Can you win this game? Behavioral economics says no

Editor’s Note: Let’s play the ultimatum game. Here’s how it works: I give your friend $20. He has to share a portion of his $20 with you and can give you as much as he wants. If you accept the offer, you get that amount, and he keeps the rest. If you turn down his offer, both of you get nothing.

Let’s say he offers you $2. Would you take it?

Economics correspondent Paul Solman sat down with Richard Thaler, who’s been called the inventor of behavioral economics, to learn about the ultimatum game. And in the process, he learned quite a bit about behavioral economics. Economic theory assumes that people make rational, selfish, and mathematical economic decisions. Behavioral economics, however, acknowledges that humans aren’t always rational. Enter the ultimatum game.

To learn how you fared, read the two conversations below. The following text has been edited and condensed for clarity and length. You can also Watch Thursday’s Making Sen$e segment on the subject.

—Kristen Doerer, Making Sen$e Editor

In Chicago’s Millennium Park, economics correspondent Paul Solman and behavioral economist Richard Thaler set about to play the ultimatum game. They ask an unsuspecting woman to join them.

Richard Thaler: We’re going to run a little experiment. And in this game, I give this gentleman [Paul Solman] $200.

Woman: Okay?

Richard Thaler: I tell Paul he can share some of the money with you. He can make you an offer. If you accept the offer, then you get what he offers you, and he keeps the rest. If you say “no,” neither of you get anything.

Woman: It depends on the offer, of course.

Richard Thaler: Okay. Let’s say, I give him $200, and he offers you $1. What do you say? Yes or no?

Woman: No.

Richard Thaler: No. How about $5?

Woman: No!

Richard Thaler: $10?

Woman: No!

Richard Thaler: $20?

Woman: No.

Paul Solman: I would have $180, you would have $20! That’s $20 you wouldn’t have had before.

Woman: Ok, I mean, why not? I would say yes for $20.

Richard Thaler: But not for $5.

Woman: No.

Paul Solman: Why? Because it doesn’t seem fair to you?

Woman: Well, $5 doesn’t change anything, you know? It’s so little. If I’m going to accept something, it has to mean something to me. I should be able to buy something with it, for example.

Richard Thaler: Okay. Now, suppose I had just given him $10. And he offered you $5. Would you have accepted that?

Woman: Yes, if that’s all the money he has.

Paul Solman: So, is how fair I am important to you?

Woman Turk: Yes.

Paul Solman: If I’m sharing 50/50—

Woman: I would say yes.

Paul Solman: Even though that’s the same $5 which you can’t do very much with?

Woman: But the total amount changes, you know? So, the total amount and how much you share is important in this case, I think.

Richard Thaler: Okay. So you would accept $5 from a $10 pie, but not from a $200 pie.

Woman: That’s true.

Richard Thaler: So that illustrates the point that we behavioral economists talk about, which is that people want to be treated fairly.

Woman: Definitely. I agree with you!

And now, the “Aha” Moment. Richard Thaler shares the secret behind the ultimatum game.

Paul Solman: When you play the ultimatum game, what’s the usual outcome?

Richard Thaler: Typically, all offers of less than 20 percent have a pretty good chance of getting turned down.

Paul Solman: What’s the average offer?

Richard Thaler: Most people make offers close to half—

Paul Solman: 50 percent?

Richard Thaler: Yes. However, that is not proof that they are trying to be fair. Instead, they may be worried about getting turned down. In fact, empirically, the profit maximizing offer is 40 percent. Because if you offer much less, you might get turned down. So it makes sense to be conservative when playing the ultimatum game, especially if you were playing at high stakes.

Paul Solman: But even at high stakes, people more or less split?

Richard Thaler: At high stakes, they make pretty generous offers, because remember, when you’re raising the stakes, you’re also introducing bigger risk. Let’s say you are playing the ultimatum game for $1 million—

Paul Solman: I’d go half and half, because I want to make sure the other person would take my offer. And if I was on the other side of the deal, I wouldn’t want to take less than half, because I would assume that the person making the offer would understand my notion of fairness. I would feel resentful if they took advantage of me.

Richard Thaler: Well, you might be quite resentful if you demanded half. I don’t think you would really demand half in a $1 million ultimatum game.

Paul Solman: Do you want to make an offer? We’ll see what happens.

Richard Thaler: I’m betting that you could be bought for $100 grand, Paul.

Paul Solman: Really? I don’t think I would take a $100 grand.

Richard Thaler: I don’t know. I’d like to hear you explain that to your wife.

Paul Solman: She would be behind me all the way. And that’s the truth. (Laughter.) So there’s a game show in England called Golden Balls, where at the end, the two contestants have to say they’re going to either take all the money, or split the money.

Richard Thaler: Right. This game is really the classic prisoners’ dilemma. And the way they play it on this show is you and I have won, say, $50,000. And we each have to say split or steal, and, if we both split, we both get half. If one says “split,” and the other says “steal,” the one who steals gets it all. If we both say “steal,” we both get nothing. Now, economic theory says, everybody’s going to steal. What people have found in laboratory experiments is about 40 to 50 percent of people split. Here was a chance to play this game at very high stakes. We found that the results were just like in the lab. About 40 to 50 percent of the people split, even at very high stakes.

Paul Solman: And then one guy, who seemed to know economic theory, played a particularly canny strategy, right?

Richard Thaler: There was one guy, his name is Nick, who said, “I want you to trust me. I’m going to steal. But, after the show, I’ll give you half the money.” The other contestant, Ibrahim, said, “Look, if you want to split with me, why don’t you just agree to split?” And Nick insisted, “No, no. I’m going to steal, but then I’m going to share it with you.”

Paul Solman: And, of course, the other contestant, Ibrahim, would be completely screwed if he also said “steal.”

Richard Thaler: Right. And, the show apparently went on for several minutes longer than usual while they tried to sort out whether this was legal or not. And should I spoil the ending?

Paul Solman: Go ahead.

Richard Thaler: At the last minute, the perplexed contestant, Ibrahim, seemed to change his mind and decided to split. And then, much to everyone’s surprise, Nick, the clever one, who made the offer in the first place also split.

Why is this Golden Balls episode significant? Nick, the clever one, understood behavioral economics. He had watched the show and noticed that most people followed the logic of traditional economics and stole, figuring it was their best option because no one would run the risk of sharing, and get taken advantage of. Nick wanted his partner to split, but couldn’t trust him to. So by convincing his opponent he was going to steal, he gave Ibrahim no option but to share. He then insured the sharing to which he was committed all along by himself choosing to split.

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