Incentives, expectations and game theory

Define what an economic incentive is and classify the following as a positive or negative incentive: a double-parking fine, a discount for paying the annual gym fee in one go, and a tax credit for installing solar panels. Justify each classification.

A supermarket starts charging $0,15\ \text{€}$ for each plastic bag, which were previously free.

1. a) What incentive does the charge create and who does it act upon?
2. b) Predict what will happen to the number of bags used and explain the mechanism.

Distinguish between monetary and non-monetary incentives, and classify the following: a medal for the best academic record, a bonus in your pay packet, the embarrassment of arriving late, and applause from the audience. Add one example of your own of each type.

A school pays pupils $2\ \text{€}$ for every book they read and discovers that they all choose the thinnest, simplest books. Explain what a perverse incentive is and why this reward is an example: what behaviour did it seek and what has it actually caused?

A nursery fined parents who arrived late to pick up their children and, against all expectations, lateness increased: the cheap fine turned embarrassment into a paid service.

1. a) What has gone wrong with the incentive?
2. b) What does this case teach about the difference between monetary incentives and moral or social incentives?

After taking out fully comprehensive insurance, some cyclists leave their lock loose or park in theft-prone areas.

1. a) What is this phenomenon called (moral hazard) and what does it have to do with incentives?
2. b) Explain what insurers do to limit it (excesses, no-claims bonuses) and why these measures work.

Explain what expectations are in economics and why they matter. Illustrate it with this case: word spreads that petrol will go up on Monday and on Sunday queues form at petrol stations. What has driven people: today's price or the one they expect tomorrow?

The Government announces that in three months it will raise the tax on sugary drinks.

1. a) What can consumers and shops be expected to do before the increase?
2. b) Explain what role expectations play in that reaction.

If all workers and firms expect prices to rise by $5\ \%$, collective agreements demand $5\ \%$ increases and firms pass them on to prices, which end up rising by $5\ \%$.

1. a) Explain in what sense the expectation has fulfilled itself.
2. b) Why are central banks so concerned about "anchoring" inflation expectations? Reason your answer.

What is a strategic decision, one in which your best option depends on what others do? Give two everyday examples (choosing the supermarket queue by looking at the others, deciding whether to leave for break early to avoid queuing at the cafeteria) and explain what you are anticipating in each one.

In game theory, a "game" has players, strategies and payoffs. Identify those three elements in this situation: two friends must choose, without agreeing beforehand, between going to the cinema or to the park, and they only truly enjoy it if they end up together.

Two food trucks must choose where to park on a one-kilometre seafront promenade. Customers go to the nearest truck and, in the event of a tie, they split between them.

1. a) Reason why, if each one chooses while thinking about the other, both end up parking together in the centre.
2. b) Is that the best outcome for the people strolling by? Relate the game to the difference between individual interest and collective outcome.

The figure shows the payoff matrix of a prisoner's dilemma between two rival bakeries deciding whether to lower their prices or maintain them. The first number in each cell is the profit of Pastelería Alba and the second is that of Pastelería Bego, in thousands of euros.

1. a) What profit does each bakery get if both maintain prices? What if both lower them?
2. b) If Alba lowers prices and Bego maintains them, who comes out winning and by how much?

In the prisoner's dilemma, both players end up worse off than if they had cooperated.

1. a) Explain why, despite this, each has reasons not to cooperate.
2. b) Give a real-life example (in class, sports, or among neighbours) with the same logic and analyse it in the same way.

"Norte" and "Sur" are the only two ice cream parlours on a seafront promenade. If both sell an ice cream cone for $3\ \text{€}$, they each make $500\ \text{€}$ per week; if one lowers the price to $2,50\ \text{€}$ and the other does not, the one that lowers it makes $750\ \text{€}$ and the other $200\ \text{€}$; if both lower it, they each make $300\ \text{€}$.

1. a) Construct the payoff matrix and analyse what each ice cream parlour will do if they cannot reach an agreement.
2. b) Compare that outcome with the one they would achieve by cooperating and explain the paradox.