basic proof of the efficiency of the free market. That is MRS = MRT. We are Pareto Optimal. We turn shortly to some technical objections. 16

17 Summing Up This is the basic proof of the efficiency of the free market. The primary objection people raise is about the resulting distribution of income. Summing Up This is the basic proof of the efficiency of the free market. The primary objection people raise is about the resulting distribution of income. How is it, that the market is so good if a very wealthy person can feed his dogs filet minion while others are struggling to live on dog food? Summing Up This is the basic proof of the efficiency of the free market. The primary objection people raise is about the resulting distribution of income. The argument is that the competitive solution achieves efficiency. Summing Up This is the basic proof of the efficiency of the free market. The primary objection people raise is about the resulting distribution of income. The argument is that the competitive solution achieves efficiency. We cannot make one person better off without making another worse off. If we take filet from the wealthy, depriving their dogs, to give to the poor, we are making one person better off and another worse off. 17

18 Summing Up The final distribution of apples and bananas between Harry and Sally is ultimately determined by who owns the capital and labor. Summing Up The final distribution of apples and bananas between Harry and Sally is ultimately determined by who owns the capital and labor. If you think Harry is getting too much at the expense of Sally, economists argue you ought to redistribute income by redistributing the ownership of capital from Harry to Sally. Summing Up The final distribution of apples and bananas between Harry and Sally is ultimately determined by who owns the capital and labor. Efforts to interfere with markets lead to inefficiency. We end up inside the production possibility curve. Summing Up The final distribution of apples and bananas between Harry and Sally is ultimately determined by who owns the capital and labor. Efforts to interfere with markets lead to inefficiency. We end up inside the production possibility curve. Most distribution schemes involve income taxes If I must pay a tax of (say) 50% of my salary, then my incentives to work are reduced. 18

19 Optimality Hicks-Kaldor Optimality Pareto Optimality. A change is good if At least one party is made better off No party is made worse off. Hicks-Kaldor Optimality Optimality Pareto Optimality. A change is good if At least one party is made better off No party is made worse off. Hicks Kaldor Optimality. A change is good if The gains to the winners exceed the losses to the losers. 19

20 Optimality Pareto Optimality. A change is good if At least one party is made better off No party is made worse off. Hicks Kaldor Optimality. The winners A change could is good if compensate the losers and The gains to make the winners this a Pareto exceed Optimum the losses to the losers. Change An Example John works for Sam for 40 hours. He loses leisure worth $200 He grows crops which Sam sells for 300. An Example John works for Sam for 40 hours. He loses leisure worth $200 He grows crops which Sam sells for $300. If John gets paid $200-$300, it is Pareto Optimal for him to work for Sam. An Example John works for Sam for 40 hours. Suppose John doesn't get paid. 20

21 An Example John works for Sam for 40 hours. Suppose John doesn't get paid. That is not Pareto Optimal. An Example John works for Sam for 40 hours. Suppose John doesn't get paid. That is not Pareto Optimal. It is Hicks Kaldor Optimal. A payment of $200-$300 would have left both better off. Lake Restful The town of Lake Restful decides to make some lake improvements, which are worth $10 per resident. The cost per resident is only $5. Lake Restful The town of Lake Restful decides to make some lake improvements, which are worth $10 per resident. The cost per resident is only $5. Lake Restful levies a cigarette tax. Since only 1/4 of the residents smoke, the smokers end up paying $20 each. 21

22 Lake Restful Lake Restful The town of Lake Restful decides to make some lake The improvements, non-smokers which get $10 are of worth $10 per resident. benefits, The and cost the per Smokers resident get is only $5. $10 of net costs Lake Restful levies a cigarette tax. Since only 1/4 of the residents smoke, the smokers end up paying $20 each. The town of Lake Restful decides to make some lake The improvements, non-smokers which get $10 are of worth $10 per resident. benefits, The and cost the per Smokers resident get is only $5. $10 of net costs Lake Not Restful Pareto levies Optimal a cigarette tax. Since only 1/4 of the residents smoke, the smokers end up paying $20 each. Lake Restful The town of Lake Restful decides to make some lake The improvements, non-smokers which get $10 are of worth $10 per resident. benefits, The and cost the per Smokers resident get is only $5. $10 of net costs Lake Not Restful Pareto levies Optimal a cigarette tax. Since only 1/4 of the residents smoke, the smokers Hicks-Kaldor end up paying Optimal $20 each. Acme Paper Mill Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water. 22

23 Acme Paper Mill Acme Paper Mill Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water. It would cost $200 to clean up the mess. Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water. It would cost $200 to clean up the mess. Acme is allowed to begin operations without paying compensation to the residents. Acme Paper Mill Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water. It would cost $200 to clean up the mess. Acme Not is Pareto allowed Optimal to begin operations without paying compensation to the residents. Acme Paper Mill Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water. It would cost $200 to clean up the mess. Acme Not is Pareto allowed Optimal to begin operations without paying compensation to the residents. Hicks-Kaldor Optimal 23

24 The Stop Sign The Stop Sign Cars go through the intersection at Third and Main without any stop sign Cars go through the intersection at Third and Main without any stop sign There are accidents. The town installs a stop sign. The Stop Sign Cars go through the intersection at Third and Main without any stop sign There are accidents. The town installs a stop sign. While most benefit, the few coming from Third are inconvenienced, and on balance are net losers. The Stop Sign Cars go through the intersection at Third and Main without any stop sign There are accidents. The town installs a stop sign. Not Pareto Optimal While most benefit, the few coming from Third are inconvenienced, and on balance are net losers. 24

25 The Stop Sign Cars go through the intersection at Third and Main without any stop sign There are accidents. The town installs a stop sign. Not Pareto Optimal While most benefit, the few coming from Third Hicks-Kaldor are inconvenienced, Optimal and on balance are net losers. This is the test used. The Defense The Defense The Defense This is the test used. The transactions cost of ensuring that every stop sign installed is Pareto Optimum is enormous. This is the test used. The transactions cost of ensuring that every stop sign installed is Pareto Optimum is enormous. While we lose from particular stop signs, we are almost certainly net beneficiaries of stop signs. 25

26 Three Options Three Options Installing stop signs without paying compensation. Installing stop signs and paying compensation (and bearing the transactions costs). Not installing stop signs at all Installing stop signs without Option paying One is Probably compensation. Better for us than Two or Installing stop signs and paying Three compensation (and bearing the transactions costs). Not installing stop signs at all Game Theory Game Theory Developed along with expected utility model Applicable to many duopoly situations 26

27 The Basic Idea Consider a simple game odds or evens The Basic Idea Consider a simple game odds or evens Has the two key elements: Strategies Payoff Matrix Odds or Evens Odds or Evens Player A One Finger Two Fingers Player B One Finger Two Fingers Player A One Finger Two Fingers Player B One Finger Two Fingers A Wins B Wins B Wins A Wins 27

28 Odds or Evens The Prisoner s Dilemma Player A One Finger Two Fingers Player B One Finger Two Fingers W B =-1 W A = 1 W B =1 W B =1 W A = -1 W B =-1 Prisoner A Confess Don t Confess Prisoner B Confess Don't Confess W A = -1 W A = 1 The Prisoner s Dilemma The Prisoner s Dilemma Prisoner A Confess s B =3 Don t Confess Prisoner B Confess Don't Confess s A = 3 s B = ½ s A = 5 s B = 5 s A = ½ s B = 1 s A = 1 Prisoner A Confess s B =3 Don t Confess Prisoner B Confess Don't Confess s A = 3 s B = ½ s A = 5 s B = 5 s A = ½ s B = 1 s A = 1 28

29 The Prisoner s Dilemma The Prisoner s Dilemma Prisoner A Confess s B =3 Don t Confess Prisoner B Confess Don't Confess s A = 3 s B = ½ s A = 5 s B = 5 s A = ½ s B = 1 s A = 1 Prisoner A Confess s B =3 Don t Confess Prisoner B Confess Don't Confess s A = 3 s B = ½ s A = 5 s B = 5 s A = ½ s B = 1 s A = 1 The Prisoner s Dilemma The Prisoner s Dilemma Prisoner A Confess s B =3 Don t Confess Prisoner B Confess Don't Confess s A = 3 s B = ½ s A = 5 s B = 5 s A = ½ s B = 1 s A = 1 Prisoner A Confess s B =3 Don t Confess Prisoner B Confess Don't Confess s A = 3 s B = ½ s A = 5 s B = 5 s A = ½ s B = 1 s A = 1 29

30 How much to Produce How much to Produce Total Revenue Production Firm A 1 B =18 A = 18 2 B = 10 A = 20 Firm B 1 2 B = 20 A = 10 B = 11 A = 11 How much to Produce Total Revenue Production Firm A Firm B B =18 B = 20 A = 18 A = 10 2 B = 10 B = 11 A = 20 A = 11 How much to Produce Cooperative Strategy Firm A Firm B B =18 B = 20 A = 18 A = 10 2 B = 10 B = 11 A = 20 A = 11 30

31 How much to Produce Dominant Strategy Nash Equilibrium Firm A Firm B B =18 B = 20 A = 18 A = 10 2 B = 10 B = 11 A = 20 A = 11 Simple Business Games How much to Produce Dominant Strategy Nash Equilibrium Firm A Firm B B B =18 B = 20 A = 18 A = 10 2 B = 10 B = 11 A = 20 A = 11 Do all Games Have Dominant Strategies? Automotive Firm 1 has great engineering skills. Firm 2 has good designers and does great styling. Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 2 =20 Styling model change 2 = 15 1 = 40 1 = 60 2 = 16 2 = 18 1 = 8 1 = 12 31

32 Do all Games Have Dominant Strategies? Firm 1 has a dominant strategy: technical change. Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 2 =20 Styling model change 2 = 15 1 = 40 1 = 60 2 = 16 2 = 18 1 = 8 1 = 12 Do all Games Have Dominant Strategies? Firm 2 does not have a dominant strategy. Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 2 =20 Styling model change 2 = 15 1 = 40 1 = 60 2 = 16 2 = 18 1 = 8 1 = 12 Do all Games Have Dominant Strategies? Firm 2 s choice is still obvious: assume #1 acts rationally. Adopt a technical change. Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 2 =20 Styling model change 2 = 15 1 = 40 1 = 60 2 = 16 2 = 18 1 = 8 1 = 12 Do all Games Have Dominant Strategies? The lesson: assume your opponent will act rationally. Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 2 =20 Styling model change 2 = 15 1 = 40 1 = 60 2 = 16 2 = 18 1 = 8 1 = 12 32

33 The new firm has a dominant strategy Early and Late Entry Firm 1 s choices of When to extend the brand Firm 2 s choices of when to enter the new brand Early entry Late entry Early entry 2 =60 2 = 20 1 = 40 Late entry 2 = 80 1 = 95 1 = 45 1 = 35 2 = 55 Early and Late Entry The existing firm does not have a dominant strategy but it can rely on the new firm s strategy Firm 1 s choices of When to extend the brand Firm 2 s choices of when to enter the new brand Early entry Late entry Early entry 2 =60 2 = 20 1 = 40 Late entry 2 = 80 1 = 95 1 = 45 1 = 35 2 = 55 Early and Late Entry Moral of the story. Let the new guys try the gutsy strategies. Stodgy pays. Firm 1 s choices of When to extend the brand Firm 2 s choices of when to enter the new brand Early entry Late entry Early entry 2 =60 2 = 20 1 = 40 Late entry 2 = 80 1 = 95 1 = 45 1 = 35 2 = 55 Multiple Nash Equilibria This is the styling problem with a new payoff matrix. Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 1 = 20 1 = 60 2 =20 2 = 55 Styling model change 1 = 60 1 = 25 2 = 55 2 = 25 33

34 Multiple Nash Equilibria Now there are two Nash Equilibria Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 1 = 20 1 = 60 2 =20 2 = 55 Styling model change 1 = 60 1 = 25 2 = 55 2 = 25 Early and Late Entry New entrant can enter either new or wait. Established Firm can extend early or late. Firm 1 s choices of when to extend the brand Early entry Late entry Firm 2 s choices of when to enter the new brand Early entry Late entry 2 =60 2 = 20 1 = 40 1 = 45 2 = 80 2 = 55 1 = 95 1 = 35 Multiple Nash Equilibria Look at the first Nash Equilibrium. Neither firm has reason to change Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 2 =20 Styling model change 2 = 55 1 = 20 1 = 60 2 = 55 2 = 25 1 = 60 1 = 25 Multiple Nash Equilibria Ditto for the second equilibrium Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 2 =20 Styling model change 2 = 55 1 = 20 1 = 60 2 = 55 2 = 25 1 = 60 1 = 25 34

35 Multiple Nash Equilibria This is an introduction. It shows how to get going. There is more to come. Firm 1 s choices Technical Model Change Styling Model Change Firm 2 s choices Technical model change 1 = 20 1 = 60 2 =20 2 = 55 Styling model change 1 = 60 1 = 25 2 = 55 2 = 25 Sequential Games A Sequential Game A Sequential Game Our basic payoff matrix assumes that strategies are enacted at the same time, as in odds or evens In many games, the moves take place in sequence In chess, one player moves Then the other player moves A firm is considering entering a new business. After it enters, or doesn t, the incumbent can either expand or maintain his capacity. 35

36 A Sequential Game A Sequential Game A firm is considering entering a new business. After it enters (or doesn t), the incumbent can either expand or maintain his capacity. The incumbent threatens that it will expand capacity if the new firm enters. If it does, the new firm will lose money. A firm is considering entering a new business. After it enters, or doesn t, the incumbent can either expand or maintain his capacity. The incumbent threatens that it will expand capacity should the new firm enter the business. If it does, the new firm will lose money. A simple test: Is it then in the interest of the existing firm to expand? If so, the threat to expand is credible. If not, it is simply a bluff. Enter Entrant Stay Out Enter Entrant Stay Out Not Not 36

37 Enter Entrant Stay Out Enter Entrant Stay Out Not Not Not Not (-5,5) (10, 15) (0,20) (0,10) (-5,5) (10, 15) (0,20) (0,10) Enter Entrant Stay Out Enter Entrant Stay Out Not Not Not Not (-5,5) (10, 15) (0,20) (0,10) (-5,5) (10, 15) (0,20) (0,10) 37

38 Enter Entrant Stay Out Enter Entrant Stay Out Not Not Not Not (-5,5) (10, 15) (0,20) (0,10) (-5,5) (10, 15) (0,20) (0,10) Enter Entrant Stay Out Enter Entrant Stay Out Not Not Not Not (-5,5) (10, 15) (0,20) (0,10) (-5,5) (10, 15) (0,20) (0,10) 38

39 Enter Not Entrant Stay Out Not (-5,5) (10, 15) (0,20) (0,10) Entrant Enter Stay Out The choice is easy; expand. The incumbent s threat to expand is not credible because it is not in his self-interest Not Not (-5,5) (10, 15) (0,20) (0,10) How to be Credible How can the incumbent firm make its threat credible? It wants to expand, but also wants to keep the new entrant out. How to be Credible How can the incumbent firm make its threat credible? It could, for example, sign a binding contact on a new building. 39

40 How to be Credible How can the incumbent firm make its threat credible? It could, for example, sign a binding contact on a new building. Suppose it spends $15 on a new building. If it actually expands, the money is not lost. If it doesn t the money is lost forever. Enter Not Entrant Stay Out Not (-5,5) (10, 15) (0,20) (0,10) (10, 0) (0, -5) Enter Entrant Stay Out Enter Entrant Stay Out Not Not Not Not (-5,5) (10, 15) (0,20) (0,10) (10, 0) (0, -5) (-5,5) (10, 15) (0,20) (0,10) (10, 0) (0, -5) 40

41 Enter Not Entrant Stay Out Not (-5,5) (10, 15) (0,20) (0,10) (10, 0) (0, -5) Entrant Enter Stay Out The potential entrant will stay out because the threat to expand is now, thanks to the advance commitment, credible. Not Not (-5,5) (10, 15) (0,20) (0,10) (10, 0) (0, -5) How to be Credible This example illustrates the importance of credibility and how to achieve it. How to be Credible This example illustrates the importance of credibility and how to achieve it. An example: Independence Day Important to be the holiday blockbuster With this title, the promise to come out is credible. 41

42 Another Illustration I am thinking of hiring you to do some work. Another Illustration I am thinking of hiring you to do some work. I get $60 of benefit You give up $40 of leisure We agree on $50. Another Illustration I am thinking of hiring you to do some work. I get $60 of benefit You give up $40 of leisure We agree on $50. However the agreement is not enforceable. Another Illustration I am thinking of hiring you to do some work. However the agreement is not enforceable. Should you show up and do the work? 42

43 Employee Employee Work Don t Work Work Don t Work Employer Employer Employer Employer Pay Don t Pay Pay Don t Pay Pay Don t Pay Pay Don t Pay (10,10) (-40, 60) (50,-50) (0,0) (10,10) (-40, 60) (50,-50) (0,0) Pay Employer Work Don t Pay Employee Don t Work Pay Employer Don t Pay (10,10) (-40, 60) (50,-50) (0,0) Work Employee Don t Work In short, you know it will be Employer in the employer s interest Employer not to pay once the work is done. Pay Don t Pay Pay So, the work will never get Don t Pay done. (10,10) (-40, 60) (50,-50) (0,0) 43

44 Work Employee Don t Work There is an important Employer missing element: the Employer Pay employer s right to sue for Don t Pay Pay non-payment. The legal Don t Pay system plays an important (10,10) role. Suppose the courts (-40, 60) (50,-50) would award $60 if the (0,0) employer failed to pay. Pay Employer Work Don t Pay Employee Don t Work Pay Employer Don t Pay (10,10) (-40, 60) (50,-50) (0,0) (20, 0) Employee Employee Work Employer Don t Work Employer Because Work we have a legal system Don t and Work contracts are enforceable, you will do the work and get Employer paid. We have a win-win situation. Employer Pay Don t Pay Pay Don t Pay Pay Don t Pay Pay Don t Pay (10,10) (-40, 60) (50,-50) (0,0) (20, 0) (10,10) (-40, 60) (50,-50) (0,0) (20, 0) 44

45 Some Extensions Some Extensions If I pay you in advance, we have the same issue If I pay you in advance, we have the same issue Without a legal system, we would pass up many valuable opportunities for contracts and exchange of goods and services. End 45