Friday, January 30, 2009

What Is Fair?

This post refers to two Keystone Economic Principles:

1. We all make choices.
and
4. Economic systems influence choices.

There is a fascinating article in The Atlantic that delves into the idea of fairness in the marketplace.

In economics, we often have opportunities to discuss the idea of "fair exchange". And the idea is central to our idea of how markets work.

Furthermore, in recent years, much has been done in the area of experimental economics with something called "The Ultimatum Game" which is explores how people approach the idea of fairness.

If you're not familiar with the game, it involves two people: a proposer and a responder. The proposer has $10 and must make an offer to the responder on how to split the money. If the responder accepts, they split the money. If the responder rejects, no one gets the money.

Basic economics would suggest that any split should be accepted. After all, anything is better than nothing. But research has shown that if the responder does not view the offer as fair, it gets rejected.

The article goes deeper, exploring the evolution of the idea and the word (relatively recent surprisingly), but it's worth a look. The idea of fairness is an informal institution in our society and, consequently, it affects how we choose. It's something we all might want to understand better.

I look forward to your comments.

2 comments:

tom said...

"Basic economics would suggest that any split should be accepted. After all, anything is better than nothing. But research has shown that if the responder does not view the offer as fair, it gets rejected."

I dislike this conclusion. Basic economics tells us that the split should be accepted with perfect information: ie that this game was a one time thing, you will never interact with the offerer again, your decision has no lasting effects on the future. People don't think this way, even when you (as the researcher) promise the event is a one time thing for all they know you are lying because you want to study, say, a person's reaction to a second game once the rules of the first game have been violated. Because the sums used in these games are very small it makes it hard to really identify the underlying principles. How would these games change if the offer was to split $1,000,000 into $990,000 and $10,000. Are people going to reject ten grand in the name of fairness at the same rate they would reject a $0.10 offer out of $10?

For my interpretation of these studies is that at best you can determine that a sense of fairness, coupled with uncertainty of the future is worth more than the offering.

Tim Schilling said...

You raise an interesting point about the magnitude. I've heard or read a couple experimental economics explain this as a budget constraint. I certainly understand that aspect. But one would still be better off by $1. Regarding the trustworthiness of the experiment - that brings in another institutional aspect.