[User] Please transcribe this text

[Assistant] The dashed portion of this budget constraint is from the old cash example. And the dotted indifference curve is what they would have chosen with cash. Remember, person X with cash would have chosen to still spend less than $500 on food. Even when you gave them $500, they still only spent $300 on food. So we are forcing them to not be on their preferred budget constraint. Rather, we're forcing them down to point X2.


[User] Please transcribe this text

[Assistant] Which is, they'll spend, you know, the minimum they can on food, but the minimum is $500. Okay? They were, we are forcing them down to point X2.


[User] Please transcribe this text

[Assistant] Now why do I say forcing them? Why do I know for sure they are being forced, that they're less happy at X2 than they would have been when they gave them the cash? I don't know for sure, yeaah.


[User] Please transcribe this text

[Assistant] Think of it this way. The fundamental, one of the important things is people always get to the point that makes them happiest.


[User] Please transcribe this text

[Assistant] Okay, we call it the robustness of economic equilibria. People get to the point that makes them happiest. They want


[User] Please transcribe this text

[Assistant] Therefore, if you force them to find food, they must be less happy.


[User] Please transcribe this text

[Assistant] Okay? Think of it that way. They always could have spent $500 on food. They didn't. Therefore I force them and you're making them less happy. Okay? So they are worse off. Okay?


[User] Please transcribe this text

[Assistant] They are forced to spend, they'd rather spend some of that money, find a nicer place to live, but we're not letting them. We're making them buy food. Okay.


[User] Please transcribe this text

[Assistant] Do people, I don't want, I just want you to understand the graphics here. And the conclusions I drew. Okay, now, why? Why are we doing this? Why would you, they're better off with cash. Why would we force them to have food? Yeah.


[User] Please transcribe this text

[Assistant] If, if, let me, let me say, I'm not accusing you, I'm just saying look, if, if people knew best, maybe they'd like to just like, have a nice house and die. Okay? If people knew best, then there'd be no reason to do this.


[User] Please transcribe this text

[Assistant] The reason to do this is because we think they don't know best. So for example, let's change the label on the y-axis. Just a small change. Let's cross out shelter and write cocaine.


[User] Please transcribe this text

[Assistant] Well in that case, maybe we don't feel so bad about forcing a guy to buy food instead of cocaine.


[User] Please transcribe this text

[Assistant] Okay, in other words, this is a program which might make sense if we are paternalistic. Now we're getting into norm of economics. Paternalistic.


[User] Please transcribe this text

[Assistant] If we think that people won't necessarily make the right decisions for themselves,


[User] Please transcribe this text

[Assistant] Then it may be worth actually making them worse off, because they're not worse off. Their perceived benefits are worse, but they don't know what they're doing. Okay? Now, you can see why


[User] Please transcribe this text

[Assistant] I hope you can sort of immediately see why this concept makes economists a little nervous. Because why do we know what they want better than they do?


[User] Please transcribe this text

[Assistant] Okay, so it makes people a little bit nervous, the economy's a little bit nervous, and a lot of people a little bit nervous, to say, gee, maybe they're just happier doing cocaine.


[User] Please transcribe this text

[Assistant] That's a very good point. Now, but there's sort of two points there. First of all, if the taxpayer's goal is to help poor people, then why shouldn't you make them as happy as possible? Right? If, if the tax, why am I giving money to this poor guy? Because I'm sad he's poor.


[User] Please transcribe this text

[Assistant] But what you're saying, I'm not actually that sad he's poor, I'm sad he's not eating. If you're really just sad he's poor, then you should give him money.


[User] Please transcribe this text

[Assistant] If what you're sad about is, gee, I don't like how he's living, I don't like his, I'm sad he can't have better food to eat, sadder place to live, then you're starting to impose your preferences. But let's be important that's imposing your preferences. Yeah.


[User] Please transcribe this text

[Assistant] Well, that's, that's a related point to the taxpayer. If the taxpayer cares about, look, we want a healthy populace that's gonna live a long time and be productive and pay taxes, then that would be a reason to do this. But once again, I want to emphasize, okay, this is paternalism. If you really just care what makes people happiest, you should give them cash. Okay? So that raises, uh, two questions. Okay? Uhm, first of all, uh, first question, yeah.


[User] Please transcribe this text

[Assistant] Yeah, yeah, so basically it's a great question. In general, we're gonna, I'm gonna answer a lot of those questions with the same cheat this semester, which is we're gonna assume the markets are perfectly functioning, so there's no, you're, you're imposing sort of a market failure.


[User] Please transcribe this text

[Assistant] If there's no market, once there's market failures, all bets are off. With no market failure and no paternalism, you'd wanna give them cash. So this raises an important question. Do food stamps actually increase food purchases? First of all, there's two reasons why that might not. Reason one is everybody could be like, why? Okay, X is sort of a silly case, right? You're gonna die if you eat that little. And food stamps aren't that much. They're, you know, maybe like three grand a year. Everybody's gonna spend three grand on food.


[User] Please transcribe this text

[Assistant] You know, the first reason why food stamps may not matter is that in fact everybody's spending at least that amount. Everybody's like Y, nobody's like X. What's another reason why it might not matter? What's a re- what's a way people could get around food stamps? Yeah.


[User] Please transcribe this text

[Assistant] Where they essentially say, look, I only want $2,000 of food, the garbage making is worth $3,000, I'll buy my extra $1,000 of food, I'll sell to people who do want it, and I'll end up still leaving $2,000 worth of food.


[User] Please transcribe this text

[Assistant] So, we actually want to know, do food stamps actually increase food consumption in practice? Are they making a difference? Well actually, we've run an experiment on this.


[User] Please transcribe this text

[Assistant] Okay, we're gonna talk in this class a lot about empirical results in economics. We'll talk, we're, this class is mostly gonna be a theoretical class.


[User] Please transcribe this text

[Assistant] That is, we'll talk about models and ideas, but we're also, since basically I'm an empirical economist, we're gonna talk about, about empirical economics, which is results, and testing the theories we develop.


[User] Please transcribe this text

[Assistant] Empirically, here's a great example of empirical economics is, we set up a theoretical model. You always want to start with a theory.


[User] Please transcribe this text

[Assistant] But the theory sometimes has predictions which are uncertain. Here we have an uncertain prediction from theory, about whether food stamps will affect food purchase or not. So let's test it.


[User] Please transcribe this text

[Assistant] And the way we test it is we actually have run food stamps cash out experiments.


[User] Please transcribe this text

[Assistant] Where we literally take guys on food stamps and give them cash instead and watch what happens to their consumption before and after. It's a real randomized trial. We literally flip a coin.


[User] Please transcribe this text

[Assistant] Heads, you keep your food stamped. Tails, we replace those food stamps with an equal amount of cash. Then watch what happens.


[User] Please transcribe this text

[Assistant] On food when you give them cash instead of food stamps. That is food stamps is forcing people


[User] Please transcribe this text

[Assistant] To spend about 15% more on food than they would like to unconstrained. By the cash, yea.


[User] Please transcribe this text

[Assistant] Yeah, you know, it's a great question and that's, there's, you're asking about rich or theory?


[User] Please transcribe this text

[Assistant] Richard theory, and I'm telling you that I'm gonna give you the empirical evidence. Whatever the theory is, the empirical evidence tells you what happens. You just, there's different explanations for why. So empirical evidence,


[User] Please transcribe this text

[Assistant] Is that basically the price of our paternalism is 15%.


[User] Please transcribe this text

[Assistant] Okay, we are making people effectively 15% worse off. Making them spend 15% more on food than they want to. So is it worth it?


[User] Please transcribe this text

[Assistant] Well, actually the evidence is starting to pour in that it might not be worth it.


[User] Please transcribe this text

[Assistant] Cause there's starting to be a lot of experiments where giving people just cash, especially developing countries.


[User] Please transcribe this text

[Assistant] In developing countries, the answer seems to be just giving people cash makes them better off. That actually, especially in developing countries, people use the cash in productive ways.


[User] Please transcribe this text

[Assistant] So for example, uhm, they have a series of valuation programs where they've given people cash, mostly in developing countries, in Africa, uh, in particular, some in the US.


[User] Please transcribe this text

[Assistant] And they find that people spend relatively little of that on, you know, drugs and alcohol. But they actually tend to spend it productively.


[User] Please transcribe this text

[Assistant] And in fact, they found developing countries, this often provides valuable resources for individuals to start businesses. So ran an experiment in Uganda, where a non-profit company randomly offered a group of women $150.


[User] Please transcribe this text

[Assistant] Okay, uhm, which is huge relative income. That's 50 to 100% of the annual income in Uganda.


[User] Please transcribe this text

[Assistant] $150. And what they found was after two months, after 18 months, these women had used that money to start businesses and that actually raised their earnings. That actually effectively doubled their earnings.


[User] Please transcribe this text

[Assistant] From that one in, in, in uhm, injection of cash, it led them to actually double their annual earnings. Okay?


[User] Please transcribe this text

[Assistant] So, that leads one to think that maybe we should stop being paternalistic and just give cash.


[User] Please transcribe this text

[Assistant] Unfortunately, if you're a reader of policy websites like I am, the best one of which is Vox.com. It's a great website.


[User] Please transcribe this text

[Assistant] They had an article just the other day pointing out how they actually filed these women up nine years later, and nine years later the effect had totally gone away. So, until...


[User] Please transcribe this text

[Assistant] You know, the story isn't quite necessarily positive, but it's not negative. They're not worse off. But, uh, it looks like it at least was in the short run made the better off. All that effect fades over time.


[User] Please transcribe this text

[Assistant] But the bottom line is, at this point, I think the evidence is sort of probably in favor of being less paternalistic and just giving people cash. But that, uh, that runs into a lot of difficulties in terms of our concerns about how people will spend it.


[User] Please transcribe this text

[Assistant] So let me stop there. Uhm, we will come back on Monday and we'll talk about how we actually go from this stuff to the demand curves we started the class with.


[User] Please transcribe this text

[Assistant] You harass my men, destroy my equipment, and cost my client millions. Give me one good reason I should not kill you right now.


[User] Please transcribe this text

[Assistant] This mean we're good? You will help me secure Norman. After that I make no promises.


[User] Please transcribe this text

[Assistant] Trap failed? Soften him up. Time for plan B.


[User] Please transcribe this text

[Assistant] As a researcher, every once in a while you encounter something.


[User] Please transcribe this text

[Assistant] A little disconcerting. And this is something that changes your understanding of the world around you and teaches you that you're very wrong about something that you really believe firmly in. And these are unfortunate moments because you go to sleep that night dumber than when you woke up.


[User] Please transcribe this text

[Assistant] So that's really the goal of my talk is to A. Communicate that moment to you and B. Have you leave the session a little dumber than when you entered. Uh, so I hope I can really accomplish that.


[User] Please transcribe this text

[Assistant] So this, uh, incident that I'm gonna describe really began with some diarrhea.


[User] Please transcribe this text

[Assistant] Now we've known for a long time the cause of diarrhea. Uh, that's why there's a glass of water up there. For us, it's a problem, the people in this room.


[User] Please transcribe this text

[Assistant] For babies, it's deadly. They lack nutrients, and uhm, diarrhea dehydrates them. And so, as a result, there's a lot of death. A lot of death.


[User] Please transcribe this text

[Assistant] In India in 1960, there was a 24% child mortality rate. Lots of people didn't make it.


[User] Please transcribe this text

[Assistant] incredibly unfortunate. One of the big reasons this happened was because of diarrhea. Now, there was a big effort to solve this problem, and there was actually a big solution.


[User] Please transcribe this text

[Assistant] And this solution has been called by some potentially the most important medical, uh, advance this century.


[User] Please transcribe this text

[Assistant] Now, the solution turned out to be simple. And what it was, was...


[User] Please transcribe this text

[Assistant] Oral rehydration salt. Many of you have probably used this. Brilliant. It's a way to get sodium.


[User] Please transcribe this text

[Assistant] So that when you add it to water, the child is able to absorb it even during situations of diarrhea. Remarkable impact on mortality. Massive solution to the problem. Flash forward.


[User] Please transcribe this text

[Assistant] 1960, 24% child mortality has dropped to 6.5% today. Still a big number, but a big drop. It looks like the technological problem is solved.


[User] Please transcribe this text

[Assistant] But if you look even today, there are about 400,000 diary related deaths in India alone. What's going on here?


[User] Please transcribe this text

[Assistant] Well the easy answer is, we just haven't gotten those salts to those people. That's actually not true.


[User] Please transcribe this text

[Assistant] If you look in areas where these salts are completely available, the price is low or zero, these debts still continue abated. Maybe there's a biological answer. Maybe these are the debts that simple rehydration alone doesn't solve. That's not true either. Many of these debts are completely preventable.


[User] Please transcribe this text

[Assistant] And this is what I want to think of as the disconcerting thing, what I want to call the last mile problem.


[User] Please transcribe this text

[Assistant] See, we spent a lot of energy in many domains. Technological, scientific, hard work, creativity, human ingenuity to crack important social problems with technology solutions. That's been the discoveries of the last 2000 years. That's mankind moving forward. But in this case, we cracked it.


[User] Please transcribe this text

[Assistant] But a big part of the problem still remains. 999 miles went well. The last mile is proving incredibly stubborn. Now, that's oral rehydration therapy.


[User] Please transcribe this text

[Assistant] It's not even unique to poor people in India. Here's an example from, uhm, a variety of contexts. I've put a bunch of examples up here. I'll start with insulin, diabetes, uh, medication in the US.


[User] Please transcribe this text

[Assistant] Okay, it's American population. On Medicaid, if you're fairly poor, you get Medicaid. If you have health insurance, insulin's pretty straightforward. You get it, uh, either in pill form or you get it as an injection. You have to take it, you know, every day to maintain your blood sugar levels. Massive technological advance took an incredibly deadly disease, made it solvable. Adherence rates. How many people are taking their insulin every day?


[User] Please transcribe this text

[Assistant] On average, a typical person is taking it 75% of the time.


[User] Please transcribe this text

[Assistant] As a result, 25,000 people a year go blind.


[User] Please transcribe this text

[Assistant] Hundreds of thousands lose limbs every year for something that's solvable. Here I have a bunch of other examples.


[User] Please transcribe this text

[Assistant] We think there's a food problem, so we create new seeds. We think there's an income problem, so we create new ways of farming that increase income. Well, look at some old ways, some ways that we'd already cracked, intercropping. Intercropping really increases income. Sometimes in rice, we found incredible increases in yield when you mix different varieties of rice side by side. Some people are doing that, many are not.


[User] Please transcribe this text

[Assistant] What's going on? This is the last mile. The last mile is everywhere problematic. Alright, what's the problem? The problem is this little


[User] Please transcribe this text

[Assistant] They do lots of inconsistent things and the inconsistencies create


[User] Please transcribe this text

[Assistant] Fundamentally, this last mile problem. See, when we're dealing with our biology, bacteria, the genes, the things inside of here, the blood, that's complex, but it's manageable. When we're dealing with people like this, the mind is more complex. That's not as manageable, and that's what we're struggling with. Let me go back to diarrhea for a second. Here's a question that was asked in the National Sample Survey, which is a survey asked of many Indian women. Your child has diarrhea. Should you increase?


[User] Please transcribe this text

[Assistant] Maintain or decrease the number of fluids, just so you don't embarrass yourselves, I'll give you the right answer. It's increase.


[User] Please transcribe this text

[Assistant] Now, diarrhea is interesting because it's been around for thousands of years, ever since humankind really, uh, uh, lived side by side enough to have really polluted water.


[User] Please transcribe this text

[Assistant] One Roman strategy that was very interesting was that, uh, and it really gave them a comparative advantage. They made sure their soldiers didn't drink even remotely muddied waters. Because if some of your troops get diarrhea, they're not that effective on the battlefield.


[User] Please transcribe this text

[Assistant] Uh, so if you think of Roman comparative advantage, part of it was the breast shields, uh, the breast plates, but part of it was drinking the right water. So here are these women, they've seen their parents have struggled with diarrhea, they've struggled with diarrhea, they've seen lots of deaths. How do they answer this question? In India, 35 to 50% say reduce.


[User] Please transcribe this text

[Assistant] Think about what that means for a second. 35 to 50% of women. Forget oral rehydration therapy.


[User] Please transcribe this text

[Assistant] I think that's how most people respond to this. Is to say, that's just stupid.


[User] Please transcribe this text

[Assistant] I don't think that's stupid. I think there's something very profoundly right in what these women are doing. And that is, you don't put water into a leaky bucket.


[User] Please transcribe this text

[Assistant] So think of the mental model that goes behind reducing the intake. It just doesn't make sense. Now, the model is intuitively right. It just doesn't happen to be right about the world. But it makes a whole lot of sense at some deep level. And that to me is the fundamental challenge of, uh, The Last Mile.


[User] Please transcribe this text

[Assistant] This first challenge is what I refer to as the persuasion challenge. Convincing people to do something, take oral rehydration therapy, intercrop, whatever it might be, is not an act of information. Let's give them the data.


[User] Please transcribe this text

[Assistant] And when they have data, they'll do the right thing. It's more complex than that.


[User] Please transcribe this text

[Assistant] If you want to understand how it's more complex, let me start with something, uhm,


[User] Please transcribe this text

[Assistant] Kind of, uh, interesting. So I'm gonna give you a little math problem.


[User] Please transcribe this text

[Assistant] And I want you to just yell out the answer as fast as possible. A bat and a ball together cost a dollar ten. The bat cost a dollar more than the ball. How much does a ball cost? Quick.


[User] Please transcribe this text

[Assistant] So somebody out there says five. A lot of you said ten. Let's think about ten for a second. If the ball costs ten, the bat costs, this is easy, dollar ten, yeaah. So uh, together they would cost a dollar twenty. So here you all are, ostensibly educated people. Most of you look smart. The combination of that produces something that is actually, you got this thing wrong. How is that possible? Let's go to something else.


[User] Please transcribe this text

[Assistant] Algebra can be complicated, so let's dial this back. That's what, fifth grade? Fourth grade? Let's go back to kindergarten.


[User] Please transcribe this text

[Assistant] There's a great show on American television that you have to watch. It's called Are You Smarter Than a Fifth Grader? I think we've learned the answer to that here. Let's, uh, move to kindergarten. Let's see if we can beat five-year-olds.


[User] Please transcribe this text

[Assistant] Here's what I'm gonna do. I'm gonna put objects on the screen.


[User] Please transcribe this text

[Assistant] I just want you to name the color of the object. That's all it is. Okay? And I wanna do it fast. Say it out loud with me and do it quickly. I'll make the first one easy for you. Ready? Black.


[User] Please transcribe this text

[Assistant] Now, the next ones I want you to do quickly and say it out loud. Ready? Go.


[User] Please transcribe this text

[Assistant] You see, what's going on here, and in the bat and ball problem, is that you have some intuitive ways of interacting with the world. Some models that you use to understand the world. These models, like the leaky bucket, work well in most situations. I suspect, most of you.


[User] Please transcribe this text

[Assistant] I hope it's true for the rest of you. Actually do pretty well with addition and subtraction in the real world.


[User] Please transcribe this text

[Assistant] I found a problem, a specific problem that actually kind of...


[User] Please transcribe this text

[Assistant] Found an error with that. Diarrhea and many last mile problems are like that. They're situations where the mental model doesn't match the reality.


[User] Please transcribe this text

[Assistant] Same thing here. You had an intuitive response to this that was very quick. You read blue and you wanted to say blue even though you knew your task was red. Now I do this stuff because it's fun, but uhm,


[User] Please transcribe this text

[Assistant] It's more profound than fun. I'll give you a good example of how it actually affects persuasion. BMW is a pretty safe car.


[User] Please transcribe this text

[Assistant] And they're trying to figure out, safety is good, I want to advertise safety. How am I going to advertise safety? I could give people numbers, we do the well on crash test, but the truth of the matter is, you look at that car, it doesn't look like a Volvo. And it doesn't look like a Hummer.


[User] Please transcribe this text

[Assistant] So what I want you to think about for a few minutes is how would you convey safety of the BMW. Okay? So now while you're thinking about that, let's move to a second task. The second task is fuel efficiency. Okay? Here's another puzzle for all of you.


[User] Please transcribe this text

[Assistant] One person walks into a car lot and they're thinking about buying this Toyota Yaris. Uh, they're saying this is 35 miles per gallon. I'm going to do the environmentally right thing. I'm going to buy the Prius, 50 miles per gallon.


[User] Please transcribe this text

[Assistant] Another person walks into the, uh, lot and they're about to buy a Hummer, nine miles per gallon, fully loaded, luxury. And they say, you know what? Do I need turbo? Do I need this heavyweight car?


[User] Please transcribe this text

[Assistant] I'm gonna do something good for the environment. I'm gonna take off some of that weight and I'm gonna buy a hummer that's 11 miles per gallon. Which one of these people has done more for the environment?


[User] Please transcribe this text

[Assistant] So you have a mental model. 50 versus 35, that's a big move. 11 versus 9, come on. Turns out, go home and do the math.


[User] Please transcribe this text

[Assistant] The 9 to 11 is a bigger change. That person has saved more gallons. Why? Because we don't care about miles per gallon, we care about gallons per mile.


[User] Please transcribe this text

[Assistant] Think about how powerful that is if you're trying to encourage fuel efficiency. Miles per gallon is the way we present things. If we want to encourage change of behavior,


[User] Please transcribe this text

[Assistant] Here was BMW's brilliant insight, which they embodied into an ad campaign. They showed a BMW driving down the street. There's a truck on the right. Boxes fall out of the truck. The car swerves to avoid it.


[User] Please transcribe this text

[Assistant] BMW realizes safety in people's minds has two components. You can be safe because when you're hit, you survive, or you can be safe because you avoid accidents.


[User] Please transcribe this text

[Assistant] Even if I persuaded you to do something, it's hard sometimes to actually get action as a result. You all probably intended to wake up, uh, I don't know, 6.30, 7 a.m. This is a battle we all fight every day, along with trying to get to the gym. Now, this is an example of that battle.


[User] Please transcribe this text

[Assistant] It makes us realize intentions don't always translate into action. And so one of the fundamental challenges is how we would actually do that. Okay? Let me now talk about the last mild problem. So far, I've been pretty negative. I've been trying to show you the oddities of human behavior. And I think maybe I'm being too negative. Maybe it's the diarrhea.


[User] Please transcribe this text

[Assistant] Maybe the last mile problem, it really should be thought of as a last mile opportunity. Let's go back to diabetes. This is a typical insulin injection. Now carrying this thing around is complicated. You gotta carry the bottle, you gotta carry the syringe. It's also painful.


[User] Please transcribe this text

[Assistant] Now, you may think to yourself, well, my eyes depended on it.


[User] Please transcribe this text

[Assistant] You know, paying attention, remembering to put it in your purse when you go on a long trip. These are the day to day of life, and they do pose problems. Here's an innovation, a design innovation. This is a pen, called an insulin pen, preloaded. The needle is particularly sharp, you just gotta carry this thing around. It's much easier to use, much less painful.


[User] Please transcribe this text

[Assistant] Anywhere between 5 and 10% increase in adherence, just as a result of this. That's what I'm talking about as a last mile opportunity.


[User] Please transcribe this text

[Assistant] You see, we tend to think the problem is solved when we solve the technology problem.


[User] Please transcribe this text

[Assistant] But the human innovation, the human problem, still remains, and that's a great frontier that we have left.


[User] Please transcribe this text

[Assistant] This is about energy efficiency. We're spending a lot of time on fuel cells right now.


[User] Please transcribe this text

[Assistant] What this company does is they send a letter to households that say, here's your energy use, here's your neighbor's energy use, you're doing well, smiley face. You're doing worse, frown.


[User] Please transcribe this text

[Assistant] And what they find is just this letter, nothing else, has a 2-3% reduction in electricity use. And you want to think about the social value of that, in terms of carbon offsets, reduced electricity, $900 million per year. Why? Because for free, this isn't a new technology, this is a letter. We're getting a big bang in behavior. So, how do we tackle the last mile? So I think this tells us there is an opportunity, and I think to tackle it, we need to combine psychology, marketing,


[User] Please transcribe this text

[Assistant] Art, we've seen that. But you know what we need to combine it with? We need to combine this with the scientific method.


[User] Please transcribe this text

[Assistant] See, what's really puzzling and frustrating about the last mile to me is that the first 999 miles are all about science. No one would say, hey, I think this medicine works, go ahead and use it. We have testing, we go to the lab, we try it again, we have refinement. But you know what we do on the last mile? Oh, this is a good idea, people will like this, let's put it out there. The amount of resources we put in are disparate.


[User] Please transcribe this text

[Assistant] Billions of dollars into fuel efficient technology. How much are we putting into energy behavior change? In a credible, systematic testing way.


[User] Please transcribe this text

[Assistant] I think that we're on the verge of something big. We're on the verge of a whole new social science. It's a social science that recognizes, much like science recognizes the complexity of the body, biology recognizes the complexity of the body, we'll recognize the complexity of the human mind. The careful testing, retesting, design are going to open up vistas of understanding complexities


[User] Please transcribe this text

[Assistant] Difficult things and those vistas will both create new science.


[User] Please transcribe this text

[Assistant] 60% of it is exactly what you say. There are insights to be gleaned there. 40% of it is about what marketing is. Marketing is selling an ad to a firm.


[User] Please transcribe this text

[Assistant] Which is so, there's a little bit of slippage there. That's just a caveat. So that's different from actually having an effective ad campaign. And one of the new movements in marketing is how do we actually measure effectiveness? Are we effective?


[User] Please transcribe this text

[Assistant] So the scientific method I alluded to is pretty important. We work closely with companies that have operational capacity, or non-profits that have operational capacity. And then we say, well, you want to get this behavior changed. Let's come up with a few ideas. Test them.


[User] Please transcribe this text

[Assistant] Yeah, that's me. I'll explain later. But right now you need to find a Dr. Morgan Michaels. Martin Lee's coming after him.


[User] Please transcribe this text

[Assistant] I think he's the head scientist on this Devil's Breath project. Did you find him?


[User] Please transcribe this text

[Assistant] Okay, I have an idea on how to find him. I'll let you know if it works.


[User] Please transcribe this text

[Assistant] We will. Before Delaney died, he gave Lee a name. Morgan Michaels.


[User] Please transcribe this text

[Assistant] Not sure, but I bet he works on the Devil's Breath project. Have you learned anything from that Devil's Breath file?


[User] Please transcribe this text

[Assistant] Everything leads back to Norman Osborn. Guess it's time to pay him a visit.


[User] Please transcribe this text

[Assistant] Can't get in there without shutting down some security systems. But if they see me, they'll put the whole place on lockdown.


[User] Please transcribe this text

[Assistant] Now I can get into Norman's office and hopefully find out more about Morgan Michaels and Devil's Breath. GR27? Hmm.


[User] Please transcribe this text

[Assistant] Dr. Morgan Michaels is the chief scientist, but the location of the lab is redacted.


[User] Please transcribe this text

[Assistant] A.I. controlled CRISPR? If that actually works, it could cure any genetic disease. Cystic fibrosis? Huntington's? This is crazy.


[User] Please transcribe this text

[Assistant] Woah. GR27 is devil's breath. It's designed to cure diseases, but in its current form it's like a bio weapon.


[User] Please transcribe this text

[Assistant] Dr. Michaels keeps the only sample with him at all times. That's why Lee wants him. We find Michaels, we find Devil's Breath.


[User] Please transcribe this text

[Assistant] MJ, get this. Devil's Breath wasn't designed to be a weapon. It's a treatment for genetic disorders. But its current form is wildly imperfect. In trying to fix the body, it rips it apart. We need to locate Dr. Michaels. I don't trust Sable to contain something this deadly.


[User] Please transcribe this text

[Assistant] Reach him? That place is crawling with guards, how are you trying to reach him?


[User] Please transcribe this text

[Assistant] I've never heard Doc this excited by a project. Hope he's not too excited. Where are you MJ?


[User] Please transcribe this text

[Assistant] You snuck into the middle of an armed mili- You know what? Can we not do this right now? Please? Did you learn anything about Dr. Michaels?


[User] Please transcribe this text

[Assistant] Awesome. Anything else? Was he saying something about Grand Central before I jumped in?


[User] Please transcribe this text

[Assistant] Peter. That's how you know she's still mad. Peter. Nice work, Mr. Superhero.


[User] Please transcribe this text

[Assistant] Mr. Parker is probably someone more together than me.


[User] Please transcribe this text

[Assistant] Gotcha, I'm the same way. I'll let Ed May know. And I'll make sure I'm there his first day.


[User] Please transcribe this text

[Assistant] Hey, I came here to work for you because of what you've got up here. That's not going anywhere. So neither am I.


[User] Please transcribe this text

[Assistant] Auto, the neural web isn't isolating your motor neurons.


[User] Please transcribe this text

[Assistant] Thanks so much. So uhm, you know, this whole area is so fascinating. I mean, it sometimes feels listening to behavioral economists that they're kind of...


[User] Please transcribe this text

[Assistant] How do you take, uhm, your insights here and actually get them integrated into, you know, working business models on the ground in Indian villages, for example?


[User] Please transcribe this text

[Assistant] Hey, thanks. No problem. Hey, uh, you think you're gonna add that new Spider-Man 2?


[User] Please transcribe this text

[Assistant] Hey, is Teo's bodega around here? Yea, bright yellow sign down the block. Can't miss it. Thanks. Beautiful work by the way.


[User] Please transcribe this text

[Assistant] Well, I had heard that one canister of Nuform survived the incident on the bridge. Now, if we had access to that, I- Don't you think that if I had it, I would give it to you? Yes, Mr. Krieger.


[User] Please transcribe this text

[Assistant] Let Krieger and the Tinker kill each other. Go back to being Spider-Man when the heat dies down.


[User] Please transcribe this text

[Assistant] Why don't we get started? Uhm, today we're going to move on to, finally, uh, the most realistic market structure. We talked about perfectly competitive markets, and now that was...


[User] Please transcribe this text

[Assistant] A very useful extreme example to help us think about economic efficiency.


[User] Please transcribe this text

[Assistant] We then flipped over to talk about the somewhat more realistic case of monopoly.


[User] Please transcribe this text

[Assistant] But still very few markets have only one participant. A true monopoly is rare in the private market.


[User] Please transcribe this text

[Assistant] What most markets are marked by are probably more features of oligopoly.


[User] Please transcribe this text

[Assistant] Which is a market with a small group of firms competing with each other.


[User] Please transcribe this text

[Assistant] But with barriers to entry that keep out an unlimited number of firms.


[User] Please transcribe this text

[Assistant] Think about these as markets where there are some barriers to entry, so firms just can't cautiously enter and exit like they could in our IBM Dell example.


[User] Please transcribe this text

[Assistant] But, where there's small enough barriers to entry that a few firms have gotten in, not just one.


[User] Please transcribe this text

[Assistant] So it's not a natural monopoly, it's not like the only one firm can be in there. Multiple firms are in there, but they only know they have to compete with each other, not with the big wide world.


[User] Please transcribe this text

[Assistant] Okay, so for example, the classic example in oligopoly industry would be the auto industry. It's a, auto manufacturers clearly compete


[User] Please transcribe this text

[Assistant] Clearly if you watch any sporting event, and watch how much advertising that goes on, they clearly are competing with each other, they're comparing to each other all the time.


[User] Please transcribe this text

[Assistant] Uhm, but there's only, almost all most of the cars in the world are produced by fewer than 10 auto manufacturers.


[User] Please transcribe this text

[Assistant] The notion that we have in a perfectly competitive market of thousands of sellers selling identical goods is clearly not right when it comes to buying a car.


[User] Please transcribe this text

[Assistant] So that's sort of the model we're going to want to focus on for the next few lectures.


[User] Please transcribe this text

[Assistant] Whenever we think about this market, we want to start by noting that within this market, these limited set of competitors can behave in two ways. They can behave cooperatively.


[User] Please transcribe this text

[Assistant] Cooperatively or non-cooperatively?


[User] Please transcribe this text

[Assistant] Cooperative means that they can form what's called a cartel. So when, there's an oligopoly market,


[User] Please transcribe this text

[Assistant] And the firms cooperatively get together and make decisions. That's called a cartel. The most famous example of which is OPEC, the Organization of Petroleum Exporting Countries.


[User] Please transcribe this text

[Assistant] Which are the set of countries that control about two thirds of the world's oil.


[User] Please transcribe this text

[Assistant] And what they do is they control the vast majority of the world's oil reserves.


[User] Please transcribe this text

[Assistant] And by behaving cooperatively, they essentially turn themselves into a monopoly.


[User] Please transcribe this text

[Assistant] OPEC acts as if they've sort of got the monopoly on oil. Certainly they, uh, they used to.


[User] Please transcribe this text

[Assistant] Uh, now it's getting harder. Other non-OPEC countries are starting to produce more oil and it's breaking down. But for a long time, they were essentially the cooperative producer of oil, and they acted essentially like a monopoly, and they made lots of profits like a monopoly. They kept prices high, they kept production inefficiently low, and they made lots of money. Okay? However,


[User] Please transcribe this text

[Assistant] Uhm, that's a great outcome for producers. But as we'll talk about next time, it's actually a hard outcome to enforce. Turns out to be hard to keep cartels together.


[User] Please transcribe this text

[Assistant] And so typically oligopoly markets behave in a non-cooperative way.


[User] Please transcribe this text

[Assistant] With the participants competing with each other, not cooperating with each other.


[User] Please transcribe this text

[Assistant] And in this case, you can actually get them driving their profits down far below the monopoly level. And indeed, perhaps even all the way to the competitive level. So you think about markets as a competitive as one extreme, and the monopolies as the other extreme, oligopoly in between.


[User] Please transcribe this text

[Assistant] A cooperative oligopoly market like Cartel will end up close to the monopoly outcome. A non-cooperative market will end up somewhere in between. And we're gonna model today's where in between do they end up. Okay?


[User] Please transcribe this text

[Assistant] Now, to think about this, we're going to have to turn to a tool which has really become a dominant tool in economics over the last 40 years, which is the tool of gain theory.


[User] Please transcribe this text

[Assistant] Basically we can think of oligopoly, we're gonna think of oligopoly firms as engaging in a game. Okay? And as with any game,


[User] Please transcribe this text

[Assistant] Uhm, you need to sort of know, uh, two things. One is you need to know what's the strategy.


[User] Please transcribe this text

[Assistant] And the second is, you need to know when is the game over. Kind of what's the equilibrium.


[User] Please transcribe this text

[Assistant] And that's sort of essentially, uh, what you do with any game. Uhm, and so basically, uhm,


[User] Please transcribe this text

[Assistant] What we're gonna do, the key with game theory is that we are gonna define the equilibrium and that's gonna yield for us the strategy that players are gonna use.


[User] Please transcribe this text

[Assistant] However, equilibrium in a game is not well defined. It's like a set of rules that are printed out in like Monopoly. In a non-cooperative oligopoly market, the equilibrium, you have to actually come up with different concepts of what equilibrium is. There's not a hard and fast scientific rule.


[User] Please transcribe this text

[Assistant] And the typical one that's used is called the Nash equilibrium.


[User] Please transcribe this text

[Assistant] The Nash Equilibrium, named for the, uh, John Nash, the famous mathematician, uh, who economists have claimed as their own, even though he's really a mathematician. But we get him the Nobel Prize anyway. Uh, and, you know, if you think of his economist probably one of the most famous, you know, you all know about the movie and book Beautiful Mind.


[User] Please transcribe this text

[Assistant] Uhm, uh, he is basically the father of, uh, of game theory. Okay? So basically, what is the Nash equilibrium?


[User] Please transcribe this text

[Assistant] The national equilibrium is defined as the point at which no player wants to change their strategy given what the other players are doing.


[User] Please transcribe this text

[Assistant] So the point at which no player wants to change its strategy, give them what the other players are doing. So in other words, every player is happy with where they are.


[User] Please transcribe this text

[Assistant] Given what every other player's decided, I'm happy to do what I've decided. So I've got a strategy, and given the strategy other players are using,


[User] Please transcribe this text

[Assistant] Uh, if I'm happy with my strategy, then that's an equilibrium. Okay? So this is a super abstract concept. So let's illustrate it with an example. And the class example of game theory is the prisoner's dilemma.


[User] Please transcribe this text

[Assistant] Maybe even most of you, but let's just go through it. This is the thing from the old cop movies you see, where, uh, they arrest two guys, uhm, and they put them in separate rooms, and they basically interrogate them separately.


[User] Please transcribe this text

[Assistant] Okay, and what they say is uhm, they're put in separate rooms, and let's say that these guys get told the following. They each get told separately the following thing. They get told that right now,


[User] Please transcribe this text

[Assistant] If nothing else happens, there's enough evidence to send them each away for one year. However they're told, if they turn on their friend and say their friend's guilty, then they go free and their friend gets five years.


[User] Please transcribe this text

[Assistant] If the friend turns on them, then the friend goes free and they get five years.


[User] Please transcribe this text

[Assistant] But if they both turn on each other, they both get two years.


[User] Please transcribe this text

[Assistant] Okay, setup is if they both stay silent, they both get one year.


[User] Please transcribe this text

[Assistant] If one turns, then that person gets to leave and the other person gets five years. But if they both turn, then they each get two years.


[User] Please transcribe this text

[Assistant] So how do we think about decision making in that context? The way we do that is we write down what we call a payoff matrix. We sort of write down in matrix form this decision.


[User] Please transcribe this text

[Assistant] So let's think about what a playoff matrix looks like. Up here, a prisoner B.


[User] Please transcribe this text

[Assistant] And prisoner A can remain silent.


[User] Please transcribe this text

[Assistant] And then we just write down what are the outcomes, or the payoffs, from these different strategies. So prisoner A says nothing, and prisoner B says nothing, then A gets one year, and B gets one year. If prisoner A says nothing, and prisoner B says, oh yea, prisoner A is definitely guilty, then prisoner A gets five years, and prisoner B gets zero years.


[User] Please transcribe this text

[Assistant] If the opposite happens, the prisoner says, yeah, B's guilty and B doesn't say anything about A, then A gets zero years and B gets five years. But if they both say the other one's guilty, then they each get two years.


[User] Please transcribe this text

[Assistant] Okay, and now we want to ask, given this payoff matrix, what is the right strategy for each prisoner to pursue?


[User] Please transcribe this text

[Assistant] And the way we do this in the Nash equilibrium concept is we look for a dominant strategy.


[User] Please transcribe this text

[Assistant] Is there a strategy that I would pursue regardless of what the other person does?


[User] Please transcribe this text

[Assistant] And if there is, I'll pursue that. Because remember, the national equilibrium concept is, what do I want to do given what the other person's doing?


[User] Please transcribe this text

[Assistant] If I have a strategy I want to do no matter what the other person is doing, then I'll do it.


[User] Please transcribe this text

[Assistant] So when I ask is there a dominant strategy, is there a strategy that is the best thing to do no matter what the other guy does? Okay. Well clearly if they're cooperating,


[User] Please transcribe this text

[Assistant] If these were, if these were stupid police and they sat in the same room and told us and then left.


[User] Please transcribe this text

[Assistant] The two guys could cooperate and say well clearly the dominant cooperator strategy is for both of us to remain silent.


[User] Please transcribe this text

[Assistant] That's the dominant cooperative strategy. And as a team, we only get two total years in jail, where everything gives much more years, many more years in jail. So if they're buddies, and they trust each other, and they cooperate, then that's the cl- the right strategy. Well let's say the police are smart and put them in separate rooms. Okay?


[User] Please transcribe this text

[Assistant] What is the strategy that A or B, that A, say A should produce? Yeah. Why?


[User] Please transcribe this text

[Assistant] In this first row, compare the first row, left first column. Let's say prisoner B silent.


[User] Please transcribe this text

[Assistant] Then clearly you're better off talking than not talking. Zero rather than one. Let's say prisoner B talks. Then you're still better off talking than not talking. So no matter what B does, you should talk.


[User] Please transcribe this text

[Assistant] Likewise, prisoner B, no matter what A does, B should talk. So the non-cooperative equilibrium is actually this outcome. They both end up talking. You get sort of a race to the bottom.


[User] Please transcribe this text

[Assistant] The non-cooperative outcome is much worse than if they could have cooperated. Okay?


[User] Please transcribe this text

[Assistant] So basically, what you get is that the non-cooperative equilibrium is always worse for the players than the cooperative equilibrium.


[User] Please transcribe this text

[Assistant] Of Nash. Before Nash, we always thought competition was always and everywhere good.


[User] Please transcribe this text

[Assistant] We saw more competitions better, for the reasons we taught you in the first 10 or 12 lectures of this class.


[User] Please transcribe this text

[Assistant] Nash was the first one to say no, actually competition can be bad, cooperation can be better. I don't know if you remember the scene in A Beautiful Mind where they're picking up girls in the bar, and he describes sort of basically a Nash strategy. Okay, how competition will lead to the worst outcome. Okay, and basically that's what you see here.


[User] Please transcribe this text

[Assistant] That competition can actually lead to a worse outcome than cooperation. That was really sort of Nash's brilliant insight. Now, uhm,


[User] Please transcribe this text

[Assistant] This is, uh, sort of a cute example of prisoners, but actually, uhm, uh, but, well, two points. First of all, this generally shows you how you do game theory with Nash, with Nash equilibria. Basically, you look at the payoff matrix, you find the dominant strategy, and then you find where those dominant strategies intersect.


[User] Please transcribe this text

[Assistant] And here the dominant strategies intersect at this cell. Therefore, that's the equilibrium. Okay?


[User] Please transcribe this text

[Assistant] So that's basically how you do game theory in a, you know, game theory kindergarten level.


[User] Please transcribe this text

[Assistant] Okay, you look at the matrix, you find each player's dominant strategy, and you find the point at which those dominant strategies intersect. And at that point, that's the equilibrium.


[User] Please transcribe this text

[Assistant] Now, that's all well and good for sort of a simple, uhm, example like this, but let's actually apply to an economics example. Let's think about advertising. So think about Coke and Pepsi. Okay, uhm, now, right now, uhm,


[User] Please transcribe this text

[Assistant] Let's think about their decision to advertise. Now obviously this is a simple problem. Obviously Pepsi should just be illegal. Because Coke's just way better. But sadly it's not. And sometimes I have to drink Pepsi and I'm very sad.


[User] Please transcribe this text

[Assistant] But nonetheless, in the real world, we have Coke and Pepsi and you have to decide how much to advertise. Now, the dominant cooperative strategy would be to say, look, advertising costs us a ton of money. Let's just split the market. Let's have a monopoly market and just split it.


[User] Please transcribe this text

[Assistant] We're close to splitting it anyway. Coke's got some more of it. We're close to splitting it. Let's just split it. Yeah.


[User] Please transcribe this text

[Assistant] Uhm, we will only, we will cut you a better deal if you'll agree not to sell coke. That's not cooperation, that's competition.


[User] Please transcribe this text

[Assistant] Okay, so there's a cooperative strategy, what if they don't cooperate?


[User] Please transcribe this text

[Assistant] Okay, well let's imagine we are the following payoff matrix. Okay, you've got Pepsi up here.


[User] Please transcribe this text

[Assistant] And they can advertise or not advertise. And you've got Coke here.


[User] Please transcribe this text

[Assistant] Uhm, let's say the total amount of profit to be made is 16, whatever, billion. Whatever units want to make it. 16 billion.


[User] Please transcribe this text

[Assistant] Okay, and let's say if there's no advertising, Coke gets eight and Pepsi gets eight.


[User] Please transcribe this text

[Assistant] But let's say, but let's say advertising costs money. It costs five. Five billion. So let's say if they both advertise, then they still end up splitting the market, but they only make three. C equals three, P equals three. So if they


[User] Please transcribe this text

[Assistant] I'm sorry, it's the obvious. Uh, advertising, yes, you're right. C equals 3, P equals 3.


[User] Please transcribe this text

[Assistant] Okay, so basically, uhm, they are, uh, so basically of a situation where they both end up splitting the market either way. But they just split a smaller net profit if they advertise. So clearly they'd rather be here than here.


[User] Please transcribe this text

[Assistant] Well what happens in the off-diagonal limits? Well let's say also that if Coke


[User] Please transcribe this text

[Assistant] Advertises, but Pepsi does not. Then let's say Coke ends up making 13 billion.


[User] Please transcribe this text

[Assistant] And Pepsi ends up making minus, uhm, I'm sorry, Coke advertises.


[User] Please transcribe this text

[Assistant] And if Coke advertises and Pepsi does not, I just flipped my heat. And Pepsi makes negative two.


[User] Please transcribe this text

[Assistant] They actually lose money because they have fixed costs and they don't sell anything. Nobody buys Pepsi, they lose money. And let's say if Pepsi advertises and Coke doesn't,


[User] Please transcribe this text

[Assistant] Then Coke makes negative 2, and Pepsi makes 13. Okay?


[User] Please transcribe this text

[Assistant] If I advertise and Pepsi advertises, I make three.


[User] Please transcribe this text

[Assistant] But if I don't advertise and Pepsi advertises, I make negative 2, so I should advertise. If I advertise, Pepsi doesn't advertise, I make 13.


[User] Please transcribe this text

[Assistant] If I, if I don't advertise and Pepsi doesn't advertise, I make eight. So either way, my dominant strategy is to advertise.


[User] Please transcribe this text

[Assistant] And likewise, Pepsi does the same thing. It's actually, I screwed up writing this compared to my notes, but it's good because it shows you, I flipped the matrix, but the logic is the same. It helps you sort of, not just memorize cells in a late matrix, but learn the logic.


[User] Please transcribe this text

[Assistant] The point is either way, the dominant strategy is to advertise. So they both advertise.


[User] Please transcribe this text

[Assistant] So real world example of how you can end up. Now, so much of Pepsi and Coke do this. Actually, there was an industry that did this. So when I was a kid, you never ever saw ads for, uhm, liquor on TV. There were beer ads.


[User] Please transcribe this text

[Assistant] And wine ads, but no hard alcohol ad. No bourbon, no whiskey, no nothing. Gin. All these, all these, you know, Captain Morgan's ads we see now, they didn't exist when I was a kid. But it wasn't because of the law.


[User] Please transcribe this text

[Assistant] It was because the hard liquor industry cooperatively agreed none of them would advertise. So they actually imposed a cooperative equilibrium and then that broke down.


[User] Please transcribe this text

[Assistant] I don't know the story of how it broke down. But so it broke down, now they all advertise. And they're probably all worse off than they were when they just didn't advertise.


[User] Please transcribe this text

[Assistant] Okay, we'll talk next time about why it probably broke down. I don't know the stories, but I have a rough sense and we'll talk about that next time.


[User] Please transcribe this text

[Assistant] But this is the point of how a non-cooperative equilibrium can drive you to a bad outcome. Okay? Now,


[User] Please transcribe this text

[Assistant] Basically, uhm, this doesn't just apply to prisoners or business, it applies to people too. So let's say poor Hector back there has had a fight with his girlfriend.


[User] Please transcribe this text

[Assistant] Okay, and, uh, they've had a big fight. They've been going a little wild. They've had a big fight.


[User] Please transcribe this text

[Assistant] And Hector's gotta decide, do I apologize or do I wait for her to apologize? Okay, well,


[User] Please transcribe this text

[Assistant] The last thing Hector wants is to go up there and apologize, have him say, forget it, I'm breaking up with you. That'd be the worst. Okay?


[User] Please transcribe this text

[Assistant] If he knows she's gonna be like, oh I'm sorry too, then he'd be happy to do it.


[User] Please transcribe this text

[Assistant] But what if he goes, she doesn't know I'm breaking up with you? Well then, and she's thinking the same thing. So what happens? They break up.


[User] Please transcribe this text

[Assistant] Okay, we've been through this many times in our lives. This is the non-cooperative strategy.


[User] Please transcribe this text

[Assistant] Okay? Uh, basically, if you don't know what the other person is gonna do, your dominant strategy is to be an asshole.


[User] Please transcribe this text

[Assistant] Okay, and basically that happens a lot, uh, in the context of the real world. Okay?


[User] Please transcribe this text

[Assistant] So now, we have this sort of sad sounding outcome.


[User] Please transcribe this text

[Assistant] That basically, game theory leads to bad outcomes for producers at least.


[User] Please transcribe this text

[Assistant] But, this is what's exciting about game theory. So when I went to grad school back, you know, when dinosaurs roamed the earth,


[User] Please transcribe this text

[Assistant] Uh, game theory was sort of taught barely in the sequence. It was sort of like an extra course taught a little bit. Now it sort of dominates the teaching of microeconomics.


[User] Please transcribe this text

[Assistant] In economics, and it doesn't dominate, but it's a whole like component of our core microeconomics education.


[User] Please transcribe this text

[Assistant] Because it's given such a cool set of tools to think about these decisions. Now, I can't give you even 1% of the flavor of game theory. If you want to learn more, I highly suggest you take 14-12.


[User] Please transcribe this text

[Assistant] Which is our game theory class and you can learn a ton. But let me use sort of one interesting wrinkle of the kind of things game theory can do to go beyond this. And that's to imagine that


[User] Please transcribe this text

[Assistant] Coke and Pepsi are not playing a one shot game, but a repeated game.


[User] Please transcribe this text

[Assistant] That uhm, Coke says to Pepsi the following.


[User] Please transcribe this text

[Assistant] I promise to not advertise as long as you don't advertise.


[User] Please transcribe this text

[Assistant] But if you ever advertise, I will advertise forever.


[User] Please transcribe this text

[Assistant] Okay, Coke says to Pepsi, I promise not to advertise as long as you don't advertise. But if I ever catch you advertising, I'm gonna advertise forever. Okay? So now imagine, think about Pepsi's choice in period one.


[User] Please transcribe this text

[Assistant] Pepsi's choice in period one. In period one they could say ha, stupid coke.


[User] Please transcribe this text

[Assistant] I'm gonna jump on them and advertise, they promise I'm not gonna advertise. I'm gonna make, so Pepsi advertises.


[User] Please transcribe this text

[Assistant] They're gonna make thirteen in period one. Right? Because Coke's taking themselves off to the side.


[User] Please transcribe this text

[Assistant] But, after period one, they're gonna make eight forever. No, I'm sorry, they're gonna make three forever.


[User] Please transcribe this text

[Assistant] Because Coke's gonna advertise, they're gonna advertise, then they break down to the non-cooperative equilibrium. Okay? If Pepsi advertises. Now what if Pepsi doesn't advertise?


[User] Please transcribe this text

[Assistant] So now, we'll talk later in the course about how you combine numbers that happen at different times. And trust me, 8 forever is a way better deal than 13 and 3 forever. Okay?


[User] Please transcribe this text

[Assistant] So actually, by having this be a repeated game, Coke has solved the prisoner's dilemma.


[User] Please transcribe this text

[Assistant] It's essentially imposed a cooperative equilibria on the problem. Okay? So that's how a repeated game can fix this.


[User] Please transcribe this text

[Assistant] But! This is where game three gets really exciting. That only works if this game never ends.


[User] Please transcribe this text

[Assistant] Because once Coke or Pepsi thinks there's an end to the game, the entire thing breaks down.


[User] Please transcribe this text

[Assistant] Okay, so imagine for example that Coke makes the offer to Pepsi.


[User] Please transcribe this text

[Assistant] But Pepsi's worried that in 10 years the government's going to outlaw soda.


[User] Please transcribe this text

[Assistant] Okay, the government, you know, said, look, we're heading in that direction, so it's going to be legal in ten years. Uh, so I don't want to do this.


[User] Please transcribe this text

[Assistant] So in that case, no, so that, I'm sorry, not that I wanted to, I, so I have that in my mind. So Coke offers the deal. Now, what do I think? Well let's think about Pepsi's decision in the ninth year. They've made 88888 and they get to year nine. Now in year nine, they know that next year there's no more game. So what should they do? Advertise. Grab the 13 in the last period. Because Coke can't punish them because the game's over.


[User] Please transcribe this text

[Assistant] But Coke knows this. So what's Coke gonna do in the ninth year?


[User] Please transcribe this text

[Assistant] Advertise. It's gonna advertise, so they're both gonna make, so, so they're both gonna make a three.


[User] Please transcribe this text

[Assistant] Well, if Pepsi knows Coke's gonna advertise the 9th year no matter what, what should Pepsi do in the 8th year?


[User] Please transcribe this text

[Assistant] Advertise. And if Coke knows pets can advertise in the eighth year, what should Coke do? And so on, and it ends up that they both advertise. All the way through.


[User] Please transcribe this text

[Assistant] So the game breaks down if it's an end. This is really kind of neat. And this is what game theory is all about is how do you think through these more complicated scenarios that are much more complicated than the prisoner's dilemma and actually think about how firms and individuals might actually behave. Yeah.


[User] Please transcribe this text

[Assistant] Sure, that's much more, and once again, that's exact, that's what you cover in a field of course like game theories. What about alternative forms of contracting with exclusionary contracting, what we call tying?


[User] Please transcribe this text

[Assistant] In contracting. That's great, and they would, but that's, that's why you gotta take 14-12. Okay? Yeaah.


[User] Please transcribe this text

[Assistant] Yeah, the way I've set this problem up, if they could commit to that, that'd be right. But you'd have to commit to it.


[User] Please transcribe this text

[Assistant] Because then the period the Pepsi promised to take off, if they actually advertised that period, then Coke screwed. So that would work as a repeated game solution.


[User] Please transcribe this text

[Assistant] But it wouldn't work as a, as a non-repeated game, as, as, as, as, work as an infinite repeated game, but not a non-infinite repeated game. Okay? Good question. Okay, other questions?


[User] Please transcribe this text

[Assistant] Alright, so that's the basic game theory. That's just a taste for the excitement that you can live with game theory.


[User] Please transcribe this text

[Assistant] But in fact in economics we like to write down these fun examples, but we really prefer to do math.


[User] Please transcribe this text

[Assistant] So let's actually think about the math of how we take game theory concepts and put them in practice. And that's...


[User] Please transcribe this text

[Assistant] That, the way we do that is through the concept of the Cournot model.


[User] Please transcribe this text

[Assistant] So it's the Cournot model of non-cooperative oligopoly. It's the standard workhorse model that takes this intuition and puts it into the kind of optimizing math we've been doing so far this class. Okay?


[User] Please transcribe this text

[Assistant] So let's, now let's imagine non-cooperative case. But now let's imagine there's not just two choices, but realistically there's a whole set of choices.


[User] Please transcribe this text

[Assistant] Okay, then how would you behave, uhm, in that case?


[User] Please transcribe this text

[Assistant] So let's imagine that there's two airlines, united and American.


[User] Please transcribe this text

[Assistant] United America, so we're gonna have a oligopolistic, two-firm airline industry. Obviously the math can extend to more firms, but just to start now and I'll talk about that next lecture. But for now, imagine a two-firm industry, united and American, and because of the hub and spoke system we discussed last time, let's imagine they're the only two folks that go from Boston to Chicago.


[User] Please transcribe this text

[Assistant] Okay, because this hub and spoke system, the only folks that go from Boston to Chicago are United America, and they do in fact dominate that line. So let's imagine they're the only folks.


[User] Please transcribe this text

[Assistant] And say no other firms can compete on this route because they can't get slots at the airport.


[User] Please transcribe this text

[Assistant] So the question is, how do these firms decide how many flights to run? It's not just advertise don't, it's literally continuous decision.


[User] Please transcribe this text

[Assistant] Of how many flights to run every day, and how much to charge. Okay, they've got to make that decision.


[User] Please transcribe this text

[Assistant] And the Nash equilibrium here, we call a Cournot, the sort of subset of Nash for this example is called the Cournot equilibrium. And the Cournot equilibrium exists when a firm chooses a quantity


[User] Please transcribe this text

[Assistant] Such that given the quantity chosen by the other firm, they don't want to change.


[User] Please transcribe this text

[Assistant] So a firm chooses essentially a profit maximizing quantity, given the quantity chosen by the other firm. Okay, and if that profit maximizing quantity, okay, uhm, uhm,


[User] Please transcribe this text

[Assistant] Then that, you're in Cournot equilibrium if you have chosen, uh, uh, quantity that is profit maximizing given what the other firm is doing. Okay?


[User] Please transcribe this text

[Assistant] So basically how do we, how do we actually carry this out? Okay, let's talk about the steps. Okay, so the first step,


[User] Please transcribe this text

[Assistant] Uhm, here's, I'm gonna talk intuitively about the math, what we're gonna do, and then I'm gonna talk mathematically and graphically what we actually do. There's essentially three steps in solving for the Cournot equilibrium.


[User] Please transcribe this text

[Assistant] The first is ask how your demand changes when some of it's absorbed by other firms. So the first is solve for your residual demand function.


[User] Please transcribe this text

[Assistant] What does your demand curve look like given what the other firm does? That's step one.


[User] Please transcribe this text

[Assistant] Step two is that you develop a marginal revenue.


[User] Please transcribe this text

[Assistant] Which is a function of the other firm's quantity.


[User] Please transcribe this text

[Assistant] The other firms, that's really bad, hard to read, the other firms quantity. So it's your marginal revenues of function, typically, it's a function, I'm sorry, of both your quantity and the other firms quantity. A function of both your quantity


[User] Please transcribe this text

[Assistant] And the other firm's quantity. We develop marginal revenues as a function of your own quantity. We know how to do that. Now we develop marginal revenues as a function of your quantity and the other firm's quantity.


[User] Please transcribe this text

[Assistant] Then, you simply set this marginal revenue equal to marginal cost.


[User] Please transcribe this text

[Assistant] And that delivers you a conditional answer. That delivers you your optimal quantity as a function of the other firm's quantity.


[User] Please transcribe this text

[Assistant] Well that doesn't do us a whole lot of good, except there's two firms. So the fourth step is we do the same thing for the other firm.


[User] Please transcribe this text

[Assistant] And get the same kind of equation. Then what do we have? Two equations and two unknowns, so we solve.


[User] Please transcribe this text

[Assistant] Okay, so what we do here is essentially the same thing we did before, but now your marginal revenue is not just a function of your own quantity, it's a function of the other guy's quantity. Same with the other guy. That gives you two equations, two unknowns we solve, and the point at which both firms are happy is the Cournot equilibrium.


[User] Please transcribe this text

[Assistant] Okay, so let's actually, that's confusing, so let's actually look at that.


[User] Please transcribe this text

[Assistant] Let's start, uhm, we'll do this both graphically and mathematically. Let's start with figure 13-1. Okay?


[User] Please transcribe this text

[Assistant] To make things easy, let's start by imagining that American Airlines is a monopoly. Let's start with the world with an American Airlines monopoly. Okay? And let's say that the demand function


[User] Please transcribe this text

[Assistant] And let's say that the marginal cost to make life easy, I could have a cost function to make your life difficult, and maybe someday I'll do that.


[User] Please transcribe this text

[Assistant] Okay, I'm not gonna allow for, not gonna make life difficult with solving for marginal cost functions. For now, it's just a flat marginal cost of $147. No matter how many flights they do, it's $147 per passenger. So if you're a monopolist, how do you solve this problem?


[User] Please transcribe this text

[Assistant] Well, first you derive your marginal revenue function. Well, what's marginal revenue function? Well, revenues...


[User] Please transcribe this text

[Assistant] So your marginal revenue function is 339 minus 2q. That's your marginal revenue function if you're the monopolist.


[User] Please transcribe this text

[Assistant] The optimal quantity is 96 flights.


[User] Please transcribe this text

[Assistant] And then how do you get the price? How do you get the price of a monopoly problem? How do we know what the price is? Yeaah.


[User] Please transcribe this text

[Assistant] Plug it back to the main curve so the price is $339 minus $96 or $243.


[User] Please transcribe this text

[Assistant] Okay, so I just solved the monopoly problem quickly, but that's uhm, but that's what we did, what we've done already in this class. And you can see that in the graph here.


[User] Please transcribe this text

[Assistant] Okay, in figure 13-1, you've got demand curve, which is 3, p equals 339 minus q.


[User] Please transcribe this text

[Assistant] You've got a supply curve, which is a flat marginal cost at 147. You develop a marginal revenue function, which is 339 minus 2Q.


[User] Please transcribe this text

[Assistant] As in our previous example, that's just basically an inward shift of the demand function.


[User] Please transcribe this text

[Assistant] That intersects marginal costs at 96 flights.


[User] Please transcribe this text

[Assistant] Okay, we have this is thousand passengers per quarter. It doesn't really matter. The units ignore the, you know, it's just all standardization. Okay.


[User] Please transcribe this text

[Assistant] And then to get the price, you read it off the demand curve, you say 96 flights means a price of 243 per flight.


[User] Please transcribe this text

[Assistant] Okay? That's what we'd do if American was a monopolist.


[User] Please transcribe this text

[Assistant] Now, however, American's not a monopolist. American deals with United. And American doesn't know what United's gonna do. So what does American do?


[User] Please transcribe this text

[Assistant] Well, let's say America now has to deal with the fact


[User] Please transcribe this text

[Assistant] That, it now has to recognize that the demand, it's got its own demand function, QA.


[User] Please transcribe this text

[Assistant] Okay, so it has a residual demand function.


[User] Please transcribe this text

[Assistant] American thinks Americans got a spy inside United.


[User] Please transcribe this text

[Assistant] And America says, ha, I think United's gonna fly 64 flights.


[User] Please transcribe this text

[Assistant] Okay, so imagine America thinks United's gonna fly, uhm, 64, 64 flights.


[User] Please transcribe this text

[Assistant] Well in that case, it would say, well in that case, my, uhm, if, if they're gonna fly 64 flights, then my demand function is P sub A equals 339.


[User] Please transcribe this text

[Assistant] Okay, the big quantity is uhm, is little qA plus little qU.


[User] Please transcribe this text

[Assistant] So my demand function is 339 minus Q sub A minus 64.


[User] Please transcribe this text

[Assistant] Okay, or in other words, my residual demand function is that P sub A equals 339.


[User] Please transcribe this text

[Assistant] So if I think United's gonna fly 64 flights, then my effective demand function


[User] Please transcribe this text

[Assistant] Then I just solve for what would I do as a monopolist given the other guys flying 64 flights. So you can see that in figure 13-2. Okay? So I have a demand function.


[User] Please transcribe this text

[Assistant] I say well if United's gonna fly 64 flights, that demand function gets shifted in by 64.


[User] Please transcribe this text

[Assistant] And I do the same thing I did before. I solve for marginal revenue.


[User] Please transcribe this text

[Assistant] Okay, I solve for marginal revenue, and I intersect that with marginal cost. That's gonna happen at 64 flights and a price of $211. Okay?


[User] Please transcribe this text

[Assistant] So basically, it's the same exercise, it's not that hard to just first take out what United's gonna do. The problem is American doesn't have a spy.


[User] Please transcribe this text

[Assistant] They don't really know what United's gonna do. They have to essentially develop a strategy given the possibilities of what United might do. They have to say, look, I don't know what Q sub U is.


[User] Please transcribe this text

[Assistant] So I have to devise my optimal strategy, given Q sub u.


[User] Please transcribe this text

[Assistant] Okay, in other words, I have to simultaneously solve for what I would do at every possible quantity United would sell.


[User] Please transcribe this text

[Assistant] I've just solved what I would do for every possible quantity I would sell. And we call this developing your reaction or best response curve.


[User] Please transcribe this text

[Assistant] Your reaction curve or your best response curve. Which is what is the best thing to do given what the other guy's doing? What is the best thing to do given what the other guy's doing? Okay, you can see that in figure 13.3. We show how that works.


[User] Please transcribe this text

[Assistant] Okay, that shows best response curves. So for example, look at the intersection, uh, on the y-axis, where the red line hits the vertical, hits the y-axis.


[User] Please transcribe this text

[Assistant] That was our monopoly equilibrium. Uh, I'm sorry, where the, uh, where the... I'm sorry, where the blue line hits the x-axis. My bad. We're doing American. Look at where the blue line hits the x-axis.


[User] Please transcribe this text

[Assistant] That is assuming zero united flights, right? Where the blue line hits the x-axis is where there's zero united flights. Well, we know what American would do there.


[User] Please transcribe this text

[Assistant] They would fly 96 flights. We already solved that.


[User] Please transcribe this text

[Assistant] Now look at the point, uh, the point where United is flying 64 flights.


[User] Please transcribe this text

[Assistant] Well, we also know what America would do then. We read off the, we know that we solved, in the previous figure, they would then do 64 flights.


[User] Please transcribe this text

[Assistant] And in general, what that blue line is, is for every quantity that United flies, what does American wanna fly? Okay? Now.


[User] Please transcribe this text

[Assistant] Let's actually do, and so, meanwhile, United is doing the same mathematics.


[User] Please transcribe this text

[Assistant] Imagine, to make life easy, and we'll almost always do this to make life easy, imagine United has the same marginal cost to American, and obviously faces the same market demand curve. Well then literally their math is totally symmetric. If American wasn't in the market,


[User] Please transcribe this text

[Assistant] You'd have where the red line intersects the vertical axis. If American was flying zero, United would fly 96 flights. Because their problem is identical to Americans' monopoly problem.


[User] Please transcribe this text

[Assistant] Likewise, so that red, the red line is United's best response curve.


[User] Please transcribe this text

[Assistant] So we've graphed for every possible amount of flights that United does, what's American's optimal amount of flights. We've solved for every amount of flights that American does, what's United's optimal amount of flights. Where those lines intersect is the Cournot equilibrium.


[User] Please transcribe this text

[Assistant] Why is that the Carnot equilibrium? Because at that point, both firms are doing the best they can given what the other firm's chosen.


[User] Please transcribe this text

[Assistant] Or in other words, to say this is given what the other firm's doing, neither firm wants to deviate.


[User] Please transcribe this text

[Assistant] The profit maximizing choice is to be where they are, given the other firm's behavior.


[User] Please transcribe this text

[Assistant] So basically, the Cournot equilibrium is the only equilibrium that's possible in this market.


[User] Please transcribe this text

[Assistant] Okay, so, and why is that? So for example, imagine that American came in and said, look,


[User] Please transcribe this text

[Assistant] I like doing 96 flights. I love being a monopolist. I'm just doing 96 flights.


[User] Please transcribe this text

[Assistant] And I'm going to charge, I'm going to do 96 flights and I'm going to charge children $43.


[User] Please transcribe this text

[Assistant] Well in that case, American, United I'm sorry, would happily come in at $242 and undercut them and sell lots of flights because that's still well above marginal cost. So that's not an equilibrium.


[User] Please transcribe this text

[Assistant] Because, uh, because United and American are choosing different outcomes. It's only if they both, if they're both to the point where the same outcome makes them both happy. Okay?


[User] Please transcribe this text

[Assistant] So that's the graphics. Let's actually do the, let's do the math here. Let's do the Cornell math.


[User] Please transcribe this text

[Assistant] Okay? In general, the residual demand for American


[User] Please transcribe this text

[Assistant] Is that p equals 339 minus qA minus qU. Okay? Remember, big Q is qA plus qU. So since big Q, since the demand function is 339 minus big Q, I simply broke big Q into qA and qU. Okay? Stop me if this is all unclear. Simply broke up the big Q into those two components.


[User] Please transcribe this text

[Assistant] So that means that American's revenue function, or let's call it revenue A, revenue for American, is 339 times QA


[User] Please transcribe this text

[Assistant] This was the old, this was the old revenue function we had when there were monopolists. Now I've got this new term that didn't exist before. So that means their marginal revenue


[User] Please transcribe this text

[Assistant] So now, their marginal revenue is actually a function of their own behavior, but their competitor's behavior. That's the new marginal revenue function. Okay? Now, but...


[User] Please transcribe this text

[Assistant] The profit maximization rules the same, you just set that equal to marginal cost. So you set it equal to 147. And you solve.


[User] Please transcribe this text

[Assistant] So now we have the optimal quantity, but it's a function of what the other guy does.


[User] Please transcribe this text

[Assistant] That's a problem, except that we do the same math for united. Now, if the problem's symmetric, you don't have to do the math again. You know the best response function will be symmetric. But that won't always be the case.


[User] Please transcribe this text

[Assistant] So I've just written down their best response function, just corresponds to the graph. Look at the, so q star a, that's the, uhm, blue line. It's 96 minus 1 half q u. Okay? q star u, that's the red line. 96 minus 1 half q a.


[User] Please transcribe this text

[Assistant] That's the best response function. Now once again, to remind you, I could simply skip to this step, but normally you'd have to solve through for both firms, because they might not have identical, uh, best response functions, or symmetrical best response functions. Well now, we're golden.


[User] Please transcribe this text

[Assistant] We have two equations and two unknowns. We know how to deal with that. And you solve them and you get the QA star equals QU star equals 64. You solve those two equations and two unknowns. Okay, so 64.


[User] Please transcribe this text

[Assistant] Because they're each flying 64, and the price comes from the total demand in the market. So the price is 211.


[User] Please transcribe this text

[Assistant] That's an important mistake to avoid. A lot of people get here, they'll be super excited, they're tired, they throw the 64 back of the demand equation. But remember, demand is a function of the total market. If symmetrically each doing 64, then the price is going to be 211. And that is the Nash or Cournot equilibrium. Both firms are happy.


[User] Please transcribe this text

[Assistant] Defly 64 flights at a price of $211. Neither firm wants to deviate. And you know that because you've maximized their profits.


[User] Please transcribe this text

[Assistant] And the profits for American are maximized. When United is flying 64, the profits for American are maximized to flying 64.


[User] Please transcribe this text

[Assistant] When Americans fly in 64, the profits for United are maximized at flying 64. Therefore, that is the Nash or Cournot equilibrium.


[User] Please transcribe this text

[Assistant] Now, when we get to reality, things might not always work out so neatly. Things might not be symmetric. You might also not have an equilibrium. How could you not have an equilibrium here? How could that happen? Graphically, what would that mean?


[User] Please transcribe this text

[Assistant] You might not get an equilibrium. We don't know what the hell to do then. All chaos breaks loose. Okay? But, you might not get an equilibrium.


[User] Please transcribe this text

[Assistant] Okay, in this market because the best response curves might not, might not intersect.


[User] Please transcribe this text

[Assistant] Okay, in reality in life, you can have funky best response curves that are non-linear, you can have multiple intersections. You can have multiple, we call multiple equilibria.


[User] Please transcribe this text

[Assistant] And then it becomes an indeterminate problem, and you have to figure out which equilibrium they settle at. And that involves higher order mathematics that we'll talk about in more advanced classes.


[User] Please transcribe this text

[Assistant] So this is sort of the simplest, easiest cases, symmetric case with linear best response functions intersect, is your easiest case.


[User] Please transcribe this text

[Assistant] But in general, the general way to solve this is the same, which is to look.


[User] Please transcribe this text

[Assistant] Is to use the principle of game theory. Look, go back to the prisoner's dilemma, okay? All we're doing here was creating best response functions. It's just there wasn't a line, it was just a point. The best response function was what we laid out here. All we do is the United American example is go to a continuum and develop best response function around just the best response point. Okay? Yeaah.


[User] Please transcribe this text

[Assistant] Okay, let's stop there. We'll come back next time. We'll talk about why don't we, why don't we all just get along like Mr. Rogers wants.


[User] Please transcribe this text

[Assistant] Someone in here playing tricks, huh?


[User] Please transcribe this text

[Assistant] Hey, you the one who called us? Yeah, they're in here somewhere. Alright, if you two spread out well, I got this guy's statement.


[User] Please transcribe this text

[Assistant] Okay, class, uh, read chapter four, or five, or whatever.


[User] Please transcribe this text

[Assistant] We're gonna move on to, uh, another topic I've kept hinting at all semester, but it's finally here, which is to think more explicitly about equity or fairness. So our discussions this semester have been almost solely couched in the language of efficiency.


[User] Please transcribe this text

[Assistant] We talk about maximizing social welfare. Uh, we talk about the total size of the triangle and the squares. But we don't actually talk about who gets what. We very much stayed away from


[User] Please transcribe this text

[Assistant] Because you can have many outcomes that are equally efficient, but have different equity consequences. The best example, of course, is perfect competition, versus a perfectly priced discriminating monopolist.


[User] Please transcribe this text

[Assistant] Remember, under perfect competition, you maximize welfare.


[User] Please transcribe this text

[Assistant] But a perfectly price discriminating monopolist also maximize welfare. The difference is in the latter case, the monopolist gets all the surplus. When the former case, it's shared between producers and consumers.


[User] Please transcribe this text

[Assistant] So it's sort of weird to say we're indifferent between those two outcomes. Between one where Apple gets all our money, and one where Apple gets some of our money and we get some of our money.


[User] Please transcribe this text

[Assistant] Seems like kind of a strange, uh, strange to say we're different between those outcomes. So, now,


[User] Please transcribe this text

[Assistant] That's sort of the, in some sense, that's the easy case. So we're talking about equity efficiency.


[User] Please transcribe this text

[Assistant] In some sense, the easy case is the case where there's two equally efficient outcomes and they have different equity consequences. That's the rare case. The more common case is what we call the equity efficiency trade-off.


[User] Please transcribe this text

[Assistant] Which is that by making distributions more equal, we are going to induce inefficiencies.


[User] Please transcribe this text

[Assistant] That the act of making distribution more equal is going to introduce inefficiencies in the system. And that's where things get really interesting. Okay?


[User] Please transcribe this text

[Assistant] So in other words, so the best way to think about this, I find most helpful, is due to a famous economist named Arthur Oaken. And his thought example of the leaky bucket.


[User] Please transcribe this text

[Assistant] Okun's thought example was the following. Imagine that the way the government distributed money from the rich to the poor was literally they went to the rich, had the rich put money in a bucket, and they carried it and dumped it out in front of the poor. Imagine that's the way distribution happened.


[User] Please transcribe this text

[Assistant] Well, in that world, if I told you that every dollar a rich person put in the bucket got carried along and got handed to a poor person, so Bill Gates' dollar became a homeless guy's dollar, probably most of us would think that was okay.


[User] Please transcribe this text

[Assistant] I think the vast majority of Americans would say yeaah, probably the homeless guy could use a dollar more than Bill Gates could.


[User] Please transcribe this text

[Assistant] Okay, but now imagine that there was a leak in the bucket.


[User] Please transcribe this text

[Assistant] Imagine Bill Gates put 100 pennies in, but along the way to the poor person it leaked out and so we dumped it in front of the poor person that was less than 100. Now,


[User] Please transcribe this text

[Assistant] Then the question is how much leakage? Well, if the leakage was one penny out of a hundred, you probably wouldn't change your mind. Would it change your mind if it was twenty pennies out of a hundred?


[User] Please transcribe this text

[Assistant] 50 pennies out of 100? What if it was 100 pennies out of 100? What if taking a dollar from Bill Gates by the time we got to the poor person, it was all gone? At what point would you say, you know what, I don't think that's a good idea anymore.


[User] Please transcribe this text

[Assistant] And really that's a great way of thinking about the equity efficiency trade off. How much efficiency are you willing to give up to redistribute from rich to poor? And the efficiency you give up is represented by the leakage in the bucket. Okay? Now,


[User] Please transcribe this text

[Assistant] What we're going to do in this lecture and next Monday's lecture.


[User] Please transcribe this text

[Assistant] Is we're gonna discuss this equity efficiency trade-off in four steps. Okay?


[User] Please transcribe this text

[Assistant] The first step is going to be talking about valuation.


[User] Please transcribe this text

[Assistant] That is, taking the difficult step we've already taken so far and asking, how does society feel about some people versus other people?


[User] Please transcribe this text

[Assistant] So far, we've just thought of one generic person, and they're represented by total surplus. But in fact, we have a distribution of people, and how do economists think about taking money away from person A and giving it to person B? That's a new topic for us. The second thing we're gonna talk about


[User] Please transcribe this text

[Assistant] What do we know about what's actually happened to the distribution of resources, uh, in the US at a point in time and over time?


[User] Please transcribe this text

[Assistant] The third thing is we're going to talk about the sources of leakage.


[User] Please transcribe this text

[Assistant] That is, why does the bucket leak in practice? Why do we typically think there is an equity efficiency tradeoff? Why can't we just take the dollar from the rich guy and give it to the poor guy? What caused the leakage? And then finally, we're going to talk about some examples of transfer mechanisms.


[User] Please transcribe this text

[Assistant] We're going to talk about what society does in practice to transfer from rich to poor and how it works and what the ultimate leakage looks like.


[User] Please transcribe this text

[Assistant] Okay, so that's gonna be our goal in the next two lectures. It's gonna be to think about this equity efficiency trade-off. So to start that goal,


[User] Please transcribe this text

[Assistant] We have to start with this first issue of choosing the social optimum.


[User] Please transcribe this text

[Assistant] And so to rank outcomes, what we're going to do is use the same thing we always do when we want to think about trade-offs. Which is we're going to do a constrained maximization exercise. What I want to think about your trade-off between cookies and pizza


[User] Please transcribe this text

[Assistant] I did a constrained optimization for utility functions subject to your budget constraint. Well, now I want to think about your trade off between me and Patricia.


[User] Please transcribe this text

[Assistant] Now instead we're going to need a different utility function. In fact, we're going to use what we call a social welfare function.


[User] Please transcribe this text

[Assistant] A social welfare function is basically society's utility function. How does society value different individuals?


[User] Please transcribe this text

[Assistant] Okay, so loosely, so, loosely speaking, social water function is some function of utility of person 1 comma utility of person 2 comma dot dot dot comma utility of person 350 million if it's the US.


[User] Please transcribe this text

[Assistant] Okay, so it's some aggregation function, just like we mathematically aggregate your taste for pizza and cookies. Now we're gonna mathematically aggregate all society's utility to get a social welfare function. So for example, consider figure 21-1, okay?


[User] Please transcribe this text

[Assistant] Let's think of society as only two people, Homer and Ned. Let's imagine that's all of society, because once again it's always, these two by two examples are easy.


[User] Please transcribe this text

[Assistant] Okay, what we've drawn here are what's called ISO welfare curves.


[User] Please transcribe this text

[Assistant] What these are are basically society's indifference curves.


[User] Please transcribe this text

[Assistant] Just like if these X, if these X and Y axes said pizza and cookies.


[User] Please transcribe this text

[Assistant] I would draw a difference curve between pizza and cookies. Now I'm drawing societies a difference curve between Homer and Ned.


[User] Please transcribe this text

[Assistant] So in other words, what this says is that society is indifferent between Homer having U1 super H and Ned having U1 super N.


[User] Please transcribe this text

[Assistant] Versus the Meet Homer having U2 Super H and Ned having U2 Super N. Those are, those are combinations of resources across which society is indifferent.


[User] Please transcribe this text

[Assistant] And much like any other indifference curve, further out is better. We'd all prefer both Homer and Ned to have more. More is better.


[User] Please transcribe this text

[Assistant] Okay, so that's easy. The further out the ISO Welfare Curve goes, the happier you are, and along the ISO Welfare Curve are allocations of resources across individuals, among which we're indifferent. Okay?


[User] Please transcribe this text

[Assistant] Now, the question is, that's all well and easy to graph as a theoretical proposition. But in practice, what does a social welfare function look like? Utility functions, I just wrote down a utility function and you took it as sort of, you know, I wrote down square root, we worked with that. But there were some properties we wrote down that sort of gave us a sense of what utility functions look like.


[User] Please transcribe this text

[Assistant] Social welfare functions are much more open, because they don't come from introspection about your preferences. They come from introspection about society's preferences.


[User] Please transcribe this text

[Assistant] Which are much harder. So what we do here is we talk about some typical forms of social welfare functions that we use in economics.


[User] Please transcribe this text

[Assistant] The most common form is what's called utilitarian social welfare function. Utilitarian.


[User] Please transcribe this text

[Assistant] Social welfare function. This is due to the philosopher Jeremy Bentham. If you ever visit University College London,


[User] Please transcribe this text

[Assistant] Actually, if you did until about 15 years ago, you could see Jeremy Bentham's head.


[User] Please transcribe this text

[Assistant] It was on display, he was a famous philosopher there, but apparently students would take it out and use it for soccer. So they took it off display, you can't see it anymore. But he's a famous philosopher, and he gave with the idea of utilitarianism.


[User] Please transcribe this text

[Assistant] And basically, utilitarianism is it simply says the social welfare function is simply the linear aggregation of every individual's utility. So social welfare function is simply u1 plus u2


[User] Please transcribe this text

[Assistant] So the US social welfare function is literally just measure everyone's utility, add it up, and that's a social welfare function. And in some sense, it's a natural starting point.


[User] Please transcribe this text

[Assistant] Right, just say, look, it's just a linear, it's like having a linear utility function. It's a, it's a linear utility function. Now, let's be clear.


[User] Please transcribe this text

[Assistant] What this says is that I don't care anymore about anybody in society. So I don't care anymore or less about Bill Gates and the homeless guy. I treat them, I'm indifferent between them. Okay?


[User] Please transcribe this text

[Assistant] But, does this mean I wouldn't want to transfer money from Bill Gates the homeless guy?