After a couple of blogs on game theory, let's now tackle how it fits with government. I already mentioned the foolishness of city governments throwing taxpayer money after professional sports teams. Sports leagues make sure that a city has essentially no added value. That leaves the league with all the power in negotiations so the league and the team owner win every time
However professional sports are small potatoes compared to other government functions. What about those? Do they have added value? The answer is that some do, some do not.
At its best government provides added value in what economists call external benefits. That is benefits not worth the price to any individual user but useful to enough people to make them worth the cost in the aggregate. For example few companies would find it worth the cost to build a road for their customers. However if we consider all the users of that road it becomes worth the price. Government can use tax money to build the road which then gets used by not only that company but nearby businesses, shoppers, even visitors from far away. The road provides external benefits.
Notice that if there were no government there would probably be no road. The value of the road represents added value provided by government. Whether that value exceeds the cost is another question but that is not our concern here.
Police and fire departments also provide added value. Few homeowners could afford their own fire department but the city or county as a whole can spread the cost over all citizens. The fire department can then save homes and lives as well as lower insurance costs. It represents an added value.
However many government expenditures add no value to the game. What happens in a typical economic bail-out? The statists would claim added value because they think it really helps the economy but does it? So far in this crisis our government has saddled us with huge debts, yet unemployment remains high. Where is the added value in that? The fact is that such programs merely move money from one pocket to another, they do not create goods or services. Instead they take money one business or person might have used to create wealth and give to someone else.
The real effect of many government programs is apparent only in retrospect so it will probably be years before we can really understand the effects of the Bush-Obama bail-out. However there are eerie parallels with the Great Depression and the measures taken by Hoover and Roosevelt. Most economists now recognize that the New Deal prolonged that depression.*
The problem with government it that it has not only a monopoly but also the power to force its will on others.. A business that insists on being paid more than its added value will soon find itself with no customers at all and thus no business. However government has the ability to take what officials want or think necessary. That allows it to grab more value than it provides. In almost all cases, government provides no added value if it does something a private business could reasonably do
The only solution is a strictly limited government, one constitutionally restricted from expansion and in which the citizens insist on following that constitution. And please note that the added value problem is only one of many reasons to limit government. Even if government can add value there are often good reasons for it to stay out of the game.
*cf the book New Deal or Raw Deal by Burton Folsom, Jr.
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Showing posts with label negotiation. Show all posts
Showing posts with label negotiation. Show all posts
Thursday, November 18, 2010
Tuesday, November 16, 2010
A Bit More Game Theory
Remember the eccentric millionaire who handed you a puzzle piece and offered $100 for that plus its matching piece? He's back, this time with a twist. First he informs you that you were not the only player in the last game. He actually handed out 100 identical pieces, scattered around the country so players could not know the others who were playing. Joe had 100 identical matching pieces. All 100 pairs were turned in so the millionaire paid out a total of $10,000. The players were sensible so Joe walked away with half of that, $5,000. The other players got the other half, $50 each. Everybody got half of his added value.
Our rich if slightly crazy friend now wants to play the game again, but with a difference. Again you have one of the 100 puzzle pieces scattered around the country. However this time Joe only has 95 pieces but he knows there are 100 pieces out there to match his. Five players are going to get left out. The total value of the game is now only $9500. Joe's added value is again the entire value of the game, this time $9500, but what is your added value now? If you pull out of the game how is does that change the total value?
Well, if you pull out that leaves Joe with his 95 pieces but there are 99 others with whom he can negotiate. You cannot change the value of the entire game so your added value is zero. You have no negotiating power at all unless you can contact the other players and negotiate as a group. Joe has all the power and if he offers you a dollar for your puzzle piece you might as well take it. In fact if he offers you a dime you might as well take that. If you don't, somebody else probably will and you will be one of the five players who get nothing. Joe is negotiating with people who have no added value.
Does this happen in real life? You better believe it. Some businesses make sure that they never quite fill demand. That leaves them with the power to set the price, subject only to the maximum people are willing to pay. Of course that works only when those businesses have an effective monopoly. They may have patent protection or their product may be the “in” thing, people believe that they must have not only the product but a particular brand name. It also happens in franchise businesses which limit franchisees so they don't compete with each other. And it happens in entertainment.
Movie stars provide a good example. When a director looks to hire actors he must look at how many people will pay to see the movie. He may find a wonderful unknown actor willing to work for a pittance to get the exposure. However he will prefer the star, the well-known veteran who is popular with the public. In fact he will pay that star many times more than an unknown whose acting talent is equal or even better than what the star offers. The unknown has no box-office drawing ability so he provides no real added value. The star however will bring in paying customers and he has a monopoly since there is only one of him. He has a high added value and can demand a lot of money to play the part.
Consider also professional sports. The National Basketball Association, the National Football League, and major league baseball have effective monopolies on their product. They could put franchises in any city big enough to support a top-notch team in their sport but they don't. Instead they limit the number of teams. They know that many cities regard having a major sports team as a very desirable status symbol so they make sure that there are fewer teams available than cities wanting those teams. That forces those cities to compete against each other. Typically the city must be willing to provide a fancy stadium or other facility. In many cases it is the city, not the team owner that foots the bill for that and is stuck with that bill should the team move to another city. Any given city has an added value of essentially zero when negotiating with a professional sports league. (There are some exceptions such as New York with so many potential fans that they want teams there. However even there the “New York” Giants and Jets actually play in New Jersey.)
That is one reason why professional teams often move to new cities. They get better deals by moving. The Seattle SuperSonics became the Oklahoma City Thunder. The St Louis Cardinals now play in Arizona. The Dodgers long ago stopped dodging trolley cars in Brooklyn and moved to Los Angles. Many other teams no longer play where they once did, leaving behind empty stadiums or arenas and unhappy fans and taxpayers. Cities are put in a position in which they cannot win in that game.
What should cities do to level the playing field with the sports leagues? Clearly bidding against each other is a losing battle; the team owners have all the power. They have only two rational choices. First of course they can just refuse to play the game, tell the sports team owner that they are not going to give him any special treatment. That is an option I think voters and taxpayers should insist on in the present situation. The other rational choice is to get together as a league of cities and negotiate as a group. Such a group would have an added value equal to that of the sports league. No longer would the owner of the Seattle Sonics be able to tell Seattle and Oklahoma City that they better give him what he wants or he will go to another city. That owner would have to deal with a league of cities that has as much added value as he does. Of course cities being jealous of one another will probably never form such a league so the owners will continue to have all the power.
I could go on but you get the point. Any person, city, or business that understands added value can use that concept to decide if it wants to play the game. If it does play, that concept helps know how to play and what results to expect.
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Our rich if slightly crazy friend now wants to play the game again, but with a difference. Again you have one of the 100 puzzle pieces scattered around the country. However this time Joe only has 95 pieces but he knows there are 100 pieces out there to match his. Five players are going to get left out. The total value of the game is now only $9500. Joe's added value is again the entire value of the game, this time $9500, but what is your added value now? If you pull out of the game how is does that change the total value?
Well, if you pull out that leaves Joe with his 95 pieces but there are 99 others with whom he can negotiate. You cannot change the value of the entire game so your added value is zero. You have no negotiating power at all unless you can contact the other players and negotiate as a group. Joe has all the power and if he offers you a dollar for your puzzle piece you might as well take it. In fact if he offers you a dime you might as well take that. If you don't, somebody else probably will and you will be one of the five players who get nothing. Joe is negotiating with people who have no added value.
Does this happen in real life? You better believe it. Some businesses make sure that they never quite fill demand. That leaves them with the power to set the price, subject only to the maximum people are willing to pay. Of course that works only when those businesses have an effective monopoly. They may have patent protection or their product may be the “in” thing, people believe that they must have not only the product but a particular brand name. It also happens in franchise businesses which limit franchisees so they don't compete with each other. And it happens in entertainment.
Movie stars provide a good example. When a director looks to hire actors he must look at how many people will pay to see the movie. He may find a wonderful unknown actor willing to work for a pittance to get the exposure. However he will prefer the star, the well-known veteran who is popular with the public. In fact he will pay that star many times more than an unknown whose acting talent is equal or even better than what the star offers. The unknown has no box-office drawing ability so he provides no real added value. The star however will bring in paying customers and he has a monopoly since there is only one of him. He has a high added value and can demand a lot of money to play the part.
Consider also professional sports. The National Basketball Association, the National Football League, and major league baseball have effective monopolies on their product. They could put franchises in any city big enough to support a top-notch team in their sport but they don't. Instead they limit the number of teams. They know that many cities regard having a major sports team as a very desirable status symbol so they make sure that there are fewer teams available than cities wanting those teams. That forces those cities to compete against each other. Typically the city must be willing to provide a fancy stadium or other facility. In many cases it is the city, not the team owner that foots the bill for that and is stuck with that bill should the team move to another city. Any given city has an added value of essentially zero when negotiating with a professional sports league. (There are some exceptions such as New York with so many potential fans that they want teams there. However even there the “New York” Giants and Jets actually play in New Jersey.)
That is one reason why professional teams often move to new cities. They get better deals by moving. The Seattle SuperSonics became the Oklahoma City Thunder. The St Louis Cardinals now play in Arizona. The Dodgers long ago stopped dodging trolley cars in Brooklyn and moved to Los Angles. Many other teams no longer play where they once did, leaving behind empty stadiums or arenas and unhappy fans and taxpayers. Cities are put in a position in which they cannot win in that game.
What should cities do to level the playing field with the sports leagues? Clearly bidding against each other is a losing battle; the team owners have all the power. They have only two rational choices. First of course they can just refuse to play the game, tell the sports team owner that they are not going to give him any special treatment. That is an option I think voters and taxpayers should insist on in the present situation. The other rational choice is to get together as a league of cities and negotiate as a group. Such a group would have an added value equal to that of the sports league. No longer would the owner of the Seattle Sonics be able to tell Seattle and Oklahoma City that they better give him what he wants or he will go to another city. That owner would have to deal with a league of cities that has as much added value as he does. Of course cities being jealous of one another will probably never form such a league so the owners will continue to have all the power.
I could go on but you get the point. Any person, city, or business that understands added value can use that concept to decide if it wants to play the game. If it does play, that concept helps know how to play and what results to expect.
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If you don't like it please tell me.
Monday, November 15, 2010
A Bit of Game Theory
Game theory so-called is an interesting and useful subject, and it's not just about playing games for entertainment. It can be very useful in a wide range of situations. In fact most students of the field would agree that it is mis-named. It would be better if it were called something like “theory of human interactions.” However game theory is the historical name and we are stuck with it. That means that we call such interactions games, be they games like poker or other interactions such as business decisions.
For our purposes here, a good definition of a game is any interaction between people who do not control the actions of others in the game. The theory deals with finding the best course of action when playing such a game. Obviously that means it can apply to business, government, international relations, family life, and a myriad of other areas. Just as obviously I cannot cover the entire subject in a couple of blogs. However I can point out some interesting results.
One useful idea is the concept of “added value” discussed in the book “Co-opetition” by Brandenburger and Nalefuff. In any game your added value is the difference between the value of the entire game with you in it and the game if you do not play. For example if a tire manufacturer were to invent a tire that reduced fuel consumption by 10%, the added value would be the value of the fuel saved.
In most games you can never hope to get more than the value you add. The major exceptions are shysters, criminals, and governments. All of those can take out of a game more than their added value. They do that by taking the value someone else adds. However in honest games participants get no more than they add and usually a lot less. Here is an example, based on one in the book:
Suppose an eccentric millionaire walks up to you and hands you piece of a jigsaw puzzle, along with a toll-free phone number. He tells you, “If you call this number you will be able to talk to Joe who has the matching puzzle piece. I will pay $100 to whoever gives me the matching pair.”
The total value of this game is $100, the amount the millionaire will pay if you and Joe agree to turn in the matching puzzle pieces. But the real question is what added value you have, and what added value Joe has. If either of you pull out of the game and refuse to play, the whole game is worth nothing. The interesting part is that your added value is $100, but Joe's added value is also $100 even though the entire game is worth only $100. You cannot both get your added value. The best compromise would be to split the difference. Joe pays you $50 and you give him your puzzle piece. He then turns the matching pieces in to the millionaire and walks away with the $100. You are each richer by $50.
In a fair game, your added value is the maximum you can expect, but in many cases you will get less than your added value. That is an important idea when entering into any negotiation. You may think that you are adding a certain value to the game and you may be right. However others also add value and the total added value usually exceeds the total value of the game.
A more practical example would be when an employer and his employees divide up the gains from a business, say manufacture of some widgets which bring in sales of a million dollars per year. The employer provides the equipment, the raw materials, and the building. He may even provide the knowledge of how to make widgets. Without the employer nothing gets made and the value of the game is zero. Therefore the employer's added value is the entire value of the game, one million dollars per year.
But wait. The employees do the actual work of making the widgets. If they don't play the game no widgets get made and the value of the game is again zero. The added value of the employees is also one million dollars per year. Clearly employer and employees will not all get of their added value. Should either side insist on one million dollars per year the other will walk away, remove his added value, and the value of the game will be zero. They must reach some compromise in which each gets only part of the added value they provide.
Similar considerations hold for almost any interaction, be it trade, family relations etc. We can only function as a society if we are willing to compromise and settle for less than our added value.
Now that's enough for one day. Next I'll throw an interesting curve-ball at the eccentric millionaire game and see how that applies to life.
If you like my blog please tell others.
If you don't like it please tell me.
For our purposes here, a good definition of a game is any interaction between people who do not control the actions of others in the game. The theory deals with finding the best course of action when playing such a game. Obviously that means it can apply to business, government, international relations, family life, and a myriad of other areas. Just as obviously I cannot cover the entire subject in a couple of blogs. However I can point out some interesting results.
One useful idea is the concept of “added value” discussed in the book “Co-opetition” by Brandenburger and Nalefuff. In any game your added value is the difference between the value of the entire game with you in it and the game if you do not play. For example if a tire manufacturer were to invent a tire that reduced fuel consumption by 10%, the added value would be the value of the fuel saved.
In most games you can never hope to get more than the value you add. The major exceptions are shysters, criminals, and governments. All of those can take out of a game more than their added value. They do that by taking the value someone else adds. However in honest games participants get no more than they add and usually a lot less. Here is an example, based on one in the book:
Suppose an eccentric millionaire walks up to you and hands you piece of a jigsaw puzzle, along with a toll-free phone number. He tells you, “If you call this number you will be able to talk to Joe who has the matching puzzle piece. I will pay $100 to whoever gives me the matching pair.”
The total value of this game is $100, the amount the millionaire will pay if you and Joe agree to turn in the matching puzzle pieces. But the real question is what added value you have, and what added value Joe has. If either of you pull out of the game and refuse to play, the whole game is worth nothing. The interesting part is that your added value is $100, but Joe's added value is also $100 even though the entire game is worth only $100. You cannot both get your added value. The best compromise would be to split the difference. Joe pays you $50 and you give him your puzzle piece. He then turns the matching pieces in to the millionaire and walks away with the $100. You are each richer by $50.
In a fair game, your added value is the maximum you can expect, but in many cases you will get less than your added value. That is an important idea when entering into any negotiation. You may think that you are adding a certain value to the game and you may be right. However others also add value and the total added value usually exceeds the total value of the game.
A more practical example would be when an employer and his employees divide up the gains from a business, say manufacture of some widgets which bring in sales of a million dollars per year. The employer provides the equipment, the raw materials, and the building. He may even provide the knowledge of how to make widgets. Without the employer nothing gets made and the value of the game is zero. Therefore the employer's added value is the entire value of the game, one million dollars per year.
But wait. The employees do the actual work of making the widgets. If they don't play the game no widgets get made and the value of the game is again zero. The added value of the employees is also one million dollars per year. Clearly employer and employees will not all get of their added value. Should either side insist on one million dollars per year the other will walk away, remove his added value, and the value of the game will be zero. They must reach some compromise in which each gets only part of the added value they provide.
Similar considerations hold for almost any interaction, be it trade, family relations etc. We can only function as a society if we are willing to compromise and settle for less than our added value.
Now that's enough for one day. Next I'll throw an interesting curve-ball at the eccentric millionaire game and see how that applies to life.
If you like my blog please tell others.
If you don't like it please tell me.
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