Principles of Micro: Student Workbook

Transcription

1 Principles of Micro: Student Workbook

2 Copyright c All Rights Reserved. MobLab Inc.

3 Contents I Preliminaries 4 1 Introduction Workbook Overview Economic Models How to Test Economic Models Helpful Links II Gains From Trade 8 2 The Trade Game (Food Trucks) Warm-up questions Thinking through theory Experiment notes Further questions III Supply and Demand 17 3 Convergence Module Warm-up questions Thinking through theory Experiment notes Further questions Impacts of Taxation Warm-up questions Experiment notes Thinking through theory Further questions Theory of the Firm: Entry and Exit Warm-up questions Thinking through theory Experimental notes Further questions

4 IV Collective Action Problems 37 6 Push and Pull Warm-up questions Experiment notes Thinking through theory Further questions Common Pool Resources Warm-up questions Thinking through theory Experimental notes Further questions

5 Part I Preliminaries 4

6 Chapter 1 Introduction 1.1 Workbook Overview If you want to change the world, you need to start with how the world works. Learn economics! MobLab is honored to help you on your journey. This workbook has been developed to engage students in scientific inquiry and the joy of discovery. In each workbook chapter there are four components: Warm-up questions, Thinking through theory, Experimental notes, and Further questions: - Warm-up questions - These are a companion to MobLab video instructions. If you actively listen to the video instructions you will be able to complete the warm up questions and understand the rules of the game. - Thinking through theory - Answers to these questions require some knowledge of economic theory. Often times, what we are able to observe about an experiment depends on what we already know. These questions provide a richer context for the experiment. - Experimental notes - This component of the workbook provides an opportunity to record your role, decisions, predictions, and outcomes. It is a useful reference for reflection surveys, class discussion, or if instructors ask you to write a report about the game. - Further questions - These questions deepen the conversation between economic theory and economic outcomes. Some questions are related to game experience, data from the experiment, how the game generalizes to the real world and more. Our passion is creating ah-ha moments for students. In what follows, we provide a simple framework for understanding economic models and how economists test those models. Also, we include helpful links to videos MobLab and other organizations have created. And, of course, there are the chapters related to the classroom experiments. 5

7 1.2 Economic Models Economics is the study of human action. What do individuals care about? These are called benefits and can include motivations like consumption, fairness, prestige, etc. To secure benefits, what does it cost in terms of time, money, and foregone opportunities? Because there are numerous motivations and costs, simplification is needed. Economic models attempt to define the benefits and costs that are relevant in a decision situation. With an economic model in hand, economists can make predictions about what will happen when costs, benefits, or features of the decision situation change. Because these models are simplifications, they are incomplete descriptions of the motivations and costs to action. The question is whether the model is a useful simplification. Economists measure usefulness by how well the model can predict human behavior. Sometimes the predictive power of a model can be improved dramatically when other benefits or costs are considered. The insights of economics have been applied to politics, crime, families, religion, and other spheres of human interaction. If you have ever looked at the window and wondered why?, you are going to love economics. 1.3 How to Test Economic Models In the previous section, we noted that models attempt to define the relevant benefits and costs to individuals in a decision situation. The model relates variables (e.g. things that can vary like benefits and costs) to outcomes (what the economist cares about) and generates predictions about how outcomes change when variables change. Another name for a prediction based on a model is a hypothesis. The hallmark of science is that hypotheses are testable. Here are some examples of economic hypotheses: - If the market is perfectly competitive then, there is an equilibrium price p for which quantity demanded equals quantity supplied. - If the government imposes a binding price-ceiling (restricts how high a price sellers can obtain in the market) there will be a reduction in the number of transactions (i.e. fewer sellers willing to sell at that price). - If team outcomes are based on combined efforts, but individuals benefit regardless of how much effort they exert, individuals will free-ride and exert little effort. Standard economics uses data from natural observations (e.g. surveys, public records, transaction records, etc.) to test hypotheses. The advantage of using data from natural sources is that those data contain information about the world we care most to explain. However, there are often problems with measurement error, reporting error, and you can t always test what you want. The data either isn t available or it s unclear how you could collect it. Experiments allow economists to make precise measurements and control the environment where observations are made. This allows economists to manufacture the situation where a hypothesis is falsifiable.

8 Experiments in Economics Milton Friedman once wrote that to test hypotheses economists relied on, experiments that happen to occur. In their popular textbook Economics, Samuelson and Nordhaus asserted, One possible way of figuring out economic laws... is by controlled experiments... Economists [unfortunately]... cannot perform the controlled experiments of chemists or biologists because they cannot easily control other important factors. Like astronomers or meterologists, they generally must be content largely to observe. Times have changed. Many economists now generate their own data in using laboratory experiments to test economic theories. The 2002 and 2012 Nobel Prizes validated the usefulness of lab experiment data. 1 The revolution continues as experiments move out of the lab with field experiments and A/B testing by tech firms. Consider the first hypothesis that, If the market is perfectly competitive then, there is an equilibrium price p for which quantity demanded equals quantity supplied. What do we need to test this hypothesis? We need suppliers and demanders. We need to give demanders a value for the commodity being traded. We need to give suppliers a cost to produce the commodity being traded. Finally, we need rules for how demanders and suppliers interact with each other. These rules should be a close approximation to the perfectly competitive model. We can then test whether the equilibrium price p emerges from those interactions and conduct additional tests about the supply-demand framework. What happens if we shift the value schedule for demanders or the cost schedule for suppliers? Does that lead to the new predicted p? In short, in experiments we create micro-economies with rules of the game that mirror our economic models. We then populate those micro-economies with humans, allow them to interact, and see what outcomes happen. We can compare outcomes when there are changes to benefits, costs, or the rules of the game. The experiment that compares outcomes is controlled if outcomes were generated from situations identical except for a single difference (i.e. ceteris paribus or all else equal ). For more on the scientific method and controlled experimentation see this video (link to content). 1.4 Helpful Links There are a number of free online resources available that fit with our student workbook. Throughout the student workbook we will link to relevant videos. These might help with content on thinking through theory or they could be videos that help with calculations needed for the further questions sections.

9 Part II Gains From Trade 8

10 Chapter 2 The Trade Game (Food Trucks) You operate a food truck. The only item on your menu is a Combo meal consisting of one burger and one serving of french fries. Each morning, you have a fixed number of minutes to prepare the burgers and fries you will sell that day. Your payoff for each day is the number of Combos you will be able to sell. For example, if prepare 16 burgers and 12 servings of fries, you will be able to sell 12 Combos, meaning your payoff is Warm-up questions No Trade Game Orange and Blue are two food trucks, each producing two items: Burgers and Fries. Table 2.1 indicates for the orange food-truck operator how many of each item she can prepare if the she devotes 1 minute to the item s preparation. Watch the video instructions to answer the warm-up questions below. 1. In this game you are choosing how to allocate. 2. Each operator has minutes in total to prepare items. 3. The video instructions feature a Blue Truck. Complete the blank spaces in Table 2.1 below. Orange Blue Burgers /minute 2/minute Fries /minute 1/minute Table 2.1: Productivity for each of two Food Trucks (Orange and Blue) for two different products (Burgers and Fries). 4. The operator of the Orange truck spends 25 minutes preparing Burgers and 5 minutes preparing Fries. - How many burgers will she prepare? 9

11 - How many servings of fries will she prepare? - How many Combos will she be able to sell? 5. The operator of the Blue truck spends 5 minutes preparing Burgers and 25 minutes preparing Fries. - How many burgers will he prepare? - How many servings of fries will he prepare? - How many Combos will he be able to sell? 6. At the end of the video instructions, the blue truck produces 26 burgers and 17 fries. What is their payoff? 7. The narrator suggests the blue truck could have done better. The blue truck chose to spend 13 minutes on burgers and 17 minutes on fries. This resulted in 26 burgers and 17 fries. What is a different time allocation that could have made them better off?. Trade Game Likely you will be asked to complete this section during class, following the no-trade game. 1. Fill in the blanks by following along with the example given in the video. In case you miss it, Blue trucks have a per minute productivity of 2 burgers/minute and 1 fries/minute. - The blue truck allocates 14 minutes to prepare burgers. - The blue truck allocates 16 minutes to prepare fries. - After trade, the blue truck brings burgers and fries to the truck. - This means that the blue truck agreed to trade burgers for fries. - Could the bluck truck have allocated their time better? - 2. Suppose the blue truck allocated 20 minutes to prepare burgers, 10 minutes to prepare fries, and made a trade of 15 burgers for 15 fries. Answer the following questions. Remember, blue trucks have a per minute productivity of 2 burgers/minute and 1 fries/minute. - If the blue truck spends 20 minutes preparing burgers it will produce burgers. - If the blue truck spends 10 minutes preparing fries it will produce fries. - After trading 15 burgers to get 15 fries, how many combos can the blue truck sell?

12 - Could the blue truck have sold this many combos without trade? What is the most combos the blue truck could have sold without trade? and. 3. At the beginning of the instructions, the narrator mentions that, if trades are made, there will be a difference between what you produce and what you bring on the truck. Why is that?

13 2.2 Thinking through theory 1. On the graphs below, plot the production possibilities frontier (PPF) for the blue and orange trucks and label the graphs. Do this with the information from Table 2.1 and assume 30 minutes of preparation time. Fries are on the x-axis and burgers are on the y-axis. (Find the maximum number of burgers a truck can produce. Plot that point. Find the maximum number of fries a truck can produce. Plot that point. Then connect the points). Burgers Fries Burgers Fries 2. Circle the correct answer. The blue truck / orange truck has an absolute advantage in the production of burgers. 3. Circle the correct answer. The blue truck / orange truck has an absolute advantage in the production of fries. 4. What is the slope of the PPF for the blue truck? (Hint: Rise over run).

14 5. The operator of the Blue Truck is using all 30 minutes of prep time. What is the opportunity cost, in burgers, of producing one more fries? 6. What is the slope of the PPF for the orange truck? (Hint: Rise over run). 7. The operator of the Orange Truck is using all 30 minutes of prep time. What is the opportunity cost, in burgers, of producing one more fries? 8. has the comparative advantage in the production of burgers. 9. has the comparative advantage in the production of fries.

15 2.3 Experiment notes First Session - No Trade Your role (color truck) in this session was. Based on your role you could produce: - burgers per minute. - fries per minute. How did you decide to allocate your 30 minutes? - minutes were spent on burgers. - minutes were spent on fries. This resulted in producing burgers and fries, or combos.

16 Second Session - Trade Your role (color truck) in this session was. Based on your role you could produce: - burgers per minute. - fries per minute. How did you decide to allocate your 30 minutes? - minutes were spent on burgers. - minutes were spent on fries. With that time allocation, you prepared: How did you decide to allocate your 30 minutes? - burgers. - fries. After trade, you were able to bring burgers and fries to the truck. This resulted in combos.

17 2.4 Further questions 1. Based on your experimental notes, graph your production possibilities frontier for your role in the no-trade condition. Then locate your production decision on the graph. 2. Based on your experimental notes, graph your production possibilities frontier for your role in the trade condition. Locate your production decision on the graph and locate how much you brought back to the truck after trade. 3. Use the data to calculate the average payoffs under the no-trade and trade conditions. 4. Compare the average from the two conditions and test whether the difference between those averages is statistically significant (Here is a video on how to conduct this test.) 5. Recall that blue trucks can produce 2 burgers per minute and 1 fries per minute. Suppose that Orange Trucks could produce 8 burgers per minute or 4 fries per minute would there have been opportunities for beneficial trades? Why or why not? 6. Suppose you are taking two courses. Your scarce resource is study time, which you divide between the two courses to produce grades in each. What would cause an outward shift in the production function (study time is fixed) so that you can achieve a higher grade in economics without reducing the grade in the other course?

18 Part III Supply and Demand 17

19 Chapter 3 Convergence Module This is the first installment on Supply and Demand. In this market you are either a buyer or seller. The trading institution or rules about how buyers and sellers interact is called a double auction. Examples of double auctions outside this classroom experiment include the New York Stock Exchange. 3.1 Warm-up questions Watch the video instructions (for the No Intervention case) to answer the warm-up questions below. In this experiment what are the actions of buyers and sellers? - Buyers submit - Sellers submit What determines the price of a transaction? A transaction occurs at price $P if: - Buyer has the bid and a seller accepts - Buyer clicks buy at the ask - Seller has the ask and a buyer accepts - Seller clicks sell at the bid How are buyer payoffs and seller profits determined? Buyers Payoff = -. This is called consumer surplus. Sellers Profit = -. This is called producer surplus. Remember, zero is greater than a negative number! The buyer will have a negative payoff if > The seller will have a negative profit if > 18

20 3.2 Thinking through theory 1. The supply and demand curve drawn below are based on the values and costs shown in the picture. Label the axes as well as the supply and demand curves Figure 3.1: One buyer. One seller 2. What is the equilibrium prediction? $P = and Q = (In this case there is a single quantity but a range of prices.) 3. What if the market price were P = $1, how many oranges does this buyer demand (quantity demanded)? At P = $1 how many oranges would the seller be willing to sell (quantity supplied)? At P = $1 the difference between quantity demanded and quantity supplied is called. 4. What if the market price were P = $1.48, how many oranges does this buyer demand (quantity demanded)? How many oranges would the seller be willing to sell (quantity supplied)? The name for this difference is. 5. Equilibrium occurs where equals.

21 3.3 Experiment notes Practice Round Game In the practice round your role was. Based on your role circle the appropriate item for Value/Cost and Payoff/Profit in the table below. There were three possible units for you to buy/sell. Please record your transactions in the table below. Table 3.1: Record of Practice Round Transactions Round Unit Transaction Price Value/Cost Payoff/Profit Follow-up questions: - Did any of your transactions result in a negative payoff/profit? - Were there elements of the screen that were confusing and made it more difficult to play the game? Write down your questions here so any misunderstandings can be corrected before the Two Round Game.

22 Two Round Game Your role might be different in this session than the practice round. In the two-round game your role was a. Based on your role circle the appropriate item for Value/Cost and Payoff/Profit in the table below. There were three possible units for you to buy/sell. Please record your transactions in the table below. Table 3.2: Record of Two Round Game Transactions Round Unit Transaction Price Value/Cost Payoff/Profit Equilibrium Prediction $P = and Q = Average Economic Outcome (Round 1) $P = and Q = Average Economic Outcome (Round 2) $P = and Q = Use this space to keep notes about the game. For example, you could keep notes on your strategy and whether/how it changes. You can make a prediction about what will happen in the game. Or, use this space to keep notes on the data presentation.

23 3.4 Further questions 1. In the experiment you could see the three highest bids and the three lowest asks. Relate the concepts of excess demand and excess supply to the picture below. 2. Who do sellers compete against? Who do buyers compete against? How does this competition lead the above picture to change when the round progresses? 3. Take a bird s eye view of the market. How is the equilibrium price-quantity prediction related to total consumer and producer surplus generated by the market? 4. Compare Round 1 and Round 2 data on average price, quantity, and efficiency. What do differences between rounds suggest about when economic models will result in good quantitative predictions of human behavior? 5. Reflect on your own experiences as a consumer. Discuss some different ways that buyers and sellers meet each other and agree on a price. How are these ways different from what happened in the experiment? What differences do you think those rules make for whether the equilibrium prediction is obtained?

24 Bonus Question The double auction experiment from class is based on research from Nobel Prize winner Vernon Smith. When he was a graduate student, Smith experienced a different market where, [The Professor] gave each buyer a card with a maximum buying price for a single unit, and each seller a card with a minimum selling price for one unit. All of us were instructed just to circulate in the room, engage a buyer (or seller), negotiate a contract, or go out to and another buyer (or seller) and so on. If a buyer and a seller made a contract, they were to come to [the Professor], reveal the price of the exchange, turn in their cards, and he would post the price on the blackboard for all to see. Students would play this game for a single round. The market Smith experienced as a graduate student did not converge to the price-quantity prediction. Explain why equilibrium is reached in one market and not the other (Hint: It has nothing to do with hand-run v. computerized).

25 Chapter 4 Impacts of Taxation This is the second installment on Supply and Demand. You are either a buyer or seller in a competitive market. A per-unit tax on sellers will be added into the market. 4.1 Warm-up questions If you have already played in the competitive market game, skip the questions within the box below and move on to warm-up questions about adding a tax into the market. If you have not played the competitive market game, watch the video instructions (for the No Intervention case) to answer the warm-up questions below. General Warm Up Questions for the Competitive Market Game with no tax In this experiment, what are the actions of buyers and sellers? - Buyers submit - Sellers submit What determines the price of a transaction? A transaction occurs at price $P if: - Buyer has the bid and a seller accepts - Buyer clicks buy at the ask - Seller has the ask and a buyer accepts - Seller clicks sell at the bid How are buyer payoffs and seller profits determined? Buyers Payoff =. This is called consumer surplus. Sellers Profit =. This is called producer surplus. 24

26 Remember, zero is greater than a negative number! The buyer will have a negative payoff if > The seller will have a negative profit if >

27 Warm-up Questions for Competitive Market Game with Tax. Read the written instructions for the Seller Tax to answer these warm-up questions below. How does a seller tax impact payoff? Suppose a $0.40 per-unit tax on sellers is added into the market. - Does the tax on sellers increase or decrease the cost of selling for producers? - What does the tax on sellers do to the valuation of oranges from consumers? In this game, does the government revenue collected from the tax add to payoff for buyers? How about to payoff for sellers? How are buyer payoffs and seller profits determined after a tax is imposed? Fill in the blanks below using the correct term from the following list (note: some terms will be used more than once): Value, Cost, Price, Tax Calculating consumer surplus: Buyers Payoff =. Calculating producer surplus: Sellers Profit =. A seller will have a negative profit if + >

28 4.2 Experiment notes Market with No Tax In the market with no tax, your role was. Based on your role, circle the appropriate item for Value/Cost and Payoff/Profit in the table below. There were three possible units for you to buy/sell. Please record your transactions in the table below. Table 4.1: Record of Market (No Tax) Game Transactions Round Unit Transaction Price Value/Cost Payoff/Profit Equilibrium Prediction $P = and Q = Average Economic Outcome (Round 1) $P = and Q = Average Economic Outcome (Round 2) $P = and Q = Follow-up questions: - Did any of your transactions result in a negative payoff/profit? - Were there elements of the screen that were confusing and made it more difficult to play the game? Write down your questions here so any misunderstandings can be corrected before the game with a tax added.

29 Market with Seller Tax Your role might be different in this session than in the market with no tax. In the market with a seller tax, your role was a. Based on your role, circle the appropriate item for Value/Cost and Payoff/Profit in the table below. There were three possible units for you to buy/sell. Please record your transactions in the table below. Table 4.2: Record of Market (with Seller Tax) Game Transactions Round Unit Transaction Price Value/Cost Payoff/Profit Equilibrium Prediction $P = and Q = Average Economic Outcome (Round 1) $P = and Q = Average Economic Outcome (Round 2) $P = and Q = Use this space to keep notes about the game. For example, you could keep notes on your strategy and whether/how it changes. You can make a prediction about what will happen in the game. Or, use this space to keep notes on the data presentation.

30 4.3 Thinking through theory 1. The supply and demand curves below are based on the values and costs shown in the picture below. Note that the seller tax is not currently depicted in the supply and demand diagram. First, label the axes as well as the supply and demand curves in the diagram Figure 4.1: One Buyer, One Seller 2. What is the equilibrium prediction without the seller tax? $P can be between and, and Q = (In this case there is a single quantity but a range of prices.) 3. Now, suppose the government imposes a $0.40 per-unit tax on the seller. This means that for every unit that is sold, the seller must pay the government $0.40. How do you think this tax will impact the market equilibrium quantity and price?

31 4. How does the $0.40 per-unit tax on the seller directly impact the buyer or the seller? Complete the table below. Table 4.3: Buyer Value and Seller Cost with Tax Buyer Seller Unit Value Value After Tax Cost Cost After Tax 1 $1.26 $ $0.98 $ $0.70 $ What is the equilibrium prediction with the seller tax? $P can be between and, and Q = (Once again, there is a single quantity but a range of prices in this example.) 6. First, fill in the table below with the equilibrium quantity and price of the market before and after the tax. Then, determine whether the tax caused an increase or decrease in the equilibrium quantity. Since there is a range of equilibrium prices, determine whether price would most likely increase or decrease. Table 4.4: Comparing Equilibrium Price and Quantity Before and After Tax Before Tax After Tax Increase or Decrease? Price (Write as a Range) Quantity

32 7. Consider again the $0.40 per-unit tax on sellers. Suppose the transaction price in the market for any unit sold is always $0.75 before the tax and $1.00 after the tax. Calculate the consumer surplus, producer surplus, government revenue, and total surplus before and after the tax. Fill in the table below with your answers. (Hint: Remember to account for the tax on sellers when calculating producer surplus after the tax is imposed) Table 4.5: Welfare Analysis Before Tax After Tax Change in Surplus Consumer Surplus Producer Surplus Government Revenue Total Surplus 8. What happens to the total surplus of the market after the tax is imposed? If the total surplus is higher after the tax, where did the extra surplus come from? If the total surplus is lower after the tax, what caused the decrease in total surplus? 9. The tax burden refers to how much of the tax is paid for by consumers or producers. For instance, suppose again that the price of oranges prior to the $0.40 seller tax is $0.75 and $1.00 after the tax. Since the consumer has to pay $0.25 more for an orange because of the $0.40 tax on sellers, this means the consumer bears 62.5%(= $0.25/$0.40) of the burden from the tax. This would also mean producers bear the remaining 27.5%(= $0.15/$0.40) of the tax. This is seen from sellers receiving $0.15 less for each orange sold after the tax. Given this, explain why sellers do not bear 100% of the tax burden even though the tax was imposed on them. (Hint: Think about how an equilibrium price is determined in a market.)

33 4.4 Further questions 1. Relate the concepts of excess supply and excess demand to why the price in the market must increase after a tax is imposed. (Hint: Why don t sellers just charge $0.40 more for each orange?) 2. Why would a tax on sellers impact buyers in the market? 3. Suppose the demand for oranges is more price inelastic than the supply for oranges, and a seller tax of $0.40 is imposed. Will buyers or sellers bear a larger burden of the tax? Why? 4. Evaluate the following claim: If the government returns the entirety of the tax revenue collected from the $0.40 tax on sellers back to the buyers and sellers of the market, then buyers and sellers are no worse off when the tax is imposed. 5. Calculate from the game data consumer surplus, producer surplus, government revenue, and total surplus in Round 2 of the game before tax and then in Round 2 of the game after tax. How was each surplus affected by the tax? 6. Are the results from the data on how consumer surplus, producer surplus, government revenue, and total surplus are affected by the tax consistent with theory? If so, explain why. If not, can you explain what may have went wrong using the data? 7. When economists say things like losses in welfare or deadweight loss due to taxes what do they mean? 8. What are primary reasons for why a deadweight loss occurs? 9. In general, individuals are more likely to support taxes on supplier than consumers. How does this exercise highlight a misunderstanding individuals may have about how taxes and markets work? Bonus Question Suppose instead of a tax of $0.40 on sellers, a $0.40 tax is placed on buyers. Do you expect the results of this experiment to change? If so, how? If not, why? What if instead of the tax, the government subsidizes sellers $0.40 per unit? (Meaning they give sellers $0.40 for every unit they sell.) How would a subsidy change the equilibrium price or quantity? Carefully explain your answer.

34 Chapter 5 Theory of the Firm: Entry and Exit Time matters in economics. In the short run, firms take the number of competitors as given and fixed. Then firms make the best decisions they can given marginal revenue and marginal cost. In the long run, firms can decide to exit the market and new firms can decide to enter. As the market becomes more (or less) saturated, marginal revenue also changes. This ultimately impacts the decisions firms make in order to profit maximize. In this classroom experiment, each person can operate a car in a ride-sharing service called MobDrive. The low fixed costs to entry make this a pretty dynamic market where the long run happens pretty quickly. 5.1 Warm-up questions Watch the video instructions to answer the warm-up questions below. More drivers on the road leads to Fewer drivers on the road leads to revenue per hour if you choose to drive. revenue per hour if you choose to drive. (True or False) The fixed cost you pay to drive does not depend on the number of hours you drive. (True or False) At the time you decide to enter the market, you do not know how many other drivers will enter the market. 33

35 5.2 Thinking through theory 1. Your total cost is based on your fixed cost and the number of hours you drive, denoted by q i. The number of hours you drive determines your variable cost of driving. The formula for your total cost is C(q) = F i + qi 2, where C(q) is the total cost, F i (which does not depend on hours driven) is fixed cost, and qi 2 is the variable cost. Below, you will find a partially-filled table that shows different costs associated with varying hours of driving. Fill out the rest of the table. (Hint: Marginal cost is the change in total cost.) Table 5.1 Hours Fixed Cost Variable Cost Total Cost Marginal Cost 0 $64 $0 $64 1 $64 $1 $65 2 $64 $4 $68 3 $64 $9 $ $ $ $ $ $ $ $ $1 $3 $5 2. If marginal revenue exceeds marginal cost you should drive. 3. If marginal revenue is less than marginal cost you should drive. 4. Suppose that five drivers are in the market and marginal revenue is $17/hour. How many hours should you drive?

36 5.3 Experimental notes Table 5.2: Record of Outcomes Round Number of Drivers Your Hours Driven Revenue Per Hour Cost of Driving Final Hour Profit or Loss Equilibrium Prediction: Across time, there will be entrants. Prediction of Modal Economic Outcome: Across time, there will be entrants. Use this space to keep notes about the game. For example, you could keep notes on your strategy and whether/how it changes. You can make a prediction about what will happen in the game. Or, use this space to keep notes on the data presentation.

37 5.4 Further questions 1. Each firm has total costs T C(q) = 64 + q 2. Those who know calculus will take the derivative to figure out that marginal costs are MC(q) = 2q. Those who do not know calculus will have to trust us. (a) Given this cost curve, what market price will cause each firm in this industry to break-even (i.e., have zero economic profit)? Hint: Consider the relationship between marginal revenue, marginal cost, and price with the relationship between price and average total cost in the long run. (b) If demand is P (Q) = 88 Q, how many units are transacted at the break-even price? (c) If demand is P (Q) = 88 Q and the market is at its long-run equilibrium, how many firms are in the market? (d) If demand falls to P (Q) = 72 Q but the number of firms does not change from the previous question, what are each firm s short-run profits? (To make your life easier, once you find the equilibrium market price, please do round to the nearest integer.) (e) If demand is P (Q) = 72 Q and the market is at its long-run equilibrium, how many firms are in the market? 2. Create a graph that plots rounds on the x-axis and frequency on the y-axis. For each round after the first, plot the frequency that each of the following nine outcomes occur: (a) over-entry in current round, over-entry in previous round (b) equilibrium entry in current round, over-entry in previous round (c) under-entry in current round, over-entry in previous round (d) over-entry in current round, equilibrium entry in previous round (e) equilibrium entry in current round, equilibrium entry in previous round (f) under-entry in current round, equilibrium entry in previous round (g) over-entry in current round, under-entry in previous round (h) equilibrium entry in current round, under-entry in previous round (i) under-entry in current round, under-entry in previous round What does this graph help to show? 3. Create a graph that plots rounds on the x-axis and plots average profit for each round on the y-axis. What pattern do you notice? Bonus Question: There is a large literature on overconfidence in economics. Scholars have identified three kinds of overconfidence. First, people tend to overestimate their own abilities. Second, people tend to believe themselves to be better than others. Finally, people tend to have excessive certainty about how accurate their beliefs are. Over-entry in this game can often be attributed to overconfidence. Do you believe this is a good explanation? And, what kind of overconfidence would explain over-entry?

38 Part IV Collective Action Problems 37

39 Chapter 6 Push and Pull In the Push and Pull game, you are matched with a partner. In each round, you decide between pushing $400 to your partner (increasing your partner s payoff) or pulling $300 to yourself (increasing your own payoff). Your partner will also choose between the same two actions. Neither you nor your partner will know what the other chose until after both have chosen. 6.1 Warm-up questions Watch the video instructions to answer the warm-up questions below. In each round, each player chooses to do what? - To or (True or False) You do not know what your partner does until after both your and your partner have chosen an action. How does the final outcome of each round get determined? Analyze how the combination of both players actions impact the final outcome: Suppose you choose to push $400 and your partner also chooses to push $400, what is the outcome of this round? You receive $ and your partner receives $. Suppose you choose to push $400 but your partner also chooses to pull $300, what is the outcome of this round? You receive $ and your partner receives $. Suppose you choose to pull $300 but your partner chooses to push $400, what is the outcome of this round? You receive $ and your partner receives $. Suppose you choose to pull $300 and your partner also chooses to pull $300, what is the outcome of this round? You receive $ and your partner receives $. 38

40 6.2 Experiment notes First Session - Practice Rounds There are two rounds in the practice game. Record your and your partner s choices along with the final outcome of each round in the table below. Table 6.1: Record of Practice Game Outcomes Round Your Action Your Partner s Action Your Payoff Your Partner s Payoff 1 2 Follow-up questions: - Could you have had a higher payoff if you chose differently in one (or both) of the practice rounds? If so, what could you have done differently? - Did your partner s actions in either rounds surprise you? Why or why not? - Were there elements of the screen that were confusing and made it more difficult to play the game? Write down your questions here so any misunderstandings can be corrected before the actual five-round game.

41 Second Session - Five-Round Game Your partner is likely to be different in this game than in the practice round. Record your and your partner s choices along with the final outcome of each round in the table below. Table 6.2: Record of Five-Round Game Actions and Outcomes Round Your Action Your Partner s Action Your Payoff Your Partner s Payoff Count how many times each of the following outcomes happened: - You and your partner both pushed: - You pushed and your partner pulled: - You pulled and your partner pushed: - You and your partner both pulled: What do you think is the equilibrium outcome of this game?

42 Follow-up questions: - Are you happy with your payoff from the game? Why or why not? - You achieved your highest payoff in round(s), where your payoff was. - In the round that you achieved your highest payoff (as answered in the previous question), could you have received an even higher payoff by choosing a different action, given what your partner chose? - Suppose you were allowed to go back and change what you chose in any round(s), but your partner cannot change what they chose. Put a check next to the round(s) that you could change your action and receive a higher payoff. Table 6.3: Best Response in Each Round Round Changing Action Results in Higher Payoff? Looking at the data from todays experiment, what do you observe?

43 6.3 Thinking through theory While you do not know at the start of the round what your partner will do, you could still take a guess. 1. Suppose you think that your partner will choose Push. Which action should you pick if you want to maximize your payoff for this round? 2. Suppose you think that your partner will choose Pull. Which action should you pick if you want to maximize your payoff for this round? Is there an action that is clearly dominant for you? In other words, is there an action that should be taken regardless of what your partner chooses? Now, consider your partner. While he does not know at the start of the round what you will do, he could still take a guess. 1. Suppose he thinks that you will choose Push. Which action should he pick if he wants to maximize his payoff for this round? 2. Suppose he thinks that you will choose Pull. Which action should he pick if he wants to maximize his payoff for this round? Is there an action that is clearly dominant for your partner? In other words, is there an action that your partner should take regardless of what you choose? If there exists a strategy (action) for a player that is payoff maximizing regardless of what the other player does, it is called a dominant strategy. Is there a dominant strategy for you in this game? If so, what? Is there a dominant strategy for your partner in this game? If so, what?

44 Now, consider the concept of best response. Given an action taken by the other player, the action that maximizes your payoff for that round is called a best response. 1. When your partner chooses Push, your best response is to choose. 2. When your partner chooses Pull, your best response is to choose. Now consider your partner s best response to your actions: 1. When you choose Push, your partner s best response is to choose. 2. When you choose Pull, your partner s best response is to choose. When there is an outcome where both players are playing their best response to the other player s action, that outcome is called a Nash Equilibrium. Determine whether each outcome listed below is a Nash Equilibrium by checking whether you are playing the best response to your partner s action and your partner is playing the best response to your action. Table 6.4: Best Response and Nash Equilibrium Outcome Is your action a best response to your partner s action? Is your partner s action a best response to your action? Nash Equilibrium? You choose Push Partner chooses Push You choose Push Partner chooses Pull You choose Pull Partner chooses Push You choose Pull Partner chooses Pull Here is another way of thinking about the Nash Equilibrium (or Nash Equilibria). At an outcome that is a Nash Equilibrium, neither player has any incentive to deviate from their current action.

45 6.4 Further questions 1. If you could somehow play this game against yourself, what would you do to maximize your payoff and why? 2. What was the tradeoff between choosing to push and choosing to pull? 3. Can you think of any situation where it might be better to play something other than a dominant strategy? Explain. (Hint: Think outside the box) 4. Does the number of rounds played in this game matter? Would you have done anything different if the game only lasted for one round? Or 100 rounds? How about if you didn t know how many rounds there were? 5. The Nash Equilibrium is a theoretical prediction of the outcome of the game. Why? 6. Is it surprising to you that the Nash Equilibrium outcome does not always happen? Why do you think this is the case? 7. Would your strategy in the game have changed if you were allowed to chat with your partner? Do your incentives of choosing Push or Pull remain the same as when chat was not allowed? Explain. 8. What are some ways that you can think of to increase cooperation between you and your partner? 9. Even though cooperation brings about the highest collective payoff, that is not the predicted equilibrium outcome. Use the data to calculate how much payoff from the class is lost in each round because of a lack of cooperation. 10. Use the table below to map this game into a payoff matrix. Payoff Matrix Your Partner You,,,,

46 Bonus Question Suppose that the rules of the game changes. You no longer Push or Pull a specific amount, but the payoff of each player depends on the outcome. If both players choose to push, both players receive $100. If both players choose to pull, both players receive $0. Lastly, if one player pushes while the other one pulls, the one who pushes receives $50 and the one who pulls receives $150. First, map this game into a payoff matrix. Is there a dominant strategy for either player in this game? Can you find any Nash Equilibrium (or Nash Equilibria, if there are multiple?).

47 Chapter 7 Common Pool Resources To this point your economics training has assumed what are called private goods. There are two characteristics of a private good: (1) You can exclude others from using the good, and (2) A person s use of the good subtracts from others using the good. But, many important goods do not have these characteristics. For example, on the ocean you can t exclude others from fishing. In this game you will experience how that small point makes a big difference. 7.1 Warm-up questions Watch the video instructions to answer the warm-up questions below. (True or False) During a season you know how many fish other boats have caught (True or False) At the end of the season the fish stock triples Suppose the maximum capacity of the lake is 80 fish. - If there are 30 fish remaining at the end of the season there will be fish in the lake at the start of next season. - If there are 50 fish remaining at the end of the season there will be fish in the lake at the start of next season. (True or False) The number of fish at the end of the game matters for your payoff Payoff = + Let s do some hypothetical payoff calculations: - Suppose there were four seasons, the maximum capacity of the lake is 80 fish, and you are in a group with three other people. Across four seasons you catch 20, 30, 25, and 15 AND at the end of the fourth season 20 fish remain in the lake. What is your payoff? - Suppose there were four seasons, the maximum capacity of the lake is 80 fish, and you are in a group with three other people. Across four seasons you catch 20, 30, 25, and 15 AND at the end of the fourth season 50 fish remain in the lake. What is your payoff? 46

48 7.2 Thinking through theory 1. Define the two charactersitics that help distinguish between private goods, club goods, common pool resources, and public goods. (a) Excludable (b) Rivalrous 2. Create a graph with an x and y axis. Label the x-axis as excludability. Moving from left-to-right on the x-axis exclusion is easier. Label the y-axis as rivalry. Moving from bottom-to-top rivalry is greater. Place private goods, club goods, common pool resources, and public goods on the graph. Rivalry Excludability 3. What is the difference between private goods and common pool resources? What effect does this difference have on how people consume the good(s)? 4. Some books will invoke a 2 2 matrix with categories labeled excludable, non-excludable, rivarlous, non-rivalrous. What does a graphical depiction, rather than a 2 2 diagram, signal about the way we should think about excludability and rivalry?

49 7.3 Experimental notes First Session This first session is somewhat different from the instructions you watched before class: You are the captain of the only fishing boat on a lake. The lake starts at its maximum capacity of 40 fish. Each round, you catch fish by clicking on the boat. At the end of each round, the remaining fish stock doubles up to a maximum of the lakes capacity. Ending a round with 18 fish results in 36 at the start of the next round, while ending with 22 only results in 40, the lakes capacity. You get one point for each fish you catch. And, at the end of the fourth and final round, the fish stock doubles up to a maximum of the lakes capacity, and you receive one point for each fish. Table 7.1: Record of First Session Outcomes Round Start of Round Stock Fish Caught End of Round Stock Equilibrium Prediction: Each student will catch. Average Economic Outcome: Each student caught. Use this space to keep notes about the game. For example, you could keep notes on your strategy and whether/how it changes. You can make a prediction about what will happen in the game. Or, use this space to keep notes on the data presentation.

50 Second Session In this session there are three others on the lake with you. Table 7.2: Record of Second Session Outcomes Round Start of Round Stock Fish You Caught Fish Others Caught End of Round Stock Equilibrium Prediction: Each student will catch. Average Economic Outcome: Each student caught. Use this space to keep notes about the game. For example, you could keep notes on your strategy and whether/how it changes. You can make a prediction about what will happen in the game. Or, use this space to keep notes on the data presentation.

51 7.4 Further questions 1. Compare the second game, when you fished the sea in common with others, to the first game when you fished alone. Explain any differences in incentives across those two games and whether those differences affected how you played. 2. Institutions are the rules of the game that help define the costs and benefits of human interaction. What rules are likely important for governing the commons? What rules can communities or governments implement to aid in the sustainable use of the resource? Also, think also about what is required for those rules to work. 3. Using the data from the classroom experiment plot each group s fish stock at the end of the game on the x-axis and the average payoff for that group on the y-axis. Do this for the Commons game with group size equal to one and the commons game with group size equal to four (Tip: For group size of one each individual counts as a group so individual outcomes and average group outcomes are identical). 4. Using the data from the classroom experiment calculate the variance in payoffs across individuals in both the commons game with group size equal to one and the commons game with group size equal to four. How do the variances compare? 5. Commons problems are ubiquitous in the world around us. Choose one example of a common pool resource in the world (it doesn t need to be a natural resource) and report on how communities and governments have developed rules to improve the use of that common pool resource. 6. Likely you experienced what has been called tragedy of the commons, where overconsumption of the fish led to an extinction of the stock. In this question consider a new, but similar, problem called the tragedy of the anitcommons where there is under-consumption of a resource. Define the tragedy of the anitcommons and discuss institutions (think legal rules) that have been proposed to overcome it.