ECON 280 Final Project: Investment Dilemma Game

David Chen December 2013

Introduction
In our nal project, we looked for a way to analyze the behavior that rms

that when it comes to investing potential revenue streams. In particular, a situation we were interested in was energy companies balancing returning prots to shareholders and capital expenditures, particularly in situations where new technology is being developed. Many technologies, once developed, become easier to reproduce; the development of slick-water fracturing is an example of a technology that became prevalent a few years after development. This seems like a fairly relevant topic, as the development of alternative energy resources can somewhat be reected in the game we are developing. Developing new technologies dont provide a return on investment until fully successful, and often it will take a variety of companys spending money for one of them to emerge with the necessary technology, which then others can observe and potentially reproduce. In addition, altering the structure from dollars and technology to something like time and school group assignments shows such a situation can be expanded to other areas. Another way such a situation could be interpreted would be for countries investing in CO2 removal technologies, where they receive 1

benets only for successfully developing the technology after investments. In all these situations, we can have individuals or groups seeking to maximize their own payos, but maximizing them requires considering what others will do; in short, a perfect situation for game theory to be applicable. Collecting data will be somewhat useful; it can certainly see some natural tendencies of what people would do, particularly for more trivial situations such as group homework assignments and such. However, one could certainly expect large corporations in higher-scale situations to have much more sophisticated plan and understanding that wouldnt be reected on collecting data from normal individuals.

Model and Predictions

In the game we administered, we have groups of ve individuals in each game

as the players. Each player has a set of 100 reserves that they can exchange to prot or investment in a 1:1 manner. Prot is kept for the player, while investment goes into a larger pool together with all the other players. The investment pool has a tipping point that is below 120 total investment, with a total payo that is between 120 and 200 prot that will be distributed equally among players. The payo of the pool is uniformly distributed from 120 to 200; similarly, the tipping point of the pool is uniformly distributed between 0 and 100. Players are assumed to have linear utility functions. Players always know how much is currently in the pool and how much each player has put in. However, they only know that the tipping point is below 120 and the payo of the pool is above 120 (divide by 5 for individual payo) If the tipping point is reached, the payo is distributed and the game essentially ends, as player can then take whatever prots for themselves (the pool is not relled in any manner). As a constraint, players need to nish the game with

50 in reserves. Players have 5 rounds to make their investment/prot distribution choices. The game is played once. To solve this game, we use backwards induction. We will rst look at a 2 round game. We can begin in the nal round. Players know there is n investment currently in the pool. For the sake of simplicity, we assume a symmetrical solution where each player will contribute b investment into the pool. And so the nal pool amount is given by n + 5b. Should they reach the tipping point, the expected value of prot received from the pool is
160 5

= 32. If they do not, then they receive

0. Then the expected payo is given by: 32 b : n + 5b c Ue = b : n + 5b < c Since the tipping point range is uniformly distributed, the probability of the players hitting the tipping point is given by how much they put into the pool, and the range of where the cuto point could be: 5b 120 n

pt =

Now that we have expected payo and the probability of reaching c, we can write expected prot for the round as

Pe = (32 b)pt b(1 pt )

= (32 b)(

5b 5b ) b(1 ) 120 n 120 n

(32 b)5b 5b2 b+ 120 n 120 n

5b2 b(120 n) 5b2 160b + 120 n 120 n 120 n 120 n 160b b 120 n

Pe = As
Pe b

> 0, we pick the boundary point for pt = 1, giving us 120 n 5

b=

Meaning the players choose to put enough in to guarantee the pools payo during the second turn. With that context, we can nd the optimal turn one investment amount. As we know we are absolutely getting the pools payo, we can write: 5b 5b ) 24(1 ) 120 120 1 2 b 24

Pe = 32 b(

=8+b

Now taking the partial derivative in respect to b and setting to zero again: 1 Pe =1 b=0 b 12 b = 12 we see that the optimal strategy in the two turn game is to invest 12 in the rst turn. Where 32 is the payo players will bereceiving, b is the investment amount will players put in this rst turn, with
5b 120

probability that it will be the only

amount we need to put in, and 24 being the total the players will each put in if they do not hit the tipping point the rst turn, which occurs with probability

1 5b/120. We previously found that after the rst term, the players would ll out the pool to ensure the payo. However, using the one-shot deviation property to check for subgame perfect equilibrium, we nd that this is not the case and that there is a benet from deviating from this second turn strategy. After the rst round, n = 60. Should a player choose to deviate and not invest another 12 like the others, his expected prot is reduced by only (12/60) 32 = 6.4, which is less than the 12 he gains from not investing. And so it becomes clear that there would no incentive to invest after the rst round. This is the solution for a two round case. For games of greater steps, we would iterate the process. There are great number of assumptions in the theoretical model made to simplify the calculations. Adjustments to the assumptions of uniform distribution, linear utility functions for players, and symmetry of solutions would greatly alter and complicate the calculations. In particular, depending on the distributions of utility and the density functions of the tipping point and payo ranges, the probabilities would change greatly.

Results and Discussion

With exactly 25 people participating, we were able to have 5 people per group

as the game was designed for. In general, there was a great deal of communication and collaboration between the players, and Figure 1 shows that there was a great deal of symmetry between the players in terms of how much they were investing. The participants were, in general, quite aggressive in their investing. Knowing the oor was below 120, 4 out of 5 groups immediately invested 100 or more into investment pool, most of them hitting the 100 tipping point in the rst round and ending the game in the second. Except for a few people, most players attempted

to contribute the same amount to share the burden equally. Player 5 in group 5 was the only person who managed to take more than the equilibrium amount of 60 prot by investing 5 less than everyone else. It seems likely that unlike other groups, group 4 did not collaborate and went far beyond the tipping point due to aggressive individual investment. Due to the complication of modeling the game we administered, given the number of rounds and variability of assumptions, the theoretical model we present gives the solution to a two step game, which probably should have been the game we administered. But the fact that many of the groups aggressively completed the investment in one turn is at odds even with our two turn model, the discrepancy between what a full model would predict and the actual behavior is quite clear. For a game with more than two rounds, the reiterated process of generating probabilities would only make for slower pacing. The fact that even with ve rounds the groups rushed toward the investment targets indicate a striking deviation. It is unlikely that the sample of Middlebury students we had would have matched a theoretical, competitive model eectively anyway. For one thing, without anything at stake, it is unlikely people would take signicant eort in attempting to come up with an optimal strategy for playing the game. For many experiments, this is perhaps one of the largest issues. In addition, because of the relatively friendly atmosphere, there would likely be a greater amount of cooperation among the group of Middlebury students we used as players. The aggressive, organized investment made the game less about optimizing individual payo (as the goal was supposed to be), but rather hitting the investment as a whole. In particular, the incentives that result in the two turn models oneshot deviation dont seem to result in anything in our experimental case. As mentioned, only player 5 of group 5 chose to underinvest relative to the group, forcing someone else to pick up the investing he left o. Incentives to not invest

or free-ride simply didnt occur much. Due to the nature of our sample participants, this game could be best used as a reection of something along the lines of behavior of Middlebury students in group projects. I would be hesitant to expand our results to provide implications for our original topic of exploration, simply because of the relationships between the students in the classroom. Instead, it would be a strong reection of how Middlebury students behave in terms of group projects, and the way they attempt to share and balance something like personal time and group duties, trying to maximize the results for the group. At the same time, maybe having something to actually incentivize individual maximization would have yielded dierent results.

Additional
We also had an additional variation of the game where the payo from the

pool was distributed proportionally to the amount of investment, rather than the amount being xed. As we would expect, people tended to invest more in an attempt grab a greater share of the prots. As the pools payo did not increase with more investment, the end result was that most people ended up with less money than if they had not invested at all.

Appendix

Figure 1: Summary of Game 1, xed payos

Figure 2: Summary of Game 2, proportional payos