Economics Newsletter Edition #26

DUBAI KEYNES SOCIETY NEWSLETTER JULY 2022 EDITION

Arjun Sisodia, Sehaj Choukse & Viha Kedia

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contents Editorial

Viha

Goumbook

Arjun, Sehaj, Viha

Behavioural Economics and Public Policy How Prominent is Geography When it Comes to Inequality in the UK Economic policies to transition away from fossil fuels The age of exploration...or exploitation Sri lanka's economic crisis The economic role of children

game theory

test your knowledge: quiz!

Sara Aggarwal

Zaara Ahmad

Tess Ruddell

Namya Manghnani

Vidhi Bhansali

Zaara Mohamed

Zara Punekar & Inaaya Salim

Editorial As our term as Heads of DKS come to a close, we can only hope we left a positive legacy on the future of the Society, and served the Society well.

We aimed to bring a more fun, engaging perspective to current economics topics and we believe that this was only possible through the enthusiasm displayed by all students who attended.

We had students from Years 7-13, attending various sessions to hear bankers, investors and government officials discussing their experiences and insightful questions designed to further our knowledge.

Arjun, Sehaj and I would like to take this opportunity to sincerely thank Mr Christopher for being our guiding force through our journey as Heads, and organizing some fantastic external speakers for the students.

This is our last newsletter, and features some amazing articles from all our student speakers throughout the year, with topics ranging from behavioural economics and game theory, to economic history and exploration.

Our newsletters have consistently aimed to showcase the amazing written economic talent posed by our students, and celebrate the diversity of their opinions and thoughts- the final one of the year is no different.

--- Viha Kedia

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Goumbook This year, DKS had the privilege of working with Goumbook, a leading social enterprise promoting sustainable living and green practices in the UAE. They aim to guide, inspire and empower communities and enterprises to define and achieve their sustainability goals through education, awareness raising, capacity building and advisory. They gave two extremely enlightening and inspiring talks ranging from different topics such as, food security and the pollution of cigarette butts. They have been getting involved with different schools around the UAE to participate in their 'Save the Butts' challenge.

Cigarette butts make up 30% to 40% of all items collected in cleanups around the world.Out of the 6 trillion cigarette butts produced every year, 4.5 trillion of them wind up in our forests, beaches and waterways. A third actually makes it into the bin. 'Save the Butts – Waste to Value' is the first sustainability initiative run in the UAE that adopts a Circular Economy approach to environmental pollution, by converting discarded cigarette butts into a sustainable alternative to plywood. DC will be working closely with Goumbook next year to organise a school beach clean up so make sure to get involved next year!

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BEHAVIOURAL ECONOMICS AND PUBLIC POLICY Sara Aggarwal Neo-classical economics has been the dominant force in economic thinking and policymaking for many years. It formulates precise economic laws regarding production and consumption through the calculation of cost and benefit at the margin. Consumers and businesses are both assumed to act rationally, consumers optimise their utility per pound spent, whilst producers seek to maximise profits in both product and labour markets.

The neoclassical model assumes that agents have fixed tastes and preferences, can gather all information required to make decisions and based on that make the most optimal decision they can.

This creates the idea of homo economicus which is an agent that makes decisions that act in their self-interest and are rational.

Behavioral economics, however, suggests that agents do not always have access to all / perfect information due to asymmetries and information failure and so cannot make decisions that are completely rational. There are several biases that help explain this.

The first is present bias. If policies or decisions involve the future, agents tend to think of the present. Consumers are loss averse which means that they are more impacted by the idea of losses than they are of any gains. They also follow herd behavior, so they copy or follow what others around them are doing to ‘fit’ into society. This can also be a result of peer pressure. Consumers have limited computational capacity, so they aim for satisfaction rather than to maximize their utility as value what they have more than what they could have but don’t.

Finally, there is an availability heuristic where consumers tend to over-estimate the likelihood of something happening because a similar event has either happened recently or because they feel emotional about a previous similar event.

Taking inputs from psychology, behavioral economics incorporates the idea that we all have these behavioral biases when making decisions and that some of those behaviors can be changed. Bringing this more realistic knowledge into the design of public policies can make them more effective.

This refers to Richard Thaler and Cass Sunstein’s theory of ‘nudges’ which refers to the way in which we can influence people’s choices and decisions and steer them in certain directions without compromising their freedom of choice.

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Talking about behavioral economics in public policy, a large one affected by nudges is the pension policy. In the US, the retirement savings crisis has been ongoing for a long time and will result in a significant portion of the US population to lack the resources to live comfortably after they stop working. This, in turn, will place an increasing burden on the country’s social safety net. The U.S. has never properly considered how people will make up the difference between Social Security and a financially secure old age and it will also have a lot more retirees in coming decades, thanks partly to the aging of the baby-boom generation. A simple way to mitigate the effects of this crisis and encourage more workers to enroll in pension policies was to switch the default option of enrolling in pensions from ‘opting in’ to ‘opting out’. Following the apparent success of this, academics began to study employees’ decisions systematically and, in a celebrated paper, Madrian and Shea (2001) showed that changing the default option increased participation by more than 40 percentage points – effectively doubling it. This could be due to a number of reasons, one of which is the status quo bias which suggests that people prefer to stick to the status quo rather than change. In addition, when faced with uncertain decisions, they look at the default option as advice or the most popular option and so stick with it. Combined with human tendency to be lazy and procrastinate, it is easier to stick with default option of opting in than having to actively go and change the preference to opting out.

Another important policy in which nudges have helped is in taxation. Simplifying the messages given to taxpayers in letters about tax they owe, highlighting the action they need to take, step by step, as well as the risk of prosecution, can lead to faster tax collection.

In Colombia, personalized messages were developed that included information about the taxpayer’s debts, payment methods and the cost in terms of interest and other penalties that the taxpayer could incur if they continued their behavior. Experiments showed that messages sent by personal contact methods tended to be more effective than impersonal ones. While eight out of 100 people who received a letter paid their debts, the figure doubled in the case of those who received an email.

Phone calls increased the success rate to 30 out of 100 people, and personal visits were by far the most successful, with nearly nine out of 10 people deciding to change their behaviour and meet their tax obligations.

However, it is important to remember that before mitigating behavioural biases, nudges and behavioral policies should first work actively to dismantle the vast set of coercive legislation that hangs over competitive labor markets, including key bodies of law banning age, race, and sex discrimination in employment, or those imposing minimum wage and maximum hour regulations, or rules that otherwise ban unjust dismissal.

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HOW PROMINENT IS GEOGRAPHY WHEN IT COMES TO INEQUALITY IN THE UK Zaara Ahmad

Inequality in the UK is a significant political, economic and geographical issue, so much so that the current Conservative government has made ‘levelling up’ the economy, living standards and life chances across the country, a mantra. Overtime this has led some to suggest that it is perhaps the “centre purpose of [Johnson’s] premiership” entirely to ‘level up’ the nation. The term was a key tenet of the Queen’s Speech and the prime minister now has a 'levelling up adviser' and Chancellor Rishi Sunak has unveiled a £4.8bn 'levelling up fund', emphasising how much focus is being given to inequality and the government’s plan on how to combat it in the UK. The Spirit Level and The Inner Level both advocate that inequality, the gap between rich and poor, has a significant impact on people's health, wellbeing, human capital formation, and social cohesion. Inequality causes a wide variety of health and social issues, from shorter life expectancies and higher infant mortality to worse educational attainment, less social mobility, and higher levels of violence and psychological disorders, according to their findings. The disparities between more and less equal societies are significant, and they influence everyone. Inequality has an impact on our private life; it psychologically separates us from the status, support, and solidarity that keep us healthy and happy. The authors contend that inequality is a fundamental barrier to developing sustainable economies and societies that maximise people's and the planet's health and well-being.

Inequality exacerbates consumption since it is centred around self-improvement and status rivalry. Inequality causes a breakdown in communal trust, solidarity, and social cohesiveness, as well as a reduction in people's motivation to act for the greater good.

The UK is the second most unequal country in Europe, according to both the Gini coefficient and other indicators such as the Palma ratio. In the United Kingdom, the richest fifth earn more than 12 times what the poorest fifth earns. When it comes to the top 1%, the percentage of income generated by the top 1% in the UK has been steadily increasing since 1980, reaching at 13% in 2015. One percent of the population in the United Kingdom earns more than ten percent of the country's total revenue. This is about double the same percentage for Belgium (7%) and yet higher than Sweden (8%) and Norway (8%), for example. In the United Kingdom, wealth is distributed even more unequally than income and by a considerable amount. According to the ONS, the wealthiest ten percent of households own 44 percent of total wealth.

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Some of the distinctions in economic performance across the UK in different cities comes from the various roles that different areas in the UK play in the national economy and the ways in which they contribute towards total GDP. The capacity of various parts of the nation to make and draw in high-valued firms and occupations, and thus drive efficiency upwards, fluctuates among metropolitan and rural regions, with metropolitan regions best positioned to do so. Anticipating the South West, a dominatingly country locale, to act in the same way as the Greater London metropolitan region does, is unrealistic. Nonetheless, what ought to be generally anticipated is metropolitan regions across the nation to perform similarly. However, in a practical sense, productiveness per worker in Reading is 60% higher than in Doncaster, the normal weekly wage in Cambridge is 40% higher than the normal weekly wage in Burnley and the employment rate in Oxford is 20% higher than that of Blackburn. While a significant number of the metropolitan regions that are presently failing to meet expectations are in the North and Midlands, the separation isn't just because of geography, nor is it the situation that all urban communities in the North are struggling.

This point can be illustrated by comparing two urban areas: Bradford and Leeds, while they are just eight miles apart from each other, the cities look vastly different from an economic and financial perspective. Leeds has a larger portion of their population who are of working age, and individuals in Leeds are more likely to have attained higher qualifications, only 6.7 percent of its total populace has no qualifications, whereas Bradford has nearly double that amount6. The populace in Leeds is also more likely to be employed whereas Bradford's employment rate is 8 percent lower than Leeds’. Individuals in Leeds likewise have higher wages, with a normal week after week wage at £561 as opposed to £538 in Bradford. These differences help explain the gap in productivity between Leeds and Bradford. GDP per worker in Leeds is 13% higher than in Bradford and much of these differences can be explained by the type of industries in these two places6. Leeds specialises in more of the tertiary sector where 17% of the jobs are high skilled jobs; such as finance and insurance, professional services and information, communication and these account for 24% of all output whereas in Bradford only 10% of the jobs are high skilled.

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However, these vast differences in economic structures between the two cities have not always been there. The composition of these two cities was similar in terms of their GDP, unemployment rates and productivity, with Leeds having marginally more jobs in the tertiary sector in terms of exporting services and Bradford having a larger share of jobs in exporting goods. But then during the 1950s an important divide was created as the share of service exporting jobs began increasing much more rapidly in Leeds than Bradford. This demonstrates that the prevailing regional inequality is more dependent on how different parts of the country respond and adapt to economic and political change rather than simply due to their geographical location.

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ECONOMIC POLICIES TO TRANSITION AWAY FROM FOSSIL FUELS ramadan blog writing competition

Tess Ruddell Despite Boris Johnson’s announcement last year that the UK would end its subsides supporting overseas fossil fuel projects, the government continues to finance the non-renewable energy industry through tax breaks, as well as investment into research and development; unsuccessful calls for these privileges to be revoked were heard at COP 26, sending mixed messages about the country’s commitment to environmental change.

The UK should begin to merge its automation capabilities with its climate change targets. By ending all indirect support of the fossil fuel industry, the government will relieve itself from costs of up to £10billion a year, creating the financial means to subsidise domestic research and development into low-cost, green energy alternatives to benefit not just the UK, but also developing markets. By decreasing the cost of research for green energy companies, the quality and quantity of their research will increase, maximising opportunity for British advancement in the clean-energy sector. Moreover, the purpose of these subsides should expand further than research and development and should also support lower average production costs for green energy firms, allowing UK companies to distribute their goods to low-income countries for lower prices. The UK can begin to specialise in the continuously expanding market of clean energy, giving it a comparative advantage that can help to increase the competitivity of UK exports.

In compliment to increased domestic subsides, I would also propose an export subsidy program focused specifically on foreign trade in clean energy. Many countries lack the finances to purchase the equipment and knowledge of wind power that most Western nations have access to, therefore I would like to propose a government policy that provides subsides to British firms allowing them to sell green-energy products to low-income countries for discounted rates depending on the economic data of that country. Personally, I envisage a ranking system made up of five categories. The GDP-per-capita, the fossil-fuel consumption per capita, and an evaluation of the country’s long-term environmental plan should all be considered. With this grouping in mind, businesses should discount their goods accordingly: countries in category one, those most in need of help, should receive plentiful discount, whilst countries in category five should be obliged to pay full price. UK firms will be able to provide their goods and services below the market equilibrium price due to subsides from the British government that will cover producer losses.

In conclusion, the proposed combination of complimentary domestic subsides to UK businesses will result in the advancement of research and development into green-energy alternatives, as well as promoting UK renewable energy exports to emerging markets by making them more affordable and price competitive. In the long-run, economies of scale for British firms through these export subsidies will lead to further price reductions, reducing subsidy dependency and further lowering already competitive prices. The multiplier effects of these policies, as well as their impact on long-run aggregate supply, help to ensure the UK can expect sustainable economic growth in the years to come, whilst also aiding the transition of low-income countries away from fossil fuels.

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THE AGE OF EXPLORATION...OR EXPLOITATION? Namya Manghnani The early 16th century saw the arrival of European colonisers in the Americas, with them came advanced technology, trade opportunities and new forms of oppression. Once Spain established a foothold in the New World, the colonial empire expanded and developed a society of hierarchal organisation. This was known as Encomienda and was a legal system by which the Spanish crown attempted to define the status of the indigenous population. The highest ranking was the peninsulares, who were Spanish born officials; then came the crillos, who were born in the colonies to Spanish parents; following them were the mestizos, who had both European and Native American ancestry; below them were the mulattos, who had European and African ancestry; and finally, there were the Native Americans, who had little to no freedom and worked on estates or in mines.

This was an extremely harsh system of forced labour that helped bring Spain their wealth in the colonies.

Both Native Americans and enslaved Africans were forced to work in Spanish controlled mines in the Andes Mountains of Peru and in Mexico. This enabled the Spanish to monopolise the world’s silver market, which opened doors in Ming China and the Philippines, being an early instance of trade relations between the countries. The transatlantic trade was part of a wider transfer called the Columbian Exchange, which was a consequence of Spanish and Portuguese empires in the New World.

The Columbian exchange was the transfer of animals, plants, diseases, people, technology and ideas among Europe, the Americas and Africa. The Old to the New and back again. Two key products of the Columbian exchange were sugar and silver. Sugarcane root had arrived in the Caribbean from India, the colonists saw this as an opportunity to monopolise this profitable crop in the new environment. Sugarcane production resulted in the development of plantations throughout Spanish colonies and the trade encouraged demand for sugar. Because labour is derived demand, this increased the need for enslaved or forced labour in the colonies, which further escalated the transatlantic slave trade and the harshness of the encomienda system.

The results of the plantation system were brutal, dangerous conditions for the workers and an over-utilised natural landscape. How times have changed.

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Like we see today with modern multinational corporations, many profits in the colonies, or ‘host countries,’ were repatriated. Under the theory of mercantilism, a country actively sought to increase trade, but with a favourable balance (surplus) of trade. This was a signifier of strength and lack of dependence. Colonies were forced to give the colonising country raw resources, these were not considered imports because they were owned by the colonising country, while creating new markets for processed exports. To further aid this effort, monarchies promoted domestic industry and placed protectionist barriers such as tariffs on imports from competing empires. This only grew in the later Industrial Revolution.

Mercantilism fostered resentment in colonies as the colonial resources were shipped back to Europe while the colonists were forced to pay for products from Europe…with tax. This sparked many revolts against the abuses of the colonisers, a prime example being the American Revolution.

This was a time of economic innovation; a result of this expansion was the Commercial Revolution that saw the rise of the joint-stock company, the growth of European economies and access to new materials.

However, while this was a period of mass transoceanic interconnectedness, it was also a significant violation of many native lands. Rooted in racism and ideas of European superiority, the colonisation of the Americas resulted in 90% of the indigenous population dying under the brutality of European colonisers. While much less extreme, the patterns of exploitation of natural resources and labour in smaller developing countries by MNCs in larger MEDCs is a one that has existed for hundreds of years that seems to only grow as the world becomes more globalised.

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SRI LANKA'S ECONOMIC CRISIS Vidhi Bhansali The Sri Lankan economic crisis. Being the worst economic crisis occurring in Sri Lanka, since their independence in 1948, the wider impacts on the residents and even the impacts on different global relations have been massive; and will have implications on the future of the country. With a default on their debt where they essentially admitted they could not afford to pay back their debts, of an accumulated $51 Billion in March 2022, it was the first clarification to the population of Sri Lanka that their country was in crisis. This article will cover how a country struggling with rampant inflation, declining reserves of basic resources, and even as of the 27th of June a complete suspension of all non-essential fuel usage, came to be in the situation it finds itself in right now; with certain sides of the argument stressing the government’s (under Rajapaksa) economic policies such as changing taxes and creating policies that facilitated the ongoing agricultural crisis, and others choosing to focus on the local realities of the country in 2022; and what a massive external effect these issues are having on local population.

The Government of Sri Lanka, in 2019 under President Rajapaksa, made massive tax cuts. These affected government revenue and fiscal policies, causing budget deficits to soar. These cuts included introducing increased tax-free thresholds that resulted in a 33.5% decline in registered taxpayers, reducing VAT to 8%, and reducing corporate tax, from 28%, to 24%. These tax cuts, although indeed increasing the pressure on the government to increase spending, also removed a massive source of revenue. What happened after this, is what can truly be seen to have caused a lot of problems. Instead of listening to the IMF’s advice (International Monetary Fund), they instead chose to go against it. The Central Bank of Sri Lanka began printing money, in massive amounts breaking records, to cover the value of government spending. Instead of taking the economically sustainable route, which the IMF suggested, of increasing tax, and hiking interest rates at the same time, to avoid the risk of economic impulsion and excess flow of money in the economy; they did the opposite. This un-willingness to adapt to issues, and desire to help the mildly disliked government be seen as helpful at face value, is arguably a massive reason for this crisis the country sees itself in now, with unsustainable debt.

However, these tax-cuts cannot be given all the importance, as they were just a fraction of the realities of the country’s state.

With tea and rice production being some of the biggest industries in the country, it is clear to see that if they faced issues; so would the rest of the country as they depended on the revenue and global growth it brought. Sri Lanka had been self-sufficient in rice production with imports limited to specialty rice such as Basmati, In April 2021, President Gotabaya Rajapaksa announced that Sri Lanka will only allow organic farming, banning inorganic fertilizers and agrochemicals-based fertilizers.

The drop in tea production because of the fertilizer ban alone resulted in economic losses of around

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$425 million and created a 20% drop in rice production within the first six months alone reversing previously achieved selfsufficiency in rice production, and the country was forced to import rice for $450 million. The situation in the tea industry was described as critical, with farming under the organic program being described as ten times more expensive and producing half of the yield by the farmers. This act created an economic crisis; and was extremely worsened with the very existence of the COVID-19 pandemic. This was the introduction of the “agricultural crisis”, having a profound impact on the people of Sri Lanka.

It is also viable to mention even more global threats, that having placed in turn a threat on Sri Lanka’s sanctity. The tourism industry, all over Sri Lanka, was a massive source of GDP growth, income, and the country’s way to access the global market.

However, this was massively dampened, in 2019, with the Easter Bombings where three luxury hotels were targeted in an organised terrorist attack. Instead of being able to move past that, however, the issue was prevented from recovering due to the pandemic, which Sri Lanka was able to handle at the beginning, but faced more and more problems with, with the crippling economy.

All the factors are extremely interlinked. It is Rajapaksa’s corruption that plays a bigger role in the modern-day demise of the country? Or the pandemic, that exacerbated the extent of the issues? Maybe even the new agricultural crisis introduced with new commitments. I would argue, that although these issues can singularly be blamed depending on the viewpoint one takes on politics and economics, in reality it is a combination of them; all causing the others to become worse and put the country through more and more harm. These massive issues have led to the introduction of the Sri Lankan Protests, which are massively violent, the collapse of the healthcare system, an increasing inter-dependence and potential to be influenced by evergrowing “superpower” countries like China and India, and inflation reaching double digits. It is impossible to say that this crisis is not occurring; but it can certainly be argued to what extent, and why this is occurring.

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THE ECONOMIC ROLE OF CHILDREN Zaara Mohamed Across the world, policies regarding children differ which alter the course of an economy. Initial thoughts are that children are an added expense for parents but with the funding a child requires, the notion is to increase the likelihood they succeed, bringing benefit to the economy, with the consumption by parents but also as future skilled adults, contributing back to aggregate demand.

The institutional theory of formal institutions ban child labour, which disables markets. By legalising child labour, labour markets could increase significantly given increased productivity, output/GDP. As a result, the cost of production would be significantly less given children are cheaper to employ without regulations meaning an increase in labour. In China, 7.74% of children from 10-15 are labourers; 6.5 million more workers in the population. Interestingly, China has the second-highest GDP in the world at $14.72 trillion suggesting that continually high output and production is due to the larger percentage of society working.

Society may fall victim to the institutional theory of market failure regarding children. Imperfect information regarding the benefits of having children may trap families in the expenses. For example, a rural Finnish community offers €10,000 per child. This asymmetric information encourages parents to have more children. However, only €1000 over 10 years of the child’s life. the increased expenditure means parents’ marginal propensity to save increases, to prepare for future expenditure; reducing spending.

Children may follow the neoclassical theory of the law of diminishing marginal utility (Graph 1) as families with children can induce economic activity, increasing their marginal propensity to spend with each child. However, with multiple children, families may be forced into debt increasing reliance on government welfare benefits. In the UK, 7.21 million families seek child benefits and governments must spend more on the welfare system increasing the budget deficit. This could force the country into austerity, lowering consumption and investment, therefore lowering aggregate demand and GDP. The neoclassical cost-benefit theory can be used to analyse the worth of children in economies. While children can be costly to the economy (welfare benefits) they can be beneficial as skilled workers in the future; UNICEF claims that each additional year of education boosts one's income by 10%. Being more educated is likely to result in more spending power and thus higher demand, causing an extension in the supply curve (Graph 2). In order to meet supply; output and GDP would increase.

Investment in children is seemingly inefficient, taking years for the child to complete education to make an economic impression.

Both are extremely meaningful as institutional economics shows the nuances of having a child through market failure and lack of exploitation of resources, while neoclassical economics explores the economic assets the right number of children per family can be, with investment. I believe that children can be beneficial to the economy in the long term, particularly when a family has an optimum number of children. However, a focus on neoclassical functions with disregard to institutional theories can be harmful as they require labour and money which are drained from an economy. That said, a child is not a guaranteed success but an almost certain expense.

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GAME THEORY Inaaya Salim & Zara Punekar Game theory is the study of how and why people make decisions. (Specifically, it is "the study of mathematical models of conflict and cooperation between intelligent rational decision-makers".) a game is any set of circumstances that has a playoff (outcome) dependent on the actions of 2 or more players.

There are five main types of games, some of these will be discussed further in the article. Firstly, there are cooperative and non-cooperative games. Cooperative game theory deals with how coalitions (cooperative groups) interact only when the playoffs are known. This is a game between coalitions of players rather than between individuals. Usually, the problems are solved by following the agreement based on the mutual discussion among the players. An example of this is when cigarette firms want to reduce ad expenditure, and the government wants to restrict the advertisement of cigarettes on television.

However, non-cooperative games refer to the games in which the players decide on their own strategy to maximise their profit. The best example of a non-cooperative game is the Prisoner’s Dilemma. Non-cooperative games provide accurate results because usually, a deep analysis of the problem takes place since interests are not aligned.

In a constant sum game, the sum of all outcomes will always remain constant, even if the players have received different outcomes. For example, in poker, the combined distribution of wealth remains constant, however, its distribution shifts from player to player. Moreover, in a zero sum game, the gain from one player is equal to the loss of another player.

Conversely, non-zero sum games are when the sum of the outcomes of all players is not equal to zero.

Simultaneous games are ones in which the move of two players (the strategy adopted by two players) occurs at the same time. Here, all players select strategies without observing the choices of their rivals and each player chooses at the exact same time. Sequential games differ, as here players are aware of the moves of players who have already adopted a strategy. In these games, players observe what rivals have done in the past and there is a specific order of play.

Another key difference is that simultaneous games are represented in normal form, while sequential games are represented in extensive form.

As previously mentioned, the Prisoner’s Dilemma is a non-cooperative game in which individual decision-makers always have an incentive to choose in a way that creates a less than optimal outcome for the individuals as a group. The typical prisoner's dilemma is set up in such a way that both parties choose to protect themselves at the expense of the other participant. As a result, both participants find themselves in a worse state than if they had cooperated with each other in the decision-making process.

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This is applicable in the tragedy of commons, which is an economic theory that states that individuals tend to exploit shared resources such that the demand greatly outweighs supply, and subsequently, the resource becomes unavailable for the whole. Another classic example of the prisoner’s dilemma in the real world is encountered when there is rivalry between firms in the marketplace. For example, Coca-Cola and PepsiCo. If we assume Coca-cola is cutting prices of coke, Pepsi may have no choice but to follow in order to retain its market share. This could result in a significant drop in profits for both companies. A price drop by either company may thus be seen as defecting since it breaks an implicit agreement to keep prices high and maximise profits. So, if Coca-Cola drops its price but Pepsi continues to keep prices high, the Coca-cola is defecting, while Pepsi is cooperating (by sticking to the implicit agreement). In this scenario, Coca-Cola may win market share and earn incremental profits by selling more fizzy drinks.

However, the Prisoner’s Dilemma is just a theory, so it may not always work in the real world. Most economic and other human interactions are repeated more than once, therefore people may have developed psychological and behavioural biases over time such as higher trust with one another, leading individuals to act irrationally so that they chose outcomes which are of the most benefit to both players.

Nash Equilibrium is an outcome of a game such that no player can gain by unilaterally changing its strategy, therefore, it is achieved when each player adopts the optimal strategy, given the strategy of the other player.

An important property of Nash Equilibrium is that it is self-enforcing, thus, it is the outcome which two rational players, A and B, should ultimately reach in a non-cooperative game. Player A reaches Nash Equilibrium by employing a strategy which is their best response to the strategy chosen by its opponent, Player B. However, since the opponent also choses a strategy which gives them the maximum payoff given the strategy of Player A, the inevitable outcome is called a Nash Equilibrium.

Identifying Nash Equilibrium: If both players have dominant strategies (best payoff regardless of rival’s decision), the cell in which they intersect is the Nash Equilibrium. If one player has a dominant strategy, the cell in the dominant strategy row or column in which the other player has the maximum payoff is the Nash Equilibrium.

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Let’s consider two firms, A and B, who are making the decision of whether to change their advertising budget. The following payoff matrix shows net increase in profit of each firm:

There is a dominant strategy in this game for Firm A to advertise. This is because the maximum payoff for it in all columns occurs in its last row. However, Firm B has no dominant strategy since its maximum payoff doesn’t occur in the same column.

Using the rules discussed above, we know that the Nash equilibrium must exist in the last row (the dominant strategy of Firm A), when Firm A advertises. Since Firm A will advertise in any case, Firm B’s best response is to not change its budget because this gets it the maximum payoff. If Firm B cuts its advertising budget or increases it, its payoff will drop to $20 million in each case, which is worse than $50 million.

The Ultimatum Game is a one-shot two-stage sequential bargaining game where two players are shown a sum of money, for example, £10.

In Stage 1, the first player - the proposer - is told to offer a figure (ranging from £1 to £10) to the second player, who is the responder. In Stage 2, the responder can either accept the proposed split or reject it. If they accept, the £10 is divided according to the first player's proposal. If they reject the offer, both players get 0.

The self-interest hypothesis, supported by Adam Smith’s own ideas, where he explains that the best economic benefit for all can usually be accomplished when individuals act in their own self-interest, suggests that the proposer should offer the minimum (£1) and the responder should accept it. Even though £1 isn’t much, it is still a gain compared to getting no money.

However, only a minority of people behave in this manner. According to Daniel Houser and Kevin McCabe, average proposer offers are often one-third to one-half of the overall amount and most acceptances are when 40-50% of the overall amount is offered.

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Quiz 1. Netflix says how many households worldwide are not paying for but still using Netflix?

2. The Bank of England has increased the base rate to what percentage?

3. China has announced an economic growth target of what?

4. Which streaming company has cut 150 jobs in the USA to control costs in the wake of falling revenue?

5. Which fast food company is leaving Russia for good?

6. What trade bloc was formed on the 1st of January 2022, which has now become the largest trade bloc in the world?

7. Which streaming service shut after a month of being launched?

8. Uganda announced that it discovered deposits of what resource worth 12 trillion USD in total?

9. Which company's workers voted to go on strike over pay in the UK? 10. In June, the EU agreed to enforce rules on which type of currency?

1) 100 million

2) 1.25%

3) 5.5%

4) Netflix

Answers 5) McDonald's 6) RCEP

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7) CNN+

8) Gold

9) BT Group

10) Cryptocurrency