Externalities Game

Essay submitted to
Prof. (Dr.) Rohit Prasad as part of AGT course
[Type the author name]

[Type the abstract of the document here. The abstract is typically a short summary of the contents
of the document. Type the abstract of the document here. The abstract is typically a short
summary of the contents of the document.]
Externalities are third party effects (positive or negative) arising from the production and
consumption of goods and services for which no appropriate compensation is paid. Externalities
cause market failure if the price mechanism does not take account of the social costs and benefits of
production and consumption. They are also known as spin-over or spill-over effects.

Negative externalities in particular are a concern because they result in the market producing too
much of a certain good or service causing loss of social welfare. They occur outside of the market,
i.e. they affect people not directly involved in the production and/or consumption of a particular
good or service.

To understand the effect of externalities / spill over affect, we played a game among
ourselves (MDI Gurgaon) and Arizona university students. It was an attempt to study the decision-
making process of individuals when trying to allocate shared resources among a group and therefore
test Coase’s theory that parties will be able to negotiate a transfer of payments that result in an
optimal allocation resources.

In order to carry out this game, an online group was formed where all the students (who had opted
for Game theory) from both the institutes were asked to register. They were then divided in to three
groups namely:

1) Luxury player
2) Intermediate player
3) Substantive player

A production range was decided by the game administrator for

Luxury player (0 – 10) Units

Intermediate player (0 – 155) Units

Substantive player (0 – 240) Units

These players were treated like developed countries (luxury), developing countries (intermediate)
and Underdeveloped countries (substantive player). There was a penalty associated with the
production level of each player representing the penalties for the harm an individual player is doing
to the community ( for example in the form of population) to increase his production. Production
would fetch the profit to player; more the production more the profit for the individual but it would
affect the other players profit negatively. A target of 90 profit points was given to each player and an
excel sheet was provided to stimulate the game before deciding the actual level of productivity.

All the participating students decided to form a coalition so that profit of all the students can be
maximized and regardless of the type of player all will achieve 90 points. After doing a lot of
permutation and combinations on excel sheet online discussion, it was decided that luxury player
will player produce 5 units, intermediate will produce 25 and substantive will produce 141 units.
These units were decided in order to maximise the collective pay off. However this whole cartel was
based on trust, if any player decided to break the cartel he could maximize his own payoffs on the
expense of others.
Finally, on the pre decided date for the submission of production, all players submitted their
production level to the game admin with the doubt in their mind that whether other players will
stick to the plan or will try to maximise their payoff by ditching others.

When the result came out next day, most of the players were able to achieve 90 points suggesting
that majority of the class played according to the plan; however there were few exceptions in each
group who betrayed the trust and were able to score more than 90 points.

Learning:

In collective action games, when a person’s action has effect on the payoff of all the other players,
we say that there are spill over or externalities, They can be positive or negative and lead to
individual driven outcomes that are not sometimes socially optimal when action creates negative
spill overs, they are overused from the perspective of society.

Social custom or convention, can lead to cooperative behaviour (as in our case), other possibilities
for solutions come from the creation of the norms of acceptable behaviour. Some of these norms
are internalized in individual payoffs; others must be enforced by the use of sanction in response to
the uncooperative behavior. Had there been a penalty for breaking the coalition in our game,
nobody would have gone against the accepted norms decided.