A REPORT

ON

‘A Game-Theoretic Framework of
Trust’
by Arjen van Witteloostuijn

BY

Name of the Student ID Number

Baasit Sharief 2016AAPS0209H
Ashwin Nallan 2016A7PS0013H
Shashank Shekhar 2016A7PS0085H
Utsav Kaushik 2016A3PS0272H

Assignment 2 for BITS F314

BIRLA INSTITUTE OF TECHNOLOGY AND SCIENCE, PILANI

April, 2019
 Table of Contents

Trust as a concept 2

Game theory 3

Game theory of Trust 4

Trust In Game Theory 6

Game theory with Trust 8

Game theory and Trust 9

Trust Future 11

Page | 1
 TRUST AS A CONCEPT
There has been a lot of discussion about what the meaning of trust is as a
concept. Trust as a concept has gained momentum in many corners of the social
sciences. Fukuyama (1995) extended its application to a macro-level, stating that
a nation’s trust culture is a sign of the country’s character and performance. The
given paper by thus tries to explain the purpose of trust in the domain of
economics rather than the other aspects like personal relationship, as it is not of
much relevance.
According to most non-economists, trust is argued not to be a part of mainstream
economics, but rather instrumental in explaining phenomena if an orthodox
theory were to fail. However, this argument in itself is wrong, because a lot of
orthodox theories are based on multidisciplinary study of trust. In order to
analyze it, employing of game theory eases the task managing economics at large.
It helps in studying the actions taken by two players, or say Industries which have
conflicting interests. This makes it easier to analyze trust-related issues. Trust and
Cooperation are closely linked when it comes to economics. Cooperation is
non-opportunistic behavior that is facilitated by an atmosphere of trust or that
produces a feeling of trust. That is, cooperation can be seen as (not always) an
observable consequence of the unobservable cognition of trust. At the end, Trust
is related to the non-opportunistic behavior of a party in the face of a beneficial
opportunity.
Lastly, This article by Arjen van Witteloostuijn has three remarks worth making.
First, this includes only basic game theory, to give an idea how much game theory
has to offer for the study of trust. Second, is that the paper consists of bits and
pieces of original research, the most emphasis is put on essay like argument.
Third, is that the study of trust should be from a multidimensional approach
rather than only one single way.

Page | 2
 GAME THEORY
Before moving to issues about trust, basic game theory, as in large, the
non-cooperative game theory of duopolies i.e. a game where both the
organizations don’t explicitly communicate with each other. From the below
Bertrand Duopoly, we can easily Illustrate on how the Nash equilibrium can be
derived. Both firms, operate in the same market In this both players have two
actions, either to set the price high(H) or low(L) and sell the identical
homogeneous products and equally efficient.

In the above table, the pay-off have been as profits for each case. The 4 cases -
(L,L) , (L,H), (H,L) and (H,H).
1. (L,L) gives off a both a negative pay-off £30,000.
2. (L,H) and (H,L) gives a very high positive pay-off of £600,000 to the firm that
keeps low price and a loss of £600,000 to the one keeping it at a high price.
3. But, when both keep it H, they both get a £300,000 profit, which is
beneficial to both.
Notice, that at (H,H) both firms have the opportunity to get a higher profit by
lowering their prices on the cost of the other suffering a very heavy loss. Since,
both the companies know that, they’ll put lower prices, thus, giving us the Nash
Equilibrium. This happens where there is no trust/communication between the
two firms. If both the companies trust each other to go for a cooperative move,
the actions played will be very different and can result in both getting profits. The
paper further explains how trust creates following change.

Page | 3
 GAME THEORY OF TRUST
As the name suggests, it relates the competition of two firms into strategies of
trust and distrust. That is, it analyzes the cases where the rivalry in which
untrustworthy and trustworthy strategies fight for dominance. Suppose Firm I and
Firm II have formed alliances, with the aim of maintaining a high-price cartel. So
this implies the high-price strategy being the trustworthy so as no one suffers a
loss due to the aggressively low prices set by the other. Thus, trustworthy
behavior implies a cooperative interaction whereas the untrustworthy relates to a
competitive interaction.
This leads to four outcomes. First, if firm I and firm II chose to go for the
untrustworthy strategy and both suffer an equal amount of loss D, and reciprocal
opportunism rules the game. Second, when firm I choose the untrustworthy
strategy whereas firm II chooses to be trustworthy, resulting in a very low and
naive payoff N for firm I and a high and opportunistic payoff O for firm II. Third is
the vice versa of the second. And the last is when both show a trustworthy
behavior, and set a high price for their goods and a symmetric trust payoff T is
obtained, which, we can see, is obtained only through mutual cooperation.

The payoff structures is very determinant in how the game will played and where
the equilibrium/outcome can be established. Generally, when O>T>D>N the
classic ​Prisoner’s dilemma​ arises. It is likely that bad money drives out the good
money i.e. in many games of trust between firms, it has a nasty tendency to take
the shape of the ​Prisoner's dilemma​. Two arguments can be used to support this.
First, the survival of the fittest can be used by the untrustworthy firms to drive
out the trustworthy counterparts from the market. This may happen in two ways -

Page | 4
1. Selection processes imply that profitable companies outcompete their
loss-making rivals. This is the reasoning by standard economics. If N<<<O, the
game becomes similar to a ​Prisoner’s dilemma​ which will result in the
untrustworthy companies outperforming the trustworthy ones. In other words,
“​Aggressiveness drives out Peacefulness​”-as stated by van Witteloostuijn. In the
second place, if a firm learns from their experience, most trustworthy firms resort
to untrustworthy strategies when faced with loss-making situations. This can be
explained by the well-known tit-for-tat strategy. It can be used to state that once
a firm resorts to untrustworthy strategies, it is very likely that the rival will also
resort to untrustworthy strategy, implying a collapse in the trust equilibrium that
is very difficult to restore, which can be explained by the standard retaliation due
to the breaking of trust between two parties. For reasons like this, an enriched
study of game theory is needed to be done to ensure a higher probability of trust
equilibrium.

Page | 5
 TRUST IN GAME THEORY

Trust in game theory explores mechanisms that may promote trust. In this
context, the rules of the game are of key importance. Not very surprisingly, actual
human behavior more often than not deviates from the ideal one. However, at
the aggregate (market) level, the rules of the game do matter. A switch from
finite to infinite horizon often increases cooperation and trustworthiness. Boone,
De Brabander, and Van Witteloostuijn (1999a, 1999b) and Boone et al. (2002)
report results from three experiments with five different versions of Bertrand’s
duopoly.
Each experiment includes 5 games. Games 1 and 2 are one-shot games, and
games 3 to 5 are repeated Bertrand duopoly games, with Game 4 having an
infinite horizon. In experiments A and C in Games 1 and 4, there is a clear jump in
average trustworthy behavior from the one-shot to the infinite-horizon game, as
predicted by game theory's Folk Theorem. However, there is a decrease in
average trustworthy high-price setting behavior from Game I to IV in Experiment
B.
These simple experiments illustrate a general pattern in the experimental game
theory literature: the rules of the game do indeed matter, in ways suggested by
formal game theory, albeit imperfectly so. trustworthy behavior. For example, the
above finite-horizon effect suggests that including an explicit end-date clause in
interorganizational alliance contracts is likely to trigger untrustworthy behavior.
This observation follows from the logic of the backward-induction principle,
because the alliance contract resembles a finite-horizon supergame. That is, if the
end date of the alliance is agreed upon in advance, all alliance partners involved
can apply ex ante backward-induction reasoning to guide decision making as to
whether or not to behave cooperatively over the alliance period. Apart from the
horizon effect discussed above, three other examples may illustrate what game
theory has to offer here.
Discount factor​: A higher discount factor induces more patience, which in turn
stimulates trustworthy behavior. So, a culture of short-termism, such as is
reflected in U.S. shareholder value capitalism, is bound to produce untrustworthy
behavior, whereas the reverse holds true in cultures of long-termism, such as in
Asian types of capitalism, where trustworthy strategies likely to dominate
Page | 6
(Gordon 1996).
Payoff structure:​ The payoff structure of the game shifts in favor of cooperative
equilibria if the profit from opportunism is decreased and/or the benefit from
cooperation is increased. For example, governmental regulation may stimulate
competition, as is the case for U.S.-style antitrust law, or promote cooperation, as
the European Union (EU) has done via a series of EU innovation programs that
subsidize technology alliances (van
Multicontact density:​ Organizations can increase their mutual dependency by
developing a large number of contacts, as this raises the likelihood and damage of
retaliation.
The institutional rules of the game, as embedded in the "hard" and "soft"
institutional contexts, drive individual behavior toward untrustworthiness or
trustworthiness. This trust-in-game-theory logic implies that the rules of the
game, broadly defined and largely determined outside the realm of influence of
the players involved, might or might not promote trustworthy behavior.

Page | 7
 GAME THEORY WITH TRUST

A game theory with trust emerges when conventional and rigid economic theories
are linked with the psychological behavior of humans, thereby borrowing ideas
from the field called “behavioral economics”. Behavioral economics has a very
new theory as a foundation but it has been modified and appended by the
psychological notions of human behavior. There are two related sub-branches of
behavioral economics. The first study, headed by Nobel prize winner Gary Becker,
involves developing models in which the players are guided by utility functions
based heavily upon behavior. The second one is in conjunction with experimental
economics, decisions made by humans are guided by a bigger set of stylized facts
about human behavior. Both these branches display a significant deviation from
the conventional neoclassical theory.
Behavioral economics majorly concentrates on independent players such as
consumers. When we come to managerial economics, theories deviate from the
assumption that firms only act on maximizing profits and consider the possibilities
of firm basing their actions on non-profit motives. Good examples include models
that have size- related motives in the firms’ utility functions. An important
observation made from these models is that the non-profit firms actually turn out
to be larger and more profitable than their profit motivated counterparts because
they turn into monopolistic survivors.
A new field of study is the combination of behavioral and managerial economics.
Not much literature exists on theories that include the altruistic side of firms’
actions. The non-profit firms we talked about are motivated by self centered
motives like size, reputation, status, etc. A firm’s altruistic intents can be included
in its utility functions. For example, an axis which measures the firm’s intent to
care for the employees and the environment might be part of the organizational
utility function. Similarly, more utility functions can be introduced for all the firms
in competition and a new game theory with trust will emerge when we analyze
along the lines of managerial economics.

Page | 8
 GAME THEORY AND TRUST

Game theory and trust is used to understand the repercussions of the

Heterogeneity of trust, which is also the main reason of the genesis of this entire
concept. Type of behaviour is important for the society, from conducting various
experiments it can be said that trust depends on familiarity of the individuals to
each other, which means trust is less likely to get developed among anonymous
player unlike familiar players in the context of games. Even though the direct
effects of familiarity cannot be seen too often but indirect effects can be observed
very frequently in social life and this indirect effect is promoted by the daily social
activities.
Trust Heterogeneity arises because of the distinct behaviour of each individual
(player). Trusting someone is not always the rational choice in games and making
decisions based on the trust factor may lead to loss in a game.
The recent development of the strategic games allowed us to study the effects of
games and trust and Trust Game(TG) is most profound game to study.
TG starts with a player who can cheat or cooperate with other player, cheat
means giving nothing to the other player and cooperate means giving a coin to
other player and there is a predefined factor (f), other player also has the same
set of actions. If player 1 cheats then player 2 gets 0 coins and if player 1
cooperates then player 2 gets f coins and similar outcomes are available for player
1.
The decision of each player measures trust in this game, this game has
demonstrated very similar trust results over the years of development and
experimentations. Player who are familiar to each other tend to trust each other
more and get better outcomes than players who are not familiar with each other
although results in multi stages of the game become unpredictable and the
behaviour gets complicated to observe a really concrete pattern.

Page | 9
 Figure 1
The Trust Game Schematic.
From a wide perspective, the same observations can be applied to conclude the
behaviour of a group of people such as country in some specific games
(situations), which is helpful to determine the expected behaviour of a person in a
country or society. This theory may also lead to important conclusions in very
sensitive cases like war between two countries, such conditions give countries
opportunities similar to the trust game.

Page | 10
 TRUST FUTURE

Any time two parties with conflicting interests interact, a game is formed. In the
interorganizational world, conflicting interests are the rule rather than the
exception, implying that games of trust abound. The players’ features and the
game’s rules decide whether or not such games of trust are associated with
trustworthy behavior. Trust in game theory indicates the conditions under which
trust- worthy behavior can be expected. In addition, the players' characteristics
are crucial. A game theory with trust is flourishing in behavioral economics but is
yet to be developed for a situation that deals with organizational behavior rather
than individual behavior. In this context, the literature about game theory and
trust may offer a source of inspiration, since ample evidence has been collected
as to the origins and consequences of trust heterogeneity.
Of course, much more can be said about a game-theoretic framework of trust -
let alone about the multidisciplinary merger of the latter with insights from other
disciplines. For example, signaling games might be very informative, as may be
the cooperative game theory of bargaining. By bringing together insights from
various disciplines, a deeper understanding of trust - in different contexts and
from different origins, may emerge. Trust is a crucial determinant of not only
intra- and interorganizational behavior and performances, but also those of
societies at large, and hence a further development of a theory of trust is
important.

Page | 11
Page | 12