Evolutionary Game Theory and Behavioral Economics

Introduction

With the increasing importance of mathematics in economics approaches, our project is to focus on the application of quantitative science to behavioral economics. Specifically, we will investigate the more sophisticated tools needed to develop more complicated economic models as the economic thoughts evolve. The economic paradigms of interest are the Walrasian paradigm, which dominated in the third quarter of the 20th century, and another economic paradigm which we refer to as “Bowles’ paradigm” for the sake of easy distinction (it does not necessarily mean that Samuel Bowles invented this paradigm).

We will first analyze Walrasian’s paradigm and the mathematics behind it. Then, we will point out some of its shortage, i.e. things that the model cannot explain. Finally, we will use the game theoretical approach of Bowles’s paradigm to explain those.

3 empirically observed characteristics

1.)Social interaction

2.)Individual behaviors

3.)Technologies

- Non-contractual social interactions: when individuals interact, it is the exception, not the rule, that everything between them is regulated by an enforced contract

- Want to analyze the coordination problems in order to see how institutions work - institutions and participants in the interaction

- Believes that Walrasian paradigm is inferior to the more elaborate modeling of institutions by game theory

- Main objective in this chapter is to introduce basic game theory to provide taxonomy of social interactions and their outcomes

- Prisoner’s dilemma- each individual act to maximize their pay off but when both choose to maximize their payoff, the outcome is worse for both

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a. Classical Game Theory

Game Theory

Game Theory is a way of modeling of strategic interactions, which means the consequences of each individual's actions are dependent on the actions taken by others and it requires detailed attention to the institutional environment in which the game takes place.

Classical Game Theory

- Forward-looking cognitive evaluations by the players

- Two main solution concepts: Dominance (process of elimination) and Nash equilibrium (may be one or more outcome that no individual has any incentive to change his strategy based on the strategies taken by all the others)

- These two solutions are based on a best response strategy

b. Evolutionary Game Theory

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- "game theory makes less progress with non-cooperative n-person interactions, but it addresses complex human interaction; what makes interaction difficult is the assumption that they act strategically rather than taking the other’s actions as given"

- Walrasian case – competitive markets for goods governed by complete contracts, strategic actions, only equilibrium trade takes place; single interacting with a given set of prices, technological blueprints and constraints

- But we will see that there are many more important interactions: labor markets, credit markets, markets for information and goods of variable quality

Evolutionary game theory typically assumes that individuals have limited information about the consequences of their actions, and that they update their beliefs by trial-and-error methods using local knowledge based on their own and others recent past experience; subjects in games are “intellectually challenged” and backward looking, but classical theory opposite

- Another reason to reject classical game theory is that it assumes equilibrium can be settled solely by game theory itself and ignores history of the players; third: game theory with narrow scope of institutions; society is not well-modeled as a single game, or one with an unchanging structure

- Games are overlapping in reality

- Evolutionary game theory has modified classical game theory to take account of our limited cognitive capacities by positing agents who update their behaviors using imperfectly observed local info.

- Both evolutionary game theory and models of cultural evolution describe the interactions of adaptive agents, eschewing both the zero-intelligence agents of the standard biological models and the highly cognitive agents of the standard biological models and the highly cognitive agents of classical game theory

- Evolutionary approach: modeling of chance, differential replication, out of equilibrium dynamics, and population structure (p.61)

- Gene-behavior correspondence

- Cultural traits learned rather than transmitted genetically

- Evolutionary modeling characteristic: populations are structured hierarchically and differential replication can take place at more than one level; process of differential replication is typically taking place at many levels simultaneously: within individuals, among individuals, among groups and so on

c. Others

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Walrasian paradigm

assumes that individuals choose actions based on the far-sighted evaluation of their consequences based on preferences that are self-regarding and exogenously determined

social interactions take the exclusive form of contractual exchanges

that increasing returns to scale can be ignored in most applications and institutions do not evolve

institutions exist to facilitate trade

represents economic behavior as the solution to a constrained optimization problem faced by a fully informed individual in a virtually institution-free environment

Deduced a few strong predictions concerning the outcomes likely to be observed in the economy

- The two traditions: constitutional and evolutionary deploy different analytical techniques and distinct metaphors such as “institutions”

- Walrasian general equilibrium model and population-level models depicting evolutionary dynamics of biological systems under the combined influences of chance, inheritance, and natural selection

Similarities: both model systems of competition in which practices or designs with higher payoffs increase quickly

Differ: model of the process of heritable innovation based on mutation and recombination, but economics has no generally accepted theory of innovation; misses the important fact that humans produce novelty intentionally and often through collective actions and not simply by chance

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Theoretical Institutional Economics (Bowles’ paradigm)

Bowles’ paradigm assumes non-contractual social interactions, adaptive and other-regarding behaviors, and generalized increasing returns.

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References

(1) Bowles, Samuel. Microeconomics: Behavior, Institutions, and Evolution. Princeton, NJ: Princeton University Press, 2006. Print.

(2) Gintis, Herbert. Game Theory Evolving: A Problem-Centered Introduction to Modeling Strategic Interaction. 1st ed. Princeton, NJ: Princeton University Press, 2000. Print.

(3) Gintis, Herbert. The Bounds of Reason: Game Theory and the Unification of the Behavioral Sciences. Princeton, NJ: Princeton University Press, 2009. Print.