PUBLIC POLICY 55D CLASS NOTES PROFESSOR JUDITH KELLEY DUKE UNIVERSITY - SPRING 2007 Vanessa Villamia Sochat CONTENTS Public Policy 55D – Introduction to Policy Analysis .................................................................................. 2 Elements of Policy Analysis ..................................................................................................................................... 3 Introduction to the Theory of Games...................................................................................................................... 9 Coordination Games .......................................................................................................................................... 10 Competitive Games ........................................................................................................................................... 11 Mixed Motive Games ........................................................................................................................................ 13 Purpose of a Policy Memorandum.............................................................................................................................. 15 Structure of Policy memo ...................................................................................................................................... 15 Theory of Games II ...................................................................................................................................................... 16 Pareto Efficiency .................................................................................................................................................... 16 Sequential Games: ................................................................................................................................................. 17 Repeated Games .................................................................................................................................................... 20 Multi-Party Games ................................................................................................................................................. 22 Individual Preferences and Collective Action II: MARKETS ......................................................................................... 23 Market Demand ..................................................................................................................................................... 24 Producer’s Supply .................................................................................................................................................. 25 Market Failures ........................................................................................................................................................... 29 Public Goods........................................................................................................................................................... 29 Externalities. .......................................................................................................................................................... 32 What is Negotiation? .................................................................................................................................................. 38 Pareto Efficiency .................................................................................................................................................... 41 Ethics and Bargaining ............................................................................................................................................. 44 Negotiations II ............................................................................................................................................................. 44
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PUBLIC POLICY 55D CLASS NOTES
PROFESSOR JUDITH KELLEY
DUKE UNIVERSITY - SPRING 2007
Vanessa Villamia Sochat
CONTENTS
Public Policy 55D – Introduction to Policy Analysis .................................................................................. 2
Elements of Policy Analysis ..................................................................................................................................... 3
Introduction to the Theory of Games ...................................................................................................................... 9
Coordination Games .......................................................................................................................................... 10
Competitive Games ........................................................................................................................................... 11
Mixed Motive Games ........................................................................................................................................ 13
Purpose of a Policy Memorandum.............................................................................................................................. 15
Structure of Policy memo ...................................................................................................................................... 15
Theory of Games II ...................................................................................................................................................... 16
Repeated Games .................................................................................................................................................... 20
Multi-Party Games ................................................................................................................................................. 22
Individual Preferences and Collective Action II: MARKETS ......................................................................................... 23
Public Goods ........................................................................................................................................................... 29
What is Negotiation? .................................................................................................................................................. 38
Ethics and Bargaining ............................................................................................................................................. 44
Negotiations II ............................................................................................................................................................. 44
Valuing Social Outcomes ............................................................................................................................................. 51
Option 1: The Pareto Principle .............................................................................................................................. 52
The Discount Rate .................................................................................................................................................. 66
Probability .............................................................................................................................................................. 81
The Value of Information ....................................................................................................................................... 86
Money and Risk Subjective Expected Utility Theory .................................................................................. 89
Political Analysis 94
Rational Choice Theory ......................................................................................................................................... 100
Politics of Interests II 102
Median Voter Model............................................................................................................................................ 102
Pressure Group Theory ........................................................................................................................................ 104
The Politics of Symbols ............................................................................................................................................. 110
PUBLIC POLICY 55D – INTRODUCTION TO POLICY ANALYSIS JANUARY 11, 2007
Professor Judith Kelley
Introduction
• What is public policy?
• What is policy analysis?
• Goals of the course
• Organization of the course
What is public policy?
• definition: a public policy is an action by a government that affects public welfare
• Includes
o Laws
o Rules and regulations (FDA)
o Programs (welfare, Medicare) and practices
o Specific policy changes
• at international, national, state, and local levels
Public Policy Examples
• Health and safety
• Poverty and welfare (Medicare/Medicaid)
• Crime (gun control)
• Education (no child left behind)
• Transportation (gas mileage for cars, airbags)
• Environment (Kyoto protocol, global warming)
• Foreign Policy (Iraq)
What is Analysis
• Analysis = taking apart, breaking into components
• Description: what is happening?
• Explanation: why is it happening? (treating symptoms versus problem itself)
• Prediction: what will happen if… (we implement this policy in current situation, what are unintended
consequences?)
• Prescription: what should we do? From whose perspective? Who votes? Are the people who get to vote
the most affected?
Take it apart, describe it, explain it, try to predict all results, and prescribe
What is Policy Analysis
• Analysis of Public policies (eg governmental actions)
• Purpose: inform policy choice
• Multidisciplinary
o Economics
o Statistics
o Political science
o Law
o Ethics
o Sociology
o Psychology
ELEMENTS OF POLICY ANALYSIS
• Define the problem
o What is the problem?
• Identify Policy Options
o What could government do? What are the options? What are financial, practical constraints
• Predict consequences
o What effects would the policy have?
• Value outcomes
o How do we value those effects?
• Recommend Policy
o What should we do?
Example: School Gun Violence
What’s the Problem?
• guns are accessible
• bad parenting
• violence in video games
• security measures
• bullying in school yard (deep psychological problems)
• gangs
• wave of school violence
What are our options?
• each problem has its own solution
o installing security at school
o mechanical/physical safety measures of gun inspection
o school counselors
o drug free campaign
o public education programs
o after school programs
What effects will they likely have?
• each solution has own effects
How should we value these outcomes?
• willingness to show up to school, fear
What should we do?
• could be a mixture of different interventions
Example: Iraq
What’s the Problem?
• Syria and Iran
• Presence of Americans
• Insufficient troop levels
• Ethnic makeup of police force
• Country not ready for democracy/power sharing?
• Presence of foreign occupying force
• Energy resources (another agenda)
• Middle east political stability (Iraq isn’t the problem, we need to consider entire region)
What are our policy options?
• Surge (implies short term, effective, powerful) word use is important… escalation is a political criticism.
(relates to failed policy in Vietnam)
• What effects will this likely have?
• How should we value those outcomes? (who are we)
• What should we do?
• Difference between identifying the symptoms and defining the problem
Politics and Policy Analysis
• Being “right” is not enough, have to get majority, get through committee, persuade public
• Policy is made by political processes
Political Analysis
• informing political strategy (who are we dealing with?)
• Informing policy analysis
Goals of the Course
• get set analytic skills
• Communication Skills (basic economic analysis)
• Inform your choice of major
Global Warming Assignment
• write 1 page memo (no particular format)
o answer question “What is problem we face with global warming” NOT what we predict, what are
options.
o NOT GRADED
o Don’t worry about format
o EPA, UN website (read on syllabus)
o Only page only, double spaced, size 12 NY times font Organization of the Course: The website:
January 16, 2007
Root Causes Causes Symptoms Outcomes we can value
Businesses not reducing
Lack of accountability
Lack of international
agreement
• Kyoto protocol
• Countries like US
bending rules
Problem of the commons
• everybody wants
to cheat on the
agreement,
individual
incentive doesn’t
match group
agreement
Incentives – collective
action problem
Distributional effects that
lead to political fights
(international groups)
Ignorance
Burning fossil fuels: CO2
• transportation
• electricity gen.
Cows/paddies/(agr)
Methane
Landfills/decomposition
Nitrous Oxide
• fertilizers
HFC: refrigerators, aerosols
Deforestation
Combat acid rain
X increase in pop. & tech
Less reflection as ice caps
melt
Greenhouse gases = rising
temperatures
Changes weather patterns
• more intense
storms
• rise in sea level
Ozone layer deteriorating
Redistribution (changes)
rainfall
• droughts, torrents
Polar ice caps melting
Ph oceans change
Ocean circulation belts stop
= ice age
• NEGATIVE
• Wildfires
• Wildlife
• Bears can’t sleep
• Food production
• Shifting seasons
• Mosquitoes- disease
• Bleaching coral reefs
• Availability drink H20
• Coastal Flooding
• Rising
heating/cooling costs
• People displaced
• Energy production
complicated
• Tourism (skiing)
• Water scarcity
• Political conflicts,
violence over land
and water
• Fishing stocks
• Political conflicts over
redistribution
• Killer heat waves
• Moving costs
• Deforestation
POSITIVE
• renewable sources of
energy
• access to new ports
• new land
• access to oil!
Carbon trading
Taxes
• gas
• emission
Subsidies
• Capturing carbon
at emission point
• Carbon sinks
• Taxes (re-establish
incentives)
• Finding more
• disaster management
• water reserves
• strengthen levies
Education
Foreign Aid
Regulation
efficient fuels
• Technologies
• Burn/consume
less
• Renewables
• Increase access
public
transportation
Predicting Consequences of Actions:
• With a tax, we raise price, create large separation between wealthy and poor. Who is the tax on? Poor:
cant drive back and forth to work
Section Meeting January 17, 2007
Memos
• organized with header section
o To:
o From:
o Re:
o Date:
Executive Summary: 3-4 sentences, summarize entire paper. Be direct, upfront, say it and be done with it.
Relatively short sentences, no jargon or flowery language.
For different points, use headers and some separation. We aren’t writing in paragraph form.
ANSWER THE QUESTION! Don’t go off topic. Analyze the question and don’t discuss it
Every sentence should have a purpose. Use active verbs. Don’t conclude the memo, don’t summarize anything.
(memo is meant to advise someone briefly, superior doesn’t have time to read memo)
Individual Interests and Collective Action January 18, 2007
Games, markets, Negotiations, and Governments
• game theory is a way of understanding collective behavior of individuals in collective setting
• if these are incentives and we set everybody loose, what happens?
• It matters what the other player does… the other player’s choices determine how good/bad a choice is
• Payoff varies depending on what other player has done
INTRODUCTION TO THE THEORY OF GAMES
• What is game theory?
• Types of games
o Coordination Games
o Competitive Games
o Mixed-motive games
• Two common games
o Chicken
o Prisoner’s dilemma
Odds and Evens – EXTENSIVE FORM
Squares = choice to be made
Red Line = simultaneous game (when Student making choice, doesn’t know which node is at)
Payoffs go at end (Win/Lose)
Payoffs are written inside boxes
COORDINATION GAMES
• Definition: Both ‘win’ or both ‘lose’
o Example: which Tire?
� Four students partying, sleep in and miss midterm. Call the professor, tell that have flat
tire. Reschedule exam, take exam, and ask students which tire blew.
o Example: Meeting in New York City
• Solving Coordination Games
o Communication
o Conventions
o Focal Points (somehow it’s obvious) There are some outcomes that have higher probability of
being chosen, certain conventions
Choosing Sides
Left Right
Left (8,8)
(0,0)
Right (0,0)
(8,8)
Pure Coordination Game
Party Home
Party (8,8)
(0,0)
Home (0,0)
(4,4)
Battle of the Sexes
Party Home
Party (8,6)
(0,0)
Home (0,0)
(6,8)
(wikipedia game theory sections)
Stag Hunt
Stag Rabbit
Stag (9,9)
(0,8)
Rabbit (8,0)
(8,8)
COMPETITIVE GAMES
• Definition: If you ‘win’ I ‘lose’
• Also called ‘zero sum’ payoffs + losses = ZERO. My gain is your loss
• Examples
o Odds and Evens
o Chess and other parlor games
o Battle of Bismarck Sea
The Battle of Bismarck Sea
World War II, Pacific War, march 2, 1943- march 4
Location: Bismarck Sea, in the vicinity of the island Lae
Americans, in planes want to bomb Japanese, in ships
It tends to be foggy north of island = difficult to locate ships from air
South of island weather is quite clear.
Americans must decide to search north or south first
Americans want more days of bombing, Japanese want fewer
We can model it the other way around, and put Japanese choice first – If sail North then could get 2 or 1 days of
bombing
They never get a better outcome by sailing South – sailing north is a Dominant strategy. It always does better
Americans have dominant strategy when we see that Japanese has a dominant strategy. Solution is NORTH
NORTH
Some definitions:
• Maxi-min strategy: the strategy with the best “worst” outcome. We want to maximize the worst possible
outcome, or minimize the damage.
o We opt for strategy that avoids worst possible outcome
• Dominant Strategy: A strategy is dominant if it does better than all other strategies in at least one
circumstance and as well as every other strategy in all circumstances (never loses)
• Dominated Strategy: a strategy is dominated by another if it does worse in at least one circumstance and
no better in all (never wins)
• Equilibrium: an outcome is in equilibrium if no party regrets its choice of strategy, no player has incentive
to move away, no player regrets his or her choice.
o Ask if either player would want to switch out of situation if they could, without moving other
player’s choice
MIXED MOTIVE GAMES
• Variable-Sum
• Coordination Elements
• Competitive Elements
Chicken (also called “Hawk-Dove”)
They would rather BOTH look like chickens than one look like a chicken
To win must send message to other guy that you are crazy and won’t swerve!
TWO EQUILIBRIUM: top right, bottom left
Social Implications of the Prisoner’s Dilemma
January 23, 2007
PURPOSE OF A POLICY MEMORANDUM
• provides busy policymakers with information they need to do their jobs
• breads down complex issues into essential facts
• evaluates alternative courses of action
• provides recommendations for action
Out of the box solution to Global Warming: Netherlands huge problems with flooding: building houses that float.
Understanding the Policymaker
• Needs to master complex, substantive issues ina short time
• Needs to make decisions based on partial or imperfect information
Your job is to…
• provide essential facts and supporting evidence
• provide clear options recommendations and give some assessment of the political environment
An effective policy memo should..
• be brief 700 word limit – double spaced
• Include the following
o Heading
o Summary – contain key info (start with, this is the key problem, what are the facts, what I
recommend
o Background (if needed)
o Issues
o Options (pros and cons)
o Recommendation
o Possible limitations/caveats (a section at end) I’m making these assumptions, we should find out
ABC, this doesn’t apply if this happens
• be brief
• avoid technical jargon
• be direct address the person you or we
• be clear – omit needless words
• be well organized
• be honest (its OK to say we need to find out about something)
STRUCTURE OF POLICY MEMO
• The summary
o The issue
o Why a decision is needed
o Key information
o What I recommend
THEORY OF GAMES II
• Prisoner’s Dilemma
o Social implications
• sequential games
Player 1 has a dominant strategy to defect
Both players have a dominant strategy to defect.
Dominant strategy: mutual defect, (2,2) IS an equilibrium, because neither player would change their choice
PARETO EFFICIENCY
• n outcome is Pareto efficient if it is not possible to make one party better off without hurting another
player
• An outcome is Pareto inefficient if one (or more) party can be made better off without hurting another
Which points are pareto efficient? (D,C) (C,D) (C,C)
Pareto inefficient Point: (D,D) � both players could be made better off!
Solving the Prisoner’s Dilemma
• Contracting
• Communication
• Detecting Cheating
• Punishing Defection
• Trust
• Iteration (play again and again to learn from the experience)
• Issue Linkage (punishments, change the game)
SEQUENTIAL GAMES:
• Examples: tic tac toe, Checkers, chess
• Going first may be advantage or disadvantage
Second number is Lucy’s payoff
Two lines through branch indicate “We aren’t going that way”
The arrow indicates the direction we go
If Charley thinks about incentive structures facing Lucy, he would never kick the ball
Backwards induction: start at back/end of tree
• think about what lucy going to do
• and then figure out what I am going to do
It is an advantage to go first
The United states and Iran are both desperately trying to go first by committing to a strategy
When you aren’t sure who is going first, game of chicken dangerous in politics
• Why does nuclear deterrence work?
• Where do these payoffs come from?
o Logically thinking how players would rank outcomes
• An attack and retaliation is the WORST possible scenario
REPEATED GAMES
• Rounds
• Strategy in the shadow of the future: taking into account today what payoffs might follow from this
decision in the future
• Reputation and trust: are very important. Desired reputation depends on what game you are playing (as
nice and trustworthy, irrational in Chicken , etc)
3 3 C C
1 4 C D
2 2 D D
2 2 D D
2 2 D D
She was using Tit for Tat strategy
Happiness is a relative thing. We care how our neighbors are doing!
• Dividing the dollar:
o It always makes sense to accept whatever if offered, but at some point one person starts
rejecting, to punish other person for their behavior.
Repeated Prisoner’s Dilemma
• is it still rational to “defect”
o not until the end of the iterative game
o But if it’s rational to defect in round 6, then we should do it in round 5 as well. It unravels!
o The value of trust
o Axelrod’s computer tournament and the Evolution of Cooperation
Tit For Tat
• Rules
o Start by cooperating
o After that, copy what the other player did in the last round
• Properties
o Nice
o Can be provoked
o Forgiving(if you go back to cooperation I will as well)
o Clear
• Why and how it won the tournament
o It never actually beat another fish, but it ends up getting the most points. A player that defects
all the time might beat someone, but when they play another player they don’t get a lot of points
• the danger
o you could get exploited if playing tit for tat: the strategy is clear and predictable
o it very quickly gets into a negative spiral
MULTI-PARTY GAMES
• coalitions
• voting
• multi-party Prisoners dilemma
Application: Global Warming
• every country chooses: emission reduction or no emission reduction
• Assume:
o If everyone reduces equally, then benefits outweigh costs
o Assume: if you are only country to reduce, costs outweigh benefits
o Assume: if you are only country not to reduce, benefits are a LOT greater costs
Problem is there is payoff for defection
January 24, 2007 Section
INDIVIDUAL PREFERENCES AND COLLECTIVE ACTION II: MARKETS
Markets or Governments?
? – should we let markets or governments take care of a situation?
Ex: Medicare/Medicaid
We have an aging population and skyrocketing HC costs, by 2050 the entire budget will be consumed by
these two programs!
Democrats: cut cost of program through reforms and increase revenue
Republican: need to privatize this business, put out of hands of government into hands of market
Pro Market Position: markets are efficient Governments are wasteful and (sometimes) don’t act in the public
interest
Pro Government Position: markets are unfair and sometimes inefficient. Governments act in the public interest
PPS 55 Stance: When do markets produce desired outcomes and when don’t they?
What is a Market?
• An institution for coordinating voluntary exchange between individuals
• Exchanging
o Goods and services
• Individuals:
o Buyers and sellers
The Appeal of Markets
• coordinates production and consumption
• Efficient
• The “invisible hand”
o Voluntary
o Automatic
• individual interests � public interest
Key Questions
• when do markets work?
• When are markets efficient?
• When are market outcomes desirable?
o Moral issues: lower income individuals cannot afford
MARKET DEMAND
• Froot Loops
• Won’t pay as much for each additional box
The area under the demand curve is the willingness to pay.
Determinants of Demand
• income
• tastes
• complementary goods
• Other goods
o Prices
o Substitutability
PRODUCER’S SUPPLY
Determinants of Supply
• costs of input
o labor, sugar, flour, vitamins
• technology
o machinery, materials
• prices of related outputs
Demand curve = willingness to pay
Supply curve = willingness to produce
Social benefit – social cost = Social surplus (net social benefit)
When are Markets “Good”?
• Even if markets are efficient, we may choose to intervene
o Some people can’t pay for certain product
o Something isn’t equitable
o If market is immoral
o Positive/negative externalities
o Wages
• Distributive consequences
o Willingness to pay vs ability to pay (might be willing but not able)
o Housing, food, education (inherent human rights)
• Ethical/moral consequences
o Drugs, prostitution
Efficiency and Equity
• market outcomes may not be “equitable”
• Initial endowments
o Wealth
o Educational opportunities
o Employment opportunities
o Intelligence
o Etc.
Compensation is not necessarily proportionate to your skill. (professional sports players, CEOs)
January 30, 2007 MARKET FAILURES
MARKET FAILURES
• Public Goods
• Externalities
• Market Power (monopoly, cartels)
• Imperfect information
PUBLIC GOODS
• definition
o low “rivalry” in consumption (zero marginal cost of production)
o (often) impossibility of exclusion, or costly to exclude
Examples of Public Goods
• fighting global warming
• national defense
• clean air
• concert
• park
• voting
Free riders and under provision of goods
Examples of Common Pool Resources
• rivalrous and non-excludable
• Commons problem
o “tragedy of the commons”
o Freeways
• Free riders, overuse
Collective Action for a Public Good is a Multi-party Prisoner’s Dilemma
• (Il)logic of collective action (producing outcomes that aren’t to benefit of society
• Free riding is problem
Solving Collective Action Failures
• Negotiations
o Cheating
o Enforcement
• Government
• Privatization
• Social Norms –attach public stigma, encourage behavior, give sticker to vote!
Network externalities: a positive consumption externality, if I’m the only person in the world with a cell phone,
only me and my mom can interact in the network. As more people join the network, the network increases in
value.
so we should raise demand curve by that amount, because there is benefit to third partes
Solving Externalities
• regulation
• Incentives (internalizing the Externality)
o Tax
o Subsidize
• Negotiated compensation: winners pay losers
Coase’s Theorum: It doesn’t matter who is doing paying… if property rights are well assigned in advance, then
parties can negotiate amongst themselves and come up with solutions!
Requirements:
• property rights are well defined
• people act rationally
• transaction costs are minimal
Problems?
• are we comfortable with selling our rights?
• Is the goal always the efficient outcome?
• Barriers to negotiation
o Effective legal system?
o Transaction costs?
o Information
February 1, 2007 Negotiations
WHAT IS NEGOTIATION?
• To arrange or settle by discussion and mutual agreement
• A mixed motive game with communication
• It is difficult to negotiate where neither will trust (Samuel Johnson)
When do we Negotiate?
• Daily life
o who cleans the room
o how much to pay for the car
• Workplace
• Law
• Policy and politics
o Passing a law
o International treaties
� Bush plan for Iraq
What is Negotiation Analysis?
• technique for modeling negotiations
• predict range of possible outcomes
• inform strategies for effective negotiation
• it is a science and an art
Elements of negotiation analysis
• parties
• issues
• interests
• alternatives to agreement
• zones of possible agreement
Parties
• who plays? It isn’t always so obvious
• Two or more?
• Monolithic or not? (making decisions independently) Congress has to back the president
o 2 level games – Is ratification required?
o What is the deadline? (expiration presidential term)
o Does needing approval later an advantage or a disadvantage? Could help!
• in Salty Dog: two parties, buyer and seller
Issues
• dimensions of joint choice
• one or more?
• Are the issues and subsequent negotiations recurrent/repetitive?
• Linkage effects (DOHA)(sanctions): connecting a payoff to a negotiation. If we’re negotiating about cotton
and we can’t make an agreement, if we link it to something else, then we might be able to reach a deal.
o Earmarks must be made transparent… sneaking something into bill, maybe to get them to agree,
make incentive to pass bill because there is some other payoff to him.(making a side deal so loss
is offset elsewhere)
o Log-rolling: you vote for this bill, and I’ll vote for yours (a tradeoff)
• In Salty Dog, one issue: price.
Interests
• preferences with respect to issue outcomes
o some idea of what they want out of negotiation, inherent to them
• competing interests (I want window, you don’t)
• complementary interests (harmonious, more coordination games, we both want window, have to work
out details) we seek the same goal
• convergent interests (not necessarily competing, but not entirely in agreement) we have issues!
o Britain and US have convergent interests… not same, but aligned in what they want out of
situation.
• In salty dog: competitive
o Buyer wants low price
o Seller wants high price
Alternatives
• is agreement required? You think you are negotiating over X, but the alternatives wind up dictating the
agreement. Alternatives are important in outcome of negotiation
o is it always mandatory to reach an agreement? It isn’t always optional… we can fail to meet
deadline, but must come up with emergency plan
• Best Alternative to Negotiated Agreement (BATNA). What is your BATNA? What is your “best alternative
to a negotiated agreement?
o (If you don’t reach an agreement)
• reservation price or value:
o reservation price:
o buyer’s is 16,000, most willing to pay
o seller’s is 13,500, most willing to sell
o what is the value? We might value something differently than what our reservation price is. The
car may be valued at 25,000, but we know can’t sell for more than 15,000
• better alternatives strengthen bargaining position
Other Questions to Consider?
• Are threats possible?
• What are the norms? (relationships/settings with certain norms that prevail influence how negotiations
are conducted)
o spouse vs. professor relationship.
• Is third party intervention possible?
o Deals with lack of trust, a mediator
• Are there time constraints?
• Are the contracts binding?
• Are negotiations private or public?
Zone of Possible Agreement
• outcomes better than BATNA’s are possible for agreement (ZOPA) is this zone
• Location of reservation values define a Zone Of Possible Agreement (ZOPA)
The surplus is a value space. Each possible agreement is a point on this line
Pareto Efficiency!
PARETO EFFICIENCY
• A pareto improvement makes at least one party better off and no party worse off
• An outcome is pareto efficient if there are no possible pareto improvements
Distributive Bargaining
• leaning and influencing (divvy up fixed good or value)
• Anchoring and framing
o First offers
• Commitment
o Patterns of Concession
• The EndGame
• Ethics
Anchoring and Framing
• perception matters
o we hook onto a number, and then make adjustments. The first number thrown out frames the
negotiation
o High uncertainty
o Anchoring
� Kahneman and Tversky experiment (how the human brain makes shortcuts)
• framing is the idea that starting points matter
• implications for first offers
Anchoring
• people make estimates by starting from an initial value
• adjustments
• tend to typically insufficient
• Percentage of UN members that are African?
• “10”: 25% “65”: 45%
ISSUE SPACE. Framing High: pushed in favor of the seller, seller first offer is high. Risk of going too high and
having other person think you are ridiculous
If we can commit, we shrink the ZOPA.
Common patterns of agreement are in the middle of the ZOPA, moreso than the sides
ETHICS AND BARGAINING
• The problem
o Temptation to “strategically misrepresent”
o Fear of being lied to
• Prisoner’s Dilemma
o May fail to reach agreement
• Iteration and reputation
NEGOTIATIONS II
MULTI-ISSUE NEGOTIATIONS
Escalation
• Logic of Escalation
o Sunk costs
o Marginal calculation
o “Actions that appear rational when taken one at a time, can lead to disaster in the long run.
o Psychology of escalation
� Dollar Auction
Arguing how to divvy up pie
Multi-Issue Negotiations
• one issue negotiations are largely about dividing a fixed pie
• multi issue negotiations are about baking a bigger pie (and dividing it)
Instead of moving along a distribution, there are pareto inefficient points
Integrative bargaining: we push out together
But we also have to worry about distributive bargaining, diving between two parties (sideways arrow)
Analyzing the Nari-Situation
• Nari
• G.D.
Issues
• number of aircraft Nari + GD -
• barrels of oil Nari - GD +
• support levels Nari + GD -
• timing of delivery Nari - GD +
• guarantee Nari - GD -
• radar Nari + GD +
• spare parts Nari + GD -
Alternatives
• reservation values are given
o Nari = 900
o GD = 500
o We need to map these in value space and convert these to utils
Sources of Joint Gains
• finding complementary interests
• trading on differences in relative preferences
Integrative Bargaining
• Tactics for Creating Value
o Sharing information
o Joint Problem Solving
Barriers to Effective Integrative Bargaining
• lack of information
• complexity
• Mistrust
• “claiming” behavior
o Misinformation
o Commitments
o We cling as much value as we can for ourselves without thinking about expanding frontier
The Negotiators Dilemma
• The choice: create or claim value
• Like prisoner’s dilemma
o Both should try to create value and then distribute it
What is the “Public Interest?”
Rationales For Government (to take some kind of action)
• public goods (non excludable and non-rivalrous)
• Externalities
• Negotiation Failures
o Mistrust
o Lack of communication
o High transaction costs
o Complexity
o Claiming behavior
• inequalities or other value violations
Modes of Government
• direct provision of goods or services
• market perfecting (or improving)
• regulation
• negotiation facilitation
• redistribution
Direct Provision
• pure public goods such as Defense
• “tax and spend” may be pareto improving
• Problem: imperfect public goods (it isn’t clear they actually exist)
• Examples
o Location-specific goods: a national park?
� People that live closer can benefit more
o Group specific goods: NEA? PBS?
Market Perfecting
• Taxes or subsidies
• Aligning private costs and benefits with social costs and benefits
• Examples
o Gasoline taxes
o Research subsidies (or tax breaks)
• Issues
o how much is enough?
o Income and distribution effects
Regulation
• restricting private actions not in the “Public interest”
• Examples
o Driver’s licenses
o Drinking age
o Pesticide
o Food additives
• Issues
o Enforcement leads to inefficiencies, equity is also an issue
Negotiation Facilitation
• contract enforcement
• judicial system is government’s way or trying to enforce contracts
• Mediation: get two sides to come to agreement
• Arbitration: parties both agree that YOU come up with solution
Redistribution
• Rationales for redistribution
o Initial endowments
o Unfair processes
o “lumpy” prizes
• Policies
o Progressive taxation: you pay more if you earn more
o Social insurance (persons with higher income less eligible for benefits, Medicare)
o Affirmative action
• Property Rights vs Social Welfare
o “Fair” is equal vs. “fair” is respecting property
o Equalizing the well-being of individuals
� We care about outcomes: welfare
� How to judge well-being instead of income?
UNIT II: VALUING SOCIAL OUTCOMES
What is the Public Interst?
A PPS55 Social Decision
• 171 pieces of candy
• What to do?
o Who are we?
1. Everybody gets 1
2. Preferences
3. Fight over them
4. Consider what people already have, initial assets
5. Lottery system
6. Give out by age or sex
7. Have a dictator
8. Voting system (popularity contest)
9. Dukies
We have to decide what our goals are, and agree, and then narrow down options, and systematically evaluate
each strategy, do that one
We could vote
Representing the Public Interest
• social welfare is a function of individual welfare (but it isn’t clear what function)
• Not clear what kind of function
o Paternalistic?
o Anonymous? (we don’t think about initial endowment)
o Valuing equity?
• who is the public? Who gets to be a part of this?
OPTION 1: THE PARETO PRINCIPLE
• The pareto principle
o Make pareto improvements!
o If everyone is at least well off, then there is no question that social welfare has improved
• Limits to the Pareto Principle
o Rarely do policies allow a pareto comparison
o Usually, someone is better off, someone worse
� Is the sacrifice of one person worth the benefit of others? When do we allow tradeoffs?
OPTION 2: VOTING
• voting to reveal welfare
o individuals judge their own interests
o majority may be better off
Issues
• does not measure strength of preferences
• Voting does not guarantee a unique “winner” (Arrow’s impossibility theorem)
• “Tyranny” of the majority
OPTION 3: POTENTIAL COMPENSATION
• Potential Compensation (Kaldor-Hicks)
o If we could pay the losers from the gains of the winners then the policy is a kaldor hicks
improvement
o Government favors groups that get them elected!
• Social Benefit Cost Analysis: employs potential compensation criterion
• Does not address equity questions
We do analysis
Who is being helped, harmed
Could winners compensate losers
Equity Considerations
• Ad hoc consideration
o If there are equity concerns, address then separately
• Could use explicit weighting choices
o The poor literally count more, or
o Heavy weighting bias toward equal distributions
Social Judgment a la PS55
• One issue at a time
o Allows the marginal analysis
o What governments really do
Option 3: Potential Compensation
North Korean talks:
Reached agreement today. Talks teetering on brink of collapse because of disagreement of what should be
guaranteed to NK for ending nuclear program. Was making excessive demands electricity and oil… but we don’t
have option of walking away. Out BATNA is so bad that we MUST settle within the ZOPA. They demanded 2
million tons heavy fuel oil. They have record of starting from unrealistic bargaining position – this is where history
of negotiations comes in. We have history so we know this is excessive demand that is going to be coming down.
This negotiation went on for 16 hours… NK agreed to shut down facilities for 1 million. They got half of what they
asked for. Deal sends wrong signal around world – if you hold along long enough in negotiation, you are rewarded.
So we damaged our reputation. The US had to say that we are going to walk away.
Potential compensation (Kaldor Hicks)
• if we could pay the losers from the gains of the winners
Cost benefit Analysis Employs
• Potential compensation criterion
• does not address equity questions (we only care about the net benefit)
Equity Considerations
• Ad-Hoc consideration
o If there are equity concerns, address them separately. SO we consider them, but don’t let them
change our decision/stop us from realizing that society overall is net benefit.
o Could use explicit weighting choices
• Heavy weighting bias towards equal distributions
o The poor literally count more, or
o Heavy weighting bias towards equal distributions
Social Judgment a la PS55
• one issue at a time
o Allows a marginal analysis
o What governments really do
• placing values on outcomes (we have to find ways to do this) and on costs as well
• Social costs versus social benefits (we want to maximize net) but we have to consider both
o Efficiency: “maximize net benefits” This is the basis of cost benefit analysis
As we Proceed…
• What is the issue?
• What are the feasible choices?
• Who is relevant to the welfare calculus?
• When is “maximum net benefit” the best choice?
The Global Warming Decision
• defining the problem
• identifying options
• predicting consequences
• valuing outcomes (this is the hard part, figuring out how to value these outcomes)
Talked about going to look at houses and looking at two and eliminating one to simplify it
Cost benefit analysis focuses on the red square… the benefits versus the cost, and comparing them with the status
quo. Do we end up with a net benefit?
Defining Benefits and Costs
• value measured by individual willingness to pay (it all comes down to individual willingness to pay… how
much do people value outcomes, in dollar amounts?)
• Benefits: goods and services that people value!
• Costs: represent foregone goods and services that people value (we could have done something else with
that money… it’s the opportunity cost)
• Limited resources � opportunity Cost
Decision Process
• Analysis: “do nothing or “do this”
• Identify costs and benefits
• Value costs and benefits
• Choose option with highest net benefit
Social Benefits and Costs
Goods and services
that People Value
(take some away, these are costs) so cut away a piece of the pie.
And hopefully end up with a little bigger pie as a result of paying for the cost
Example: Tennis Courts
• City of Durham is considering building two new tennis courts on land owned by the city
Step 1: Identify benefits and costs
Step 2: Make decision if it is a good idea
Construction costs money, and land costs money.
Valuing Costs and Benefits
• both costs and benefits are ultimately a measure of willingness to pay
• Costs = opportunity costs = willingness to pay for foregone goods and services
• Market prices (representative of what people willing to pay)
o How do we get value of tennis?
� Look at price of tennis lessons
� Propose tax and see if willing to pay, vote
� Survey
� Take income of people in Durham into account, poorer individuals may not have ability
to pay so value the courts lower than higher income individuals.
• indirect market prices
o whatever we are consuming/trying to create is available in the market, so we can see what that
is, how much it costs for construction.
� We can’t directly observe value, but we can look at other relevant values in the market
that are similar and try to get an indirect measure of prices
• surveys (ask people how much they value something, how much we’d have to pay them to not have that
good)
• Statistical methods to isolate value
o Ex: clean air is hard to put value on.
� Think of health affects of dirty air
� If we could find two houses that are comparable in all ways, except one is in dirty area
and one in clean area, statistically isolate affect of clean/dirty air. Compare prices, and
this is amount people are willing to pay
Back to this… we get a net benefit, so it’s a good idea!
We have to do a Disaggregated Analysis.
Tennis Players Other Residents Society of Durham
Social Benefits
Tennis 25,000 0 25,000
Social Costs
Construction -500 -9,500 -10,000
Land -500 -9,500 -10,000
Net Benefits 24,000 -19,000 5,000
Transfers
Fee -20,000 +20,000 0
Net Benefits (new) 4,000 1,000 5,000
• we are assuming that 5 percent of Durham taxpayers are tennis players and that the tax is distributed
evenly across residents
We do an internal transfer between the people, and still wind up with 5,000.
Problem: the fee is forced on people… there is a DWL to society… introducing a fee might change the
behavior of people, (like a tax) and change the equilibrium
We see that this is very inequitable. Some people are benefiting a lot, others are losing a lot
Issue: Transfers
• fees paid by members of the community to other members are transfers
• Would a fee be more equitable?
• Might a fee change the net benefits?
• User fees may reduce net benefits if fewer people enjoy the good
• Transaction costs of a transfer (it costs money to collect the fee, administrative costs must be considered)
The people who value playing tennis LESS than the fee aren’t going to pay tennis anymore! We lose part of the
benefit because of the fee. From the perspective of the city, this is BAD, we want optimal benefit for people in
society.
Types of Transfers
• Fees
• Taxes
• Subsidies
• If there is no change in behaviors, then there is no change in net benefits.
• If transfers change behaviors, then net benefits can change
o Example: Medicaid. (at certain threshold, people eligible for benefit… may not take job if it
makes them ineligible)
Issue: Why is Labor a Cost?
• could be working elsewhere, opportunity cost
• Depends on whether or not there is unemployment in the sector that is relevant
• Key issue: Opportunity cost to society
• When full employment, use of labor represents an opportunity cost.
• When unemployment, use of labor does not represent a cost (and wages are transfer) wasted resources,
people sitting at home doing nothing! If labor isn’t a cost, then it is a transfer.
Issue: Standing
Who gets to be part of our analysis?
• courts on the edge of Duke campus
• ½ of those using courts are Duke players (how does that change our analysis? We don’t pay taxes so city
of Durham…)
• Should Duke students Willingness to pay count as much as Durham residents? Count at all?