Investment Game Experimental Economics

introduction experimental economics powerpoint

Investment game experiments are a cornerstone of experimental economics, providing valuable insights into trust, reciprocity, and social preferences. The basic setup, pioneered by Berg, Dickhaut, and McCabe (1995), involves two players: an investor (Player A) and a trustee (Player B).

The investor receives an initial endowment. They then decide how much of this endowment to send to the trustee. The amount sent is multiplied by a factor (typically 3x) before reaching the trustee. The trustee then decides how much of the multiplied amount to return to the investor.

From a purely self-interested perspective, the investor should send nothing. If Player B is also purely self-interested, they will keep the entire tripled amount, as returning anything benefits neither their monetary gain nor their utility derived from monetary gain. Knowing this, Player A, anticipating Player B’s behavior, would rationally send zero. This outcome, a Pareto-inferior equilibrium, predicts a lack of cooperation.

However, experimental results consistently defy this prediction. Investors often send a significant portion of their endowment, and trustees frequently return a positive amount, albeit often less than the initial investment. This demonstrates that factors beyond pure self-interest influence behavior.

Several explanations account for these deviations. Trust is crucial; the investor trusts that the trustee will reciprocate. Reciprocity motivates the trustee to return some of the tripled amount out of a sense of fairness or obligation. Altruism or a preference for social welfare could also play a role. Further, individuals might employ inequity aversion, disliking unequal outcomes and preferring to reduce the difference between their payoff and the investor’s.

Variations on the basic investment game have been used to explore various factors. These include changes to the multiplication factor, adding punishment or reward mechanisms, introducing reputation effects (repeated interactions), and varying the social distance between players (e.g., playing with friends versus strangers). For instance, allowing investors to punish trustees who return less than a certain amount can increase cooperation, but at the cost of reduced overall earnings due to the punishment expenditures. Repeated games demonstrate how trust and reciprocity can build over time, leading to more efficient outcomes.

The investment game’s simplicity and clear structure make it a powerful tool for studying social preferences. It has implications for understanding a wide range of economic behaviors, from lending and investment decisions to organizational dynamics and international relations. While the game is an abstraction of real-world interactions, it provides a controlled environment to examine the psychological and social factors that drive cooperation and economic exchange.