Seminar 4 (Oct 18, 2013): Trust and culture

I. Culture and trust

Consider a version of the "trust game": There are two players A and B. A starts with an endowment 10. At stage 1, she transfers any amount x between 0 and 10 to B and keeps the rest for herself. This is then doubled, so B receives 2x. At stage 2, player B decides an amount y to return to player A, chosen between 0 and 2x. This transfer is again doubled, so A receives 2y. B keeps whatever was not transfered and also receives a final payment of 10.

1. Set up the game tree and show A's and B's payoffs as functions of x and y. Use backwards induction to find the subgame perfect Nash equilibrium (SPNE) of the game, and explain why this outcome is not Pareto optimal.
2. Explain why this game can illustrate situations encountered in real life, for instance in market transactions.
3. Assume now that the players A and B meet regularly, say once every day, to play the trust game. They each have a (daily) discount factor β. Could they then be able to sustain trust in the game? One definition of "trust" is that A chooses x=10 and B chooses y=10.
   Hint: The main challenge is to get B to cooperate
4. Assume instead that there are many players around where every player is matched with a randomly chosen other player every period. Discuss to what extent trust can be sustained in this environment.
5. Assume players have a visible marker of identity, such as ethnicity. Could a situation where players trust the other player if they are both from the same ethnicity, but not if the other player is from a different ethnicity be a SPNE in the repeated game?
6. Discuss whether the existence of such an identity marker makes within group cooperation easier than it would be teh case for cooperation in the whole society. How does this correspond to Greif's findings on where the Mahgribi traders were successful and unsuccessful in setting up trading networks.

II. Contracting institutions

1. Explain what Acemoglu and Johnson (2005) and others mean by contracting instituions, and explain what differentiates them from property rights institutions
2. Try to construct a simple model of two agents who may make a jointly beneficial contractual arrangement, but where such contracts are limited by the possibility of one agent to misbehave (details of the model are left for you to decide upon, but you may benefit from looking at the simple model of property rights institutions considered in the first lecture)
3. Explain why a dynamic game à la the one studied in exercise I. can help us understand how mutually beneficial contracts can be implemented even in the absence of a proper legal framework, and use this to try to explain Acemoglu and Johnson's finding that contracting institutions are less important for economic development than property rights institutions.
4. Discuss whether a similar solution is possible for property rights issues, i.e. interaction among the individual and the government.