Testing threats in repeated games

Under most game-theoretic solution concepts, equilibrium beliefs are justified by off-equilibrium events. I propose an equilibrium concept for infinitely repeated games, called "Nash Equilibrium with Tests" (NEWT), according to which players can only justify their equilibrium beliefs with events that take place on the equilibrium path itself. In NEWT, players test every threat that rationalizes a future non-myopic action that they take. The tests are an integral part of equilibrium behavior. Characterization of equilibrium outcomes departs from the classical "folk theorems". The concept provides new insights into the impact of self-enforcement norms, such as reciprocity, on long-run cooperation. (c) 2004 Elsevier Inc. All rights reserved

COMMENTS ON THE POTENTIAL SIGNIFICANCE OF NEUROECONOMICS FOR ECONOMIC THEORY

In this short note I speculate about the various ways in which the study of neurological aspects of decision making could be fruitful for economic modelling

Monopoly pricing when consumers are antagonized by unexpected price increases: a "cover version" of the Heidhues-Koszegi-Rabin model

This paper reformulates and simpli�fies a recent model by Heidhues and Koszegi (2005), which in turn is based on a behavioral model due to Koszegi and Rabin (2006). The model analyzes optimal pricing when consumers are loss averse in the sense that an unexpected price hike lowers their willingness to pay. The main message of the Heidhues-Koszegi model, namely that this form of consumer loss aversion leads to rigid price responses to cost fluctuations, carries over. I demonstrate the usefulness of this "cover version" of the Heidhues-Koszegi-Rabin model by obtaining new results: (1) loss aversion lowers expected prices; (2) the firm's incentive to adopt a rigid pricing strategy is stronger when fluctuations are in demand rather than in costs

Simplicity of beliefs and delay tactics in a concession game

I explore the idea of simplicity as a belief-selection criterion in games. A pair of strategies in finite-automata representation (s(1), s(2)) is a Simple Nash Equilibrium (SINE) if: (1) s(j) is a best-reply to s(i); (2) every automaton for player j, which generates the same path as s(j) (given s(i)), has at least as many states as s(j). I apply SINE to a bilateral concession game and show that it captures an aspect of bargaining behavior: players employ delay tactics in order to justify their concessions. Delay tactics are mutually reinforcing, and this may prevent players from reaching an interior agreement. (C) 2003 Elsevier Inc. All rights reserved

"But can't we get the same thing with a standard model?" Rationalizing bounded-rationality models

This paper discusses a common criticism of economic models that depart from the standard rational-choice paradigm - namely, that the phenomena addressed by such models can be “rationalized” by some standard model. I criticize this criterion for evaluating bounded-rationality models. Using a market model with boundedly rational consumers due to Spiegler (2006a) as a test case, I show that even when it initially appears that a bounded-rationality model can be rationalized by a standard model, the rationalizing models tend to come with unwarranted “extra baggage”. I conclude that we should impose a greater burden of proof on rationalizations that are offered in refutation of such models

The Unbearable Lightness of the Economics-Made-Fun Genre

Several commentators have argued that the Economics-Made-Fun (“EMF”) genre contains very little actual economics. As such, it would seem that criticisms of EMF do not apply economics more broadly. In this paper I take a contrary view, arguing that, in fact, at a deep conceptual level, the engine of EMF analyses is precisely the engine of mainstream economics. Specifically, I argue that both EMF and mainstream economics rest on a conceptual foundation known as the Principal of the Substitution of Similars (“PSS”). Understanding how PSS leads EMF practitioners to make claims well beyond what is warranted by their analysis also offers insight into how PSS leaves mainstream economists in danger of overestimating the power and scope of their analyses. I explore the consequences of such problems through an example of economic analysis of the U.S. housing market in the lead-up to the recent financial crisis.Methodology, Popular Economics, William Stanley Jevons, Ontology, Anthropology of Finance

Monopoly Pricing when Consumers are Antagonized by Unexpected Price Increases: A "Cover Version" of the Heidhues-Koszegi-Rabin Model

This paper reformulates and simplifies a recent model by Heidhues and Koszegi (2005), which in turn is based on a behavioral model due to Koszegi and Rabin (2006). The model analyzes optimal pricing when consumers are loss averse in the sense that an unexpected price hike lowers their willingness to pay. The main message of the Heidhues-Koszegi model, namely that this form of consumer loss aversion leads to rigid price responses to cost fluctuations, carries over. I demonstrate the usefulness of this "cover version" of the Heidhues-Koszegi-Rabin model by obtaining new results: (1) loss aversion lowers expected prices; (2) the firm's incentive to adopt a rigid pricing strategy is stronger when fluctuations are in demand rather than in costs.monopoly pricing, loss aversion, price variation antagonism, price rigidity, price stickiness

Testing Threats in Repeated Games

I introduce a solution concept for infinite-horizon games, called “Nash equilibrium with added tests”, in which players optimize with respect to relevant threats only after having tested them before. Both the optimal response and the tests are part of equilibrium behavior. The concept is applied to repeated 2×2 games and yields the following results: 1) Sustained cooperation in games such as the Prisoner’s Dilemma is preceded by a “build up” phase, whose comparative statics are characterized. 2) Sustainability of long-run cooperation by means of familiar selfenforcement conventions varies with the payoff structure. E.g., “constructive reciprocity” achieves cooperation with minimal buildup time in the Prisoner’s Dilemma, yet it is inconsistent with long-run cooperation in Chicken. 3) Nevertheless, a “folk theorem” holds for this class of games.Game Theory, Prisoner's Dilemma

"But Can't we Get the Same Thing with a Standard Model?" Rationalizing Bounded-Rationality Models

This paper discusses a common criticism of economic models that depart from the standard rational-choice paradigm - namely, that the phenomena addressed by such models can be "rationalized" by some standard model. I criticize this criterion for evaluating bounded-rationality models. Using a market model with boundedly rational consumers due to Spiegler (2006a) as a test case, I show that even when it initially appears that a bounded-rationality model can be rationalized by a standard model, the rationalizing models tend to come with unwarranted "extra baggage". I conclude that we should impose a greater burden of proof on rationalizations that are offered in refutation of such models.Bounded rationality, methodology, theory selection, rationalizations