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Game Theory and Personal Finance

Previously I gave you a taste of my MBA in Finance thesis paper. Today I’m going to step even further back in time to my undergrad degree. Way back in the early 2000s I attended a top public university for a Bachelor’s in Computer Science and a Minor in Economics. While I owe much of my working career to the Computer Science degree, this post is most definitely inspired from the economics side. Admittedly, unlike a master’s degree, a minor during your undergrad studies is a bit more shallow, and yet I still was able to take two specific upper level classes as specialization. For these classes I chose economics of public goods and the environment. Without glossing over the concepts too far, the crux of this realm of study is Game Theory.

What is Game Theory?

Game Theory is at its core is the study of how people make decisions in a competitive environment. It first was made famous by Graham Nash, who for those non economists reading this, you may recognize from the movie, “A Beautiful Mind”. Nash created the concept of the Nash Equilibrium. This is a concept where the optimal solution to two individuals could be sub optimal to both together. The example Nash used to describe what he termed the prisoner’s dilemma essentially had two prisoners on trial. Both are on trial for a crime, and contemplating a deal with the DA. If one snitches and the other does not, then the quiet one goes to jail for life while the snitch gets off. If both snitch they go to jail for 10 years. However, if both are quiet they go to jail for 1 year. Obviously, the best decision if they were working together is to go to with the 1 year option by both keeping quiet. However, if either individual does not snitch he risks going to jail for life by being the quiet one. As such they both choose to snitch. Thus instead of collectively going to jail for 1 year, both go to jail for 10. This is obviously a bit of a negative view of Game Theory, but you can apply it to positive situations as well.

Prisoner's Dilemma

Environment and Public Good Game Theory

Much of the world of Public and Environmental Game Theory touches on public policy questions. This blog focuses on personal finance, and not politics, so I will stick to the impacts to your life. The impacts to you are largely tied to a concept known as the free rider problem. This basically refers to there being situations where you benefit from resources, goods, services, or the lack of pollution regardless of whether you bear the costs. The common example is a situation where both you and a friend have a plot of land you both can use to graze some cattle for free.   In the absence of collusion you will allow your cattle to overgraze the property simply because you don’t independently bear the costs of maintaining the property. Collectively, you bear the costs of overgrazing but individually you only see the benefits of raising more cattle. Since most of us don’t have cattle we have to dig a little deeper to relate to everyday life.

Game Theory in Personal Finance and Every Day Life

There are a number of areas where you are in competition for a resource or gain the benefits of something despite not bearing the costs. You should consider the societal impact of these situations beyond the direct consequences. Off the top of my head some of these are:

  1. Recycling and Waste Reduction – You obviously don’t directly bear the costs of filling up our landfills, but collectively we all do. Consider taking the extra moment to recycle your trash.
  2. Donating your Money and Time – You may find it unlikely you will ever need the help of a charity organization, and maybe you’re​ right. However, if something does happen it’s good to know those charities will likely be there. And yet their presence has little to do directly with whether you donate. The local homeless shelter or United Way isn’t going to turn you down for assistance because you never donated. And yet if everyone ignored donations there would be no charity organizations to lend that helping hand. Remember to give, it might just bring you a good feeling which would mean it’s not really a dilemma in the first place.
  3. Providing Kindness to your Fellow Man or Woman – Holding the door for others, helping an old lady cross the street, whatever… The reality is if they don’t know who you are then likely there is no direct upside to you except perhaps good feelings. And yet some day you will be old, or someone you care about will receive kindness from someone else. All because of stepping beyond what is of value to you directly and remembering what is best for society and the world as a whole.
  4. Recently I’ve written about my quest to get a Nintendo Classic prior to Christmas. The thing I noticed in my short search is that people scalped the item for 4-10 times the price of the item. The only way the scalpers were successful is because people bought from them rather then having patience to wait for the stock to increase. By buying the overpriced item you encourage the scalpers to continue and it becomes a self fulfilling prophecy. Consider waiting a few weeks for a better supply situation to discourage scalpers.
  5. The take a penny/ leave a penny tray, any free sample, credit card Manufactured spend, and any other free item you might be able to obtain. Likely there is a loophole that will allow you to rack up way more than was intended. You as an individual can milk any example to get ahead if you think about it long enough. And yet if everyone does so then the program ends and these are no longer are available. Then everyone loses. Consider thanking people for giveaways and not taking advantage.

Game Theory has many applications in every day life. Being the study of what you do in a competitive situation, which as a human in a capitalist society is almost every day, this is essentially the study of what you do with your money/career etc. Are there any other areas of your life you can think of that are Free Rider situations or Prisoner Dilemmas where you’d be better off to work in cooperation with others? Do you take the road less traveled?

If you are curious about the movie A Beautiful Mind please feel free to click the affiliate link in the book title. I will receive some renumeration if you purchase the book via this link through no cost to you.

10 Comments

  1. #5 is important to remember. Think of the extreme couponers-the people who use tons of coupons to get groceries for free (or nearly so). They’ve actually caused grocery stores to change their policies because people were gaming the system so much. Some stores have started making their deals not as good, to discourage the extreme folks. So then everyone loses, including the casual couponer.

    • fulltimefinance@fulltimefinance.com
      [email protected] March 15, 2017

      Great example. I’ve heard of similar cases with return policies changing.

  2. I’m notorious for trying to get a deal from people. I’m pretty frugal/cheap… at the same time though, I do practice being grateful for what I have and what I’m able to do.

    I’ve never studied Game Theory rigorously and it’s a shame given I’m a Math major and have a Master’s in Financial Math. Do you have any book suggestions on the subject?

    • fulltimefinance@fulltimefinance.com
      [email protected] March 15, 2017

      I personally learned about it from a long forgotten text book, but the book of choice for business application these days seems to be The Art of Strategy: A Game Theorist’s Guide to Success in Business and Life

  3. MUSTARD SEED MONEY
    MUSTARD SEED MONEY March 15, 2017

    It’s been a couple of years since I studied game theory and I’m trying to think of a good example from work but am coming up blank. The only thing coming to my mind and I’m not even sure if I’m using this correctly is those people that pick up “slugs” (people that ride in people’s cars for free) which allow drivers to drive in the HOV lanes so that the driver can drive quicker into the city. It’s a win/win for both parties and literally one is a free rider 🙂

    • fulltimefinance@fulltimefinance.com
      [email protected] March 16, 2017

      That’s the free rider problem. It comes into play in Game Theory at the point where everyone does it. Then the HOV lane is just as bad as the regular lanes. It also might factor in if it became rampant in no one wanting to be the driver.

  4. Leo T. Ly @isaved5k.com
    Leo T. Ly @isaved5k.com March 17, 2017

    One thing that I can think of is people sharing a common facility. If everyone uses the facility responsibly, then the facility will lasts a lot longer. This brings me back to my student days when I shared an apartment with a couple of friends. If every one clean up after himself, we would have lived in a nice and clean apartment. However, no one ever cleaned, so we all lived pretty filthy.

    • fulltimefinance@fulltimefinance.com
      [email protected] March 17, 2017

      Great example, this is why public restrooms are always so filthy.

  5. Ten Factorial Rocks (TFR)
    Ten Factorial Rocks (TFR) March 26, 2017

    Good post, and nice examples of how game theory adapts to real life situations. The main disadvantage of game theory is that it puts structural limitations on the options of players and even the number of players. Rarely are real-life business or financial situations so binary. But still, as a framework, it gives a useful ‘mental model’ as my mentor Charlie Munger would say.

    • fulltimefinance@fulltimefinance.com
      [email protected] March 27, 2017

      Very true, basic game theory is really modeling a single decision for 2 individuals. There are some applications for the combination of moves, but in general they are application specific. As you noted though, it is useful as a framework.

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