 Today's lecture, as you know from the schedule of this titled Game Theory, and when I first started giving this lecture, I guess I felt very combative. So I called it Game Theory versus Entrepreneurs. But then I realized after giving the lecture that that's not actually what I'm going to be talking about. Instead, it's something much more like this fuller title, Game Theory and Entrepreneurial Twist. And what I'm really criticizing is not Game Theory itself, the way that it might traditionally be taught, but rather suggesting that it's incomplete. So it's not that it's totally wrong, it should be trashed, but rather we need to bring to it an understanding that entrepreneurs do actually exist, that we do have people who are creative problem solvers that will try to improve situations that aren't any good. So with that in mind, let's go ahead and hop in. So first, just to give some credence to Game Theory as being part of praxeology, I look at Rothbard in the first appendix in main economy and state. He says, outside of economics, the rest of praxeology is an unexplored area. But then he goes on to list some things where there are, I guess, steps being made. So he says there's a theory of voting that people are starting to work on, and he includes that list, a theory of games that has been elaborated. Suggesting then that Game Theory is part of praxeology, that it is we are studying the science of human action in this logically deductive way. And that is, I think, certainly true. Okay, so the theory of games. Now, what do we mean by game theory? How many people have heard Game Theory before how to present in a class like that? Okay, so I don't have to spend a lot of time defining it. On the way that I like to think of Game Theory, it's a little bit fuzzy, but we're studying cases where we have a group of people and they're interacting in strategic ways. What we mean by strategic interaction is that what I do has a big impact on other people in the group. What other people in the group do has a big impact on me. So I need to take into consideration the actions of other people and I make my choice the way that they are acting now, the way they will react to things that I do since I'm having an impact on them, and so forth. Very much, we know there's the chessboard downstairs. It's a classic case of a game, right? Well, one player does, has an impact on the other and the other responds, okay. All right, so the traditional case, which is kind of where we're going to spend most of our time, would be the prisoner's dilemma, right? So we have two people, right? I'm gonna say Bonnie and Clyde, or they commit crimes together, right? But then the police catch up with them, right? And they take them into the police station, they separate them, they take Clyde into one room, they take Bonnie into another room, and they present them with this deal, right? They say, right, you have the choice, you can either confess to these crimes that you know that you've committed, or you cannot confess, right? And here are the various outcomes that will happen, right? If both of you confess, right? That is, Claudia, I'm sorry, Claudia, Clyde and Bonnie, if they both confess, right, then we get them on pretty serious crimes, they confess to them after all, but at the same time, they're both kind of involved in a sort of plea bargain, right? So, say they get five years in prison for each of them. On the other hand, if neither of them confess, right, we can't get them on the most serious crimes, we don't have good enough evidence for that, but we do have good enough evidence to put them away for a little while on less serious charges, right? So say two years for each of them, right? Now where things are more interesting is when one confesses and the other doesn't, right? So in this case, the way that I've charted things out, Clyde is choosing which room we're in, Bonnie chooses which column, so say Bonnie doesn't confess or she is true to Clyde, Clyde on the other hand being a scoundrel, besides he's gonna go ahead and confess, right? In that case, right, Clyde being the one that cooperated with the authorities gets a really nice deal, right? He gets off scot-free, right? Thank you for cooperating, feel free to go. Meanwhile, Bonnie did not confess so she doesn't get any plea bargain. At the same time, we have enough evidence to convict her of serious crimes thanks to Clyde's confession, so she gets to go to prison for 10 years. All right, if we flip that, say, Clyde is the faithful one that doesn't confess, then he would get the long prison sentence if Bonnie confesses, yeah. So then we go through analyzing how would Bonnie and Clyde act, right, given the situation? Neither of them, after all, know what the other one is going to do, right? Separate rooms, you can just make a guess, right? So we can imagine the way that Clyde would reason through this, we'd say, well, maybe Bonnie's going to confess, right? If so, I have the choice of either not confessing, in which case I get 10 years in prison, or confessing, and then I get five years. Seeing as I don't want to be in prison, five years is better than 10, right? Or perhaps Bonnie, I can actually trust her, and she's not going to confess. In that case, if I don't confess, I get two years in prison, but if I do confess, I get no years in prison, which is even better, right? So Clyde comes to the conclusion that it doesn't really matter what Bonnie does next door. The best thing for him is to confess, right? So that is, in fact, what Clyde decides to do, right? Bonnie, next door over, runs through the same reasoning process and comes to exactly the same conclusion, right? With the result being that both Bonnie and Clyde confess, and they each get put away for five years, okay? Now, what makes us a prisoner's dilemma is not that the story involves prisoners. There are a couple of very important traits. The first is that we have what we call dominant strategies. That is, what Clyde decides to do doesn't really depend on what he thinks Bonnie's going to do, right? What he should do is the same regardless of what Bonnie chooses, right? So we'd say for Clyde, confessing is a dominant strategy. It's certainly better than not confessing. Meanwhile, Bonnie has also a dominant strategy. Confessing is better than not, regardless what Clyde decides to do, right? So first, dominant strategies. The second point that makes this a prisoner's dilemma is that the outcome isn't very good according to the people involved. So when we look at this case where both of us confess, five years for each of us, both Bonnie and Clyde agree that this is a worse situation than if neither of them had confessed, right? So this is a case where Bonnie and Clyde have very strong individual reasons to do what they did, right? But we end up with an outcome that isn't very good, right? Now we can apply the same kind of reasoning to lots of other situations that are a little bit more economicy and less law enforcement. We can think of the tragedy of commons in this way, right? So we have Clyde and Bonnie. They each have the choice of whether they use the commons or not, right? Well, I know that if I use the commons, as Professor Bagus made very clear, if I fish here in these waters, I at least get some fish for myself, right? If I don't, then I don't get any fish, right? So we all have an incentive to use the commons, despite the fact that if we all use the commons, it ends up desolating them, right? So all the fish are extinct because we fish them all outside of the waters. On the other hand, if we don't all fish, then we end up much better off, right? We have fish in the ocean. We can pull them out at a very slow pace, something that's more sustainable, something like that, right? So we can understand the tragedy of the commons in the same way, right? We can also apply this to the standard argument about public goods. It ends up, right? So we have Clyde and Bonnie. They have the choice of contributing to this public good, so they could possibly provide some money to help build roads. As long as they both fund the roads, they each pay less than they benefit. They basically split the costs evenly between them so they each get a lot of benefit from the road compared to what they pay, right? So we have these beautiful highways they can all drive on. On the other hand, there's this temptation with public goods. Because with a public good, it's very difficult to prevent someone from getting the benefit. That makes it very difficult to force them to pay to get the benefit. So there's this temptation, say for Clyde, to say, well, if I think Bonnie's going to fund the thing, maybe I should just drive on the roads that she built. But at that point that tips the scale, Clyde's getting all the benefit. Bonnie's having to pay more than she benefits. So she doesn't want to do it anymore. But the result then being Bonnie also wants to free ride and we end up with this horrible situation where we ask, who will build the roads? Who will provide these public goods? Because Bonnie and Clyde don't want to do it on their own, right? Or we can also imagine the Keynesian depression trap with how we reason about wages. I don't know that Keynes himself made this argument, but it's certainly true when you read Paul Krugman, he makes an argument almost exactly like this, right? Where the suggestion is we have Bonnie and Clyde now, they're no longer criminals, now they're employers, which I guess in a certain viewpoint would make them criminals, but they're employers and they're just deciding what kinds of wages they're going to pay their employees. So they could both keep their wages low. If they do so, that means incomes will be very low, demand for their products will be very low, the economy languishes in a depression. Or they could both increase their wages. If we both increase our wages, now incomes go up, demand for our products go up, we have an economic expansion. Or I could keep my wages low, say as Clyde, while Bonnie increases her wages. In that case, it's very good for Clyde. If incomes are going up, but I as Clyde don't have to pay the cost of that, right? Right, so demand for my products are going up, my costs are still low, there's lots of profit for Clyde, Bonnie on the other hand is having to pay these high wages. It's not like all of her workers are coming back then to buy from her, they're going to buy stuff from Clyde as well. So she ends up with un-net a cost or a loss from this. So reason through, we find out that the best thing for Clyde is to keep wages low. Doesn't want the losses here. In this case, he could profit more by in effect, free riding off of Bonnie's increase in wages. Bonnie wants to do the same thing, with the result being, as Truman says, we just rely on wages to do this, we're just going to languish in a depression forever. All right, so these are all situations where we can apply that prisoner's dilemma. Despite the fact, we all agree, economic expansion would be better. So let's kind of sum this up. In these prisoner's dilemmas, people are choosing optimally based on their own perspective. They're doing the best they can, given that they don't have any control over this other person. At the same time, we end up with these bad outcomes, where we all agree, Bonnie and Clyde, and every one of these cases agree that if they had done the opposite, they both would have been better off. So this can then be a great call and we often hear this in economics classes for governments to do things like force wages up in depressions, you don't hear that as much now, at least not directly, but you might hear calls for monetary expansion to, in effect, do this. Or certainly, funding public goods with taxes, what we need to do is take Bonnie and Clyde, take some of their money from each of them, build the roads, and then they're going to be happier. They'll say, yes, this is in fact more what we wanted than what we would have done ourselves. Regulate the use of the commons, put on phishing restrictions and the like. Keep prisoners from confessing, I've never heard of a government policy suggesting we should do that, but okay. I guess we like the analogy better than the original case. So these are the typical conclusions we reach, that we can actually benefit everyone by forcing them to act a way different than they individually would have. So where does this go wrong? Well, I think we need to think about entrepreneurship. And I think in the Austrian view, there are two major lines of how we think about entrepreneurs and what they do, and this is a case where I think they both apply. So Mises suggests that entrepreneurship is really largely about having good foresight, good anticipation about the future. What will future demand for your product look like? What will future costs look like? How can I act under uncertainty using my judgment about the future in a positive way? So a successful entrepreneur in the Massassian view is someone who has pretty good foresight and knows what to do with it. So that's one view. The other view is the Kursnerian view which really emphasizes the alertness of the entrepreneur. So in this case, it's as if these opportunities are just sitting out there and the entrepreneur is somebody that has better eyes than I do or they actually see these opportunities and they can seize them. When I think of Kursnerian entrepreneurship, the image that stands out in my mind is say when we're all coming in from dinner and we're all trying to stream through that one glass door that's open. So you have 170 people trying to go through one door. A Kursnerian entrepreneur says, wait a second, around the corner there's another door that goes the same place. I'll just go around and go in that door. So there's the opportunity just sitting there, the Kursnerian entrepreneur sees it and seizes it. All right, so what happens if we introduce an entrepreneur that has good foresight that is willing to seize these opportunities that are out there? So let's revisit the prisoner's dilemma. I would suggest an entrepreneur would not just accept the game as lost. So Bonnie and Clyde don't just say, oh well we ended up with a situation we're just both gonna confess and go to prison for a long time, right? I suggest entrepreneurs change the game, right? Cause a good entrepreneur is going to see this game coming. They know where we are committing crimes together. There is some chance we will at some point get caught. We might get put in a situation where we're going to have to either betray one another or be faithful to one another. So we need to change the way that game is gonna play out in some way. Here I know that my wife is a very good entrepreneur. I'm not because she starts businesses, but quite literally when we play games she's a good entrepreneur. And there are certain types of games she just refuses to play with me, right? I don't think we've played risk in years, it is. Is it that style of game? She knows that if we pull it out she's probably going to get very frustrated and end up losing and it's not gonna be any fun. And it's not fun for either of us so I very happily say okay, we'll pull out a different game we're more evenly matched. Weirdly, while I will often win risk it's not true for chess-like games. Chess were much more closely matched. I don't know why that is. Anyway, so entrepreneurs are these people that will change the game. They say I'm not going to play the game the way that it's presented to me. I'm going to do something. I will pick a different game out of the closet. I'm going to change this game in some way so that I may actually end up with a better outcome. And it ends up this is not really news to game theorists. Game theorists already know that if you modify the prisoner's dilemma in specific ways you can end up with better outcomes. For example, one of the most famous is if you repeat the prisoner's dilemma an indefinite number of times and you have these players and they are not quite sure how many times they're going to play the game but we know we're going to be playing it repeatedly that changes the way the prisoners play is what happens now. Now we can start setting up strategies like Bonnie can say to Clyde if you confess on me you can bet I'm going to confess on you next time around. Okay, now Clyde starts thinking twice about his confession strategy because he knows maybe it saved me time now but in the future it's going to cost me five years in prison. So that changes people's behavior. If you have the capability of rewarding or punishing people people actually respond to these incentives. And actually this argument kind of underlies as part of the economic argument for the formation of the WTO, the World Trade Organization and that it's trying to solve a very bad trade policy game. You have people come back to have in this case countries come back together year after year after year. We're having to renegotiate trade and we know that we play a nasty game early on or in between these rounds then we're going to end up with bad outcomes later on. So we end up playing more cooperatively. So this is nothing new to game theorists. It's just suggesting we should apply what game theorists already know more extensively. All right, so if we re-envision game theory then the key assumption in a lot of these games the game is basically fixed. There's nothing we can do to change the game. With entrepreneurs we know this is probably not true. With most situations if you can see them coming or you can do something about it or you can make plans that will change what the outcome is going to be. This is an effect what action is all about. The fact that I believe I can change the future by taking certain steps using the resources at my disposal. Which means then if we think about game theory in those lines we need to start asking the right questions. When we're facing these prisoners dilemma the first question is how might entrepreneurs try to improve this game? We have reasons to believe we might end up with this lousy outcome. What might entrepreneurs do to move us toward a better outcome? What are the opportunities there? And if we see a situation that we believe as a prisoner's dilemma that actually plays out to the bad outcome why didn't entrepreneurs change it? What stood in the way of us reaching that better outcome? Just a couple possibilities maybe there are hidden costs involved. That's a possibility. It could be that there's something we've not taken into account when we've put up these matrices. I know I have my students play the prisoner's dilemma every semester in my microeconomics class. I don't threaten them with prison. I'm not allowed to. But I do offer them instead pieces of candy. So if you play the less cooperative strategy then you individually get more pieces of candy but if everybody plays basically the equivalent of confessing we end up with less candy than if neither of us had confessed. And inevitably I end up with people choosing not to confess basically. They play the strategy that they think wouldn't make any sense. If people only care about candy. But then we start thinking about the fact that I'm putting people in front of a room of 50 people. I'm asking them to make choices that we can very easily see. Anybody that has eyes can see that one of these strategies is nice the other one is mean. And looking like a nice person in front of a big group of people is valuable to a lot of people. Valuable enough that they're in fact willing to give up Swedish fish or M&Ms or various other suites in order to prove that they're a nice person. There's a hidden cost then to playing the less cooperative strategy that just got missed. And I often find when I ask students when they play what I call the less rational strategy they're okay, why is it that you did this? And often we see something like that. Oh, I wanted to be a nice person. Or sometimes they'll say something crazy like oh I don't eat candy. Why would you volunteer for this game if you don't eat candy? All right, fine. So there are these hidden costs that weren't accounted for. So it might be that the reason entrepreneurs aren't trying to fix the game is because it's not broken. It's perfectly fine the way things were. Okay, and other possibilities that maybe there is actually some kind of rule preventing them from fixing the game. There may be some opportunity out there but for some reason they're prevented from taking that opportunity. So how might we think about this? So there's one case we would call this using game theory wrong which is kind of what we've done before talking about depressions and wages, these common in public goods. I'd suggest Austrians are not immune to using game theory wrong. I point here to a paper from about 15 years ago from Curly and Dempster. This is a paper where they're trying to use game theory to explain the Austrian theory of the business cycle. All right, so Curly and Dempster. So when they're thinking about investing during the business cycle or the big question as Austrians we should face is if entrepreneurs are smart enough to know that booms don't last forever, why do they bother investing in the boom phase? You know that things are going to collapse. So they suggest we have basically a game set up kind of like this. This is almost drawn directly from their paper. They say we have here is one firm deciding whether they want to increase investment during the early stage of the boom or whether they want to just maintain investment at their previous level. And all other firms are also facing the same choice. The individual firm, if it decides to increase investment while everyone else does, then they're basically going to have the same performance as everyone else. So relatively their profits are going to be the same as anybody else. The same time if we all increase investment in the boom, we know that investment is not necessarily going to pay off. A lot of it's going to be malinvestment. We're going to end up with the boom bus cycle. On the other hand, if the firm decides to maintain its level of investment rather than increase it, then it's losing profit relative to other firms as it's not participating in the boom or those are profits that could be earned that it is not earning. On the other hand, if other firms decide to maintain investment, firm X can actually get some additional profit by taking advantage of the low interest rates that are available now, thereby having a profit that exceeds other firms. It's a competitive advantage. Or if they decide to just maintain investment, they're going to act like everyone else. If we all maintain investment, then we don't end up with the boom bust. We don't make any malinvestments to just keep doing what we did before. And what Krillian Dempster suggests is that increasing investment is obviously a dominant strategy because it is better to perform at least as well as everyone else than worse or better than everyone else than just as well as everyone else. Since every firm faces the same types of incentives, we end up then with the boom bus cycle for this reason. So why don't I like this argument? I should like it. I like the Austrian theory of the business cycle. I like to see it supported. I think there are weaknesses. One, this is obviously a short-term perspective, which we generally think that entrepreneurs would not have even in the boom phase of a business cycle. And I think about one of the very important, okay, there's something here. There we go. One of the very important business cycles that I went through when I was younger was the dot-com boom, late 90s, early 2000s. We really can't make the argument that Krillian Dempster made about that particular boom because we had all these dot-coms. Virtually all of them were losing money. I think eBay was the one exception at the time. So they're all losing money. Can we really then say that these entrepreneurs are very happy with this? No, no, they're looking way down into the future. Now, if our entrepreneurs are smart enough to know the bust is coming, right, okay, then they're going to look down into the future and see that we have really big losses coming in the future. We'll take that into account when we decide investment now. So there has to be another explanation. If you want to know what my other explanation is, come to my lecture tomorrow afternoon, there we go. All right, so there has to be another explanation. There's another question of relative profit, especially during the bust phase, I think this is really problematic. Oh, I'm happy to be losing money as long as I'm losing the same amount as everyone else or slightly less than everyone else. That's not true for me. I'd rather have cash sitting in my pocket not losing that much value than investing in a stock market that's crashing. Relative profit is not what I'm worried about. And just in the end, it's that they don't ask the right question, right? Why is it that firms are going down this path that is not obviously better, is in fact in the long run obviously worse than if none of them had invested, right? So why aren't firms organizing to prevent that increased investment that's going to hurt them all in the long run? I think there's an answer to that. So come tomorrow to my lecture and find out, okay? So using game theory right, right, how can we do this right? Well, so game theory can inform when entrepreneurs are going to seek creative institutional solutions to these nasty problems. Game theory does allow us to say, here people have a strong incentive to do things that in the end are not going to be beneficial, right? That's a nasty problem, right? So what are we going to do to make it actually beneficial to actually arrive at a better solution? This is one of my favorite examples. There's this game, I think it comes out of the UK, almost certainly comes out of the UK, judging from accents. It's called Splitter Steel. It's I think the last round of a game called Golden Balls. I know nothing about the rest of the game except that you end up with some sum of money as there's this pot of money that the final two players then have the choice to play this type of game, the Cal Splitter Steel. So in this case, right, the two players are Nick and Abraham, and here's the way the game plays. Each of them has a golden ball in front of them, inside there's a word written, it's either split or steel, and they get to choose which of these two balls they're going to play in that final round. If both Nick and Abraham play steel, then they each walk away with nothing. If they both play split, then we take this common pool, in this case it was 50,000 pounds, they each walk away with 25,000. Just split the thing evenly between them. Now if one plays steel and the other plays split, then things get interesting. Whoever plays steel, see in this case, Nick, if he plays steel, while Abraham plays split, Nick gets everything, he steals the whole 50,000, while Abraham gets nothing. Naturally if Nick split, while Abraham stole, but split, Abraham gets everything, Nick gets nothing. So we can walk through just kind of the standard argument. We can already get the feel, this feels kind of prisoner dilemma-like, if we both make this one play, we end up with this lousy outcome, but yet individually it's really good for me if I make that play and you don't. All right, so it ends up Nick. In the case that Abraham steals, it really doesn't matter what Nick does, right? It's gonna walk away with nothing, so it doesn't make any difference. In the case that Abraham plays split, then Nick certainly wants to steal. Stealing would get him an extra 25,000 pounds and that's pretty good, right? So this would be a case where Nick has what we call a weekly dominant strategy, which is that there are some times where what Nick does doesn't really matter as here, but in those times where it does matter, it's very clear what the strategy is, that is in this case he wants to steal, right? Abraham faces exactly the same incentives. If Nick plays steal, it doesn't matter what Abraham does. If Nick plays split, Abraham can certainly be made better off by stealing, okay? So it's a reasonable then to believe that both Nick and Abraham are going to play steal, because zero for each and in this case, it's the game show that won. This was a very cheap episode, right? They have other contestants walk away with nothing, just play for pay-production costs and that's it, right? Well in this case, right, Nick was clearly an entrepreneurial guy, right? He's seen the show before, he knows the way this game plays and I'm confident, I'm sure, that he planned ahead of time what he suggested, right? He said, here's what I want to do, Abraham. I'm going to promise to you, I'm going to play steal, right, I'm absolutely going to play steal, I'm a man of my word, you can trust me on this, I am playing steal, right? Which the hilarious thing to me is that normally people start with that same sentence of I'm a man of my word, you can trust me on this and say I'm going to play split, right? Nick did exactly the opposite, you can trust me on this, I am going to play steal. Nick doesn't care about looking like a nice guy on national television, right? I'm going to play steal, that's what I'm going to do. But, but here's where he changes the game, right? I'm going to play steal and then, right, I will take half the money I get and give it to you. Huh, what did he just do, right? He made the game far less clear for Abraham, right? Now, right, when Abraham looks at the game he says, well, if I can trust Nick to play steal, right? Then, if I play steal, I get nothing, right? If I play split, there's at least a chance he's going to actually follow through and give me the 25,000. If we believe in verbal contracts then he's definitely going to give me the 25,000, right? Okay, on the other hand, maybe Nick's going to play split, which means he's lying to me, in which case I want to play steal and then I get 50,000. There's really no reason for Nick to do that, right? Maybe I should trust him. He's actually going to play steal, right? So what happens, right, the game plays out, right? Abraham does in fact decide that he's going to play split. At this point, when they reveal, Abraham says, yes, I split. Nick reveals and said, I also split. Turns out he wasn't a man of his word, right? But he did save himself the trouble of writing a 25,000-pound check, right? They split, ended up splitting 25,000 either way, okay? All right, so this was a case where we had Nick, right? He needed to break, right? This push for us to definitely show up here, right? So what did he do? He changed the payoffs for the game, right? He said, if we play this, you're going to get more than what it sounds like they're telling you off, okay, okay, all right. And where did a Soto in his book about money, bank credit and economic cycles, that's it? He actually uses game three very well. This is a case where it's not a prisoner's dilemma, but he uses it to reason through the problem about central banking. And he says, suppose we have these two banks, bank A and bank B, they're each deciding whether they want to expand credit or not. Now if neither of us decided to expand credit, then we're both going to survive and we're operating as these 100% reserve banks, right? We don't have to worry about runs in the bank or anything like that. We're charging fees for our services. We get a small profit from that. Alternatively, we could both expand in which case we are not just fees for our services, we also earn like this great interest differential from everything for our fractional reserves and all of that. It's a much larger profit and we both survive in this case. That is true, right? That there's going to be some of my money leaving my bank, because it's the other bank's customers redeeming things, but that's basically going to be offset by money leaving the other bank coming to mine as my bank, because customers are redeeming claims on the other bank, right? So we're basically both going to be fine as long as we expand it basically the same rate, right? Where things get nasty is when one bank expands and the other one doesn't, right? So if bank A decides not to expand credit, while bank B does expand, right? Bank A is operating nice and conservatively. They're certainly going to survive. They don't have to worry that runs on their bank. They have everything in reserve. Bank B needs to be very worried because now they have this fractional reserve, right? And now some of those reserves are going to be leaving, right? Going into the other bank, right? And it's not necessarily going to come back in at the same rate, right? So bank B is going to run into liquidity problems. They eventually end up failing, right? Or we can flip it, bank A, if they expand while bank B doesn't, it's exactly reversed. Bank A is in risk of failure. Bank B would survive. Somebody walk through what are the incentives, right? So bank A says, if I think bank B isn't going to expand, right? Then expanding is deadly. I don't want to do that. That'll kill my bank. I'd rather earn a small profit and survive than fail. On the other hand, if bank A expands, right? I'd much rather earn a large profit than just survive, right? So what bank A wants to do very much depends on what bank, they expect bank B to do. Bank B is the same way. It ends up, there are lots of games that have this structure. We call them coordination games, right? So it's a case where simply coordinating between the two parties is going to pin down exactly what happens. One case of that, it ends up, it's a very mundane case, is which side of the road you drive on, right? It ends up, it doesn't matter if it's the right or the left as long as you do what everyone else is doing. If you're in the US, I don't care how devoted you are to the British road system. Well, you would be, I don't know if I've been there. But if you're very devoted to that, don't drive on the left in the US. It's gonna cause problems, right? Drive on the right. Similarly, I, despite the fact that I am very devoted to driving on the right side of the road, it is called the right side of the road. We know that right and correct are in fact synonyms, right? So I drive on the correct side of the road, right? I'm not going to do that when I go visit the UK. I will drive on the left side, the wrong side of the road like everyone else. But I'll be much safer because of that. I'm willing to give up principles for protecting my safety in that case. All right, they're very strong principles. All right, I think there's a logical fallacy that was involved there. Anyway, so it's just a coordination game. It doesn't matter which of these things we do, or either one is possible and would be stable as long as we can all agree on one or the other, right? So what is hard to DeSoto say, or which of these two things is going to happen? I will order DeSoto suggest that prudent bankers wouldn't expand, right? You're very nervous about the possibility of failure, right? So we'd have prudent bankers would just say, let's just stick with the small profit that's better than the risk of bankruptcy. You know, we'd have some bankers that are imprudent that would be very happy to expand even at the risk of failure, okay? But all bankers, regardless of whether you feel more prudent or more imprudent, right, have an incentive to try to coordinate and get this credit expansion to happen, right? If we can coordinate and make that credit expansion happen, we all earn more profits and it's not particularly dangerous, or at least doesn't appear so, right? So we would expect to see in such a system is that bankers would push for central banks that can coordinate this credit expansion, right? So they're all coordinating and expanding at basically the same rate. None of us really has to worry about going bankrupt because we're expanding too fast relative to others, right? Another thing that central banks do that is also very key to this, which I'll show them on the next slide, is they basically provide bailouts that the liquidity protection to those banks that do in fact run into short-term trouble, right? Okay, so let's consider a case like this. So here we have some kind of safety net provided to banks if they run into trouble. So in this case, right? If neither of us expand, same story as before. If we both expand, same story as before. If one of us expands too fast compared to the other, say here, right? Bank A, we know before would have failed, right? Now, okay, they run into financial troubles, right, the Fed comes in and says, okay, right? Here, we're going to give you a short-term loan. We're going to get you through this, right? So that in the end, you do end up making a small profit. We'll get you through all this. Bank B would also survive in that case, that you after all did not expand to start with, right? Here, it's just switching the identities of the two, right? So we just changed the incentives. Right now, Bank A says, if I don't expand, while Bank B doesn't expand, small profit. If I expand while Bank B doesn't expand, I still get a small profit and it doesn't actually make any difference. Either I get the small profit because I earned it myself or I get the small profit because we had the Fed come in and bail me out, protect me from all the dangers involved with that expansion. On the other hand, right? If Bank B decides to expand, right? Then I could either just survive by not expanding, right? Or I could earn a large profit by expanding as well. So what we've just done, right? It's taken this case, right? It removed that incentive to not expand anymore, right? So the only incentive that now exists is for me to go ahead and expand, okay? And that's in fact exactly what we would expect to happen if we had this type of system where banks are protected in that way, okay? All right. So, other solutions. As we've seen now, a couple of cases where we are changing, right? What are the payoffs from playing this game? It's the one we've mentioned before, repeated gains, right? So we can see this with actual literal partners in crime, say Bonnie and Clyde. We know that we are committing crimes together. We're going to keep doing this on a repeated basis, right? So we then develop that understanding that I mentioned before, right? That if you confess on me, in this particular case, when we get caught again, I'm going to confess on you, right? With the result being that we both end up spending 10 years in prison, right? As I confessed on you, you confessed on me at one point in time. Rather than two years in prison, if neither of us ever confess, right? Okay. All right, so we then end up with a much better outcome by repeating this game. And that's often the solution that we see develop. Another case would be what we call enforcers, what I call enforcers. I like to call this breaking the confessor's kneecaps, right? So in this case, what we're doing, I'll fix that later, breaking confessor's kneecaps. What does that mean? All right, so here, it's a little bit more, more like the games we actually already looked at, but a little bit more violent, right? So the understanding is if one of us confesses and walks out without a prison sentence, right? There's somebody, some third party that's sitting outside that's waiting to cause certain physical problems for me and it's going to put me in the hospital, right? So what do we do? We just change the payoff, right? And if I confess, okay, I don't go to prison, but at the same time, I end up in the hospital for a very long time with great physical discomfort for myself. Okay, okay. All right, so that's another possibility. So we have repeated games, we have enforcers, but things like the tragedy of the commons, economists certainly of the free market type would say, this is a very easy one to solve, right? Just privatize the thing, right? Make it so that you have the right there, you have your small piece of the commons, or you build a fence around your piece of the commons, so then anything good that happens there you benefit from, anything bad that happens there you lose from. So I have my little school of fish, if I over fish them, then I end up losing the value, the future value of those fish. On the other hand, if I help them to breed and all of that, I get the benefit from that. Okay, on public goods, a possible solution here would be what we call matching funds. Here, I love Kickstarter, Kickstarter is amazing, right? Because what did Kickstarter do? Yeah, it just saw this problem, it said, okay, we have these things that require a lot of money to get off the ground, no one person wants to give all of this money. All right, so what can we do? We can go without, okay, all right. All right, so what do we do? This is easy, right? We'll set things up so that we have a contingent payment system, right? So each of us then will only pay if everyone else has to pay. So that's what Kickstarter does, right? Kickstarter says to Bonnie and Clyder, if you want roads, this is what you do. We all come, we all pledge that yes, I'm willing to provide my half of the money that would build the roads. If all of us do actually make that pledge, the roads get built, right? If we don't have everybody come and make that pledge, then nobody has to pay anything, right? So we don't end up with a situation then of, say, Clyde being able to just free ride on Bonnie's investment in the roads, Bonnie's not going to offer to pay for the entire road. So we then have, by this matching fund system, a way to deal with these public goods. Forced people to actually pay for it if they want the benefit to exist. One of my favorite cases of this was with Reading Rainbow. Just a couple of years ago, yeah, if you're like me, I guess, young-ish American, you remember Reading Rainbow, or Butterfly in the Sky, I can fly twice as high, take a look, it's in a book, Reading Rainbow. Yeah, Lovar Burton is great, right? Okay, right, so it's just a little program about reading if you're not familiar with it. And a favorite of many people, right around my age, a little bit older, a little bit younger, okay? And it was discontinued by the public broadcasting system a while ago. So PBS doesn't have it anymore. But there was this idea to come along and make an app that would be based on the Reading Rainbow kind of ideas and present children of today with books, make it interactive, so something they can do on their iPads or what have you. But they weren't going to get public funding from it for it. Instead, they went to Kickstarter. And they just threw this out there and said, hey, we know that people like Reading Rainbow, can we get enough support to actually get this off the ground? And they got far more support than they needed. Plenty of people are willing to chip in at $25 or so, but enough people chip in $25, and you can pay to develop this app and to get it presented. So it's actually now available to say, my kids, they can now participate in Reading Rainbow in this new way. So using matching funds, we can think of this as a way to get around building roads, providing things like Sesame Street and Reading Rainbow as well. Just kind of cool. I think it's a brilliant way to give it entrepreneurs have solved this problem. All right. So just kind of wrapping up then, leaving maybe a couple minutes for questions. So we have two options. We can do game theory the wrong way, which is often the way it's presented. But just saying, well, we end up with these lousy outcomes from individual choice. Conclusion, we should eliminate individual choice in these certain areas. I don't know any game theorists that would say that we always should eliminate individual choice, but they seem to be very happy to say that virtually everything is a game, which is kind of wild. All right, so there are cases where we should just eliminate individual choice. On the other hand, if we think about entrepreneurs, that is the fact that there are creative problem solvers that see these games coming, that are trying to think of solutions, trying to think of ways to get to a better outcome, we will then say that the potential for these lousy outcomes will attract entrepreneurs. These entrepreneurs are then going to do something to fix things. So we should pay attention to game theory. It tells us where we should look. But the question we should then ask is what are entrepreneurs doing in these cases? And finally, if they're not actually solving the problems, why aren't they? What's standing in the way of that better solution? Well, thank you very much.