1

The Games Economists Play: Interactive Public Policy

Pennsylvania Capital CampusMarch 19, 2008

copies of this presentation can be found atwww.business.duq.edu/faculty/davies

The purpose of this simulation is to create a competitive market and to observe the market as it achieves equilibrium.

In this simulation, you will experience real market forces. The same human traits and behaviors that govern real markets exist in the simulation.

What are artificial are your surroundings. The market forces are real.

2

The Players and the Goals

In this experiment, there are CONSUMERS and FIRMS.

FIRMS manufacture stuff.

CONSUMERS buy stuff from FIRMS.

3

The Players and the Goals

Two types of firms

• Red Firms produce Red Stuff.

• Blue Firms produce Blue Stuff.

• Firms sell stuff to consumers.

Each firm’s goal: Maximize profit

4

The Objects

= 1 unit of Blue Stuff

= 1 unit of Red Stuff

= 1 dollar

Stuff

$

Stuff

= 50 cents (each)

5

Units Sold Total Cost Units Sold Total Cost

0 35.0 15 57.5

1 35.1 16 60.6

2 35.4 17 63.9

3 35.9 18 67.4

4 36.6 19 71.1

5 37.5 20 75.0

6 38.6 21 79.1

7 39.9 22 83.4

8 41.4 23 87.9

9 43.1 24 92.6

10 45.0 25 97.5

11 47.1 26 102.6

12 49.4 27 107.9

13 51.9 28 113.4

14 54.6 29 119.1

30 125.0

Each firm can produce a maximum of 30 units of stuff.

Every chip you sell constitutes 1 unit produced.

Chart shows the total cost of producing and selling various quantities.

6

Units Sold Total Cost Units Sold Total Cost

0 35.0 15 57.5

1 35.1 16 60.6

2 35.4 17 63.9

3 35.9 18 67.4

4 36.6 19 71.1

5 37.5 20 75.0

6 38.6 21 79.1

7 39.9 22 83.4

8 41.4 23 87.9

9 43.1 24 92.6

10 45.0 25 97.5

11 47.1 26 102.6

12 49.4 27 107.9

13 51.9 28 113.4

14 54.6 29 119.1

30 125.0

For example:

Firm starts with 30 units of Red Stuff.

Firm sells a total of 22 units at an average price of $4.00 per unit.

Production = 22 units.

Total cost = $83.40.

Total sales = ($4.00) (22) = $88.00

Profit = $4.60

7

Units Sold Total Cost Units Sold Total Cost

0 35.0 15 57.5

1 35.1 16 60.6

2 35.4 17 63.9

3 35.9 18 67.4

4 36.6 19 71.1

5 37.5 20 75.0

6 38.6 21 79.1

7 39.9 22 83.4

8 41.4 23 87.9

9 43.1 24 92.6

10 45.0 25 97.5

11 47.1 26 102.6

12 49.4 27 107.9

13 51.9 28 113.4

14 54.6 29 119.1

30 125.0

You do not have to sell all your stuff.

In fact, depending on what price you can get for your stuff, you’ll want to hold back.

For example:

Suppose you can sell your stuff for $4 per unit. How much should you sell?

8

Units Sold Total Cost Units Sold Total Cost

0 35.0 15 57.5

1 35.1 16 60.6

2 35.4 17 63.9

3 35.9 18 67.4

4 36.6 19 71.1

5 37.5 20 75.0

6 38.6 21 79.1

7 39.9 22 83.4

8 41.4 23 87.9

9 43.1 24 92.6

10 45.0 25 97.5

11 47.1 26 102.6

12 49.4 27 107.9

13 51.9 28 113.4

14 54.6 29 119.1

30 125.0

Sell 0 units

Sales = ($4.00) (0) = $0.00

Cost = $35.00

Profit = – $35.00

Sell 15 units

Sales = ($4.00) (15) = $60.00

Cost = $57.50

Profit = $2.50

Sell 30 units

Sales = ($4.00) (30) = $120.00

Cost = $125.00

Profit = – $5.00

9

Units Sold Total Cost Units Sold Total Cost

0 35.0 15 57.5

1 35.1 16 60.6

2 35.4 17 63.9

3 35.9 18 67.4

4 36.6 19 71.1

5 37.5 20 75.0

6 38.6 21 79.1

7 39.9 22 83.4

8 41.4 23 87.9

9 43.1 24 92.6

10 45.0 25 97.5

11 47.1 26 102.6

12 49.4 27 107.9

13 51.9 28 113.4

14 54.6 29 119.1

30 125.0

An easy way to decide whether or not you should sell more is to compare the price you get from selling one more unit to the additional cost of selling one more unit.

10

For example:

Suppose you have already sold 7 units.

A consumer offers you $5 for another unit.

Should you sell one more unit?

What is your current total cost?

7 units of output $39.90

What will selling one more unit do to your costs?

Increase total cost by $1.50

$5 extra sales exceeds $1.50 extra cost sell it!

The Players and the Goals

Workers consume stuff they buy from firms

Each worker’s goal: Maximize happiness

11

Consumers buy Red Stuff and Blue Stuff from the firms.

Consumers consume every-thing they buy.

Chart shows the happiness the consumer gets from consuming various quantities of stuff.

0 1 2 3 4 5 6 7 8 9 10

0 0 1 2 2 3 3 3 4 4 4 4

1 8 10 11 12 13 14 14 15 15 15 16

2 15 18 20 21 22 23 24 25 25 26 26

3 22 26 28 30 31 33 34 34 35 36 37

4 29 34 36 38 40 41 43 44 45 45 46

5 36 41 44 46 48 50 51 53 54 55 56

6 42 48 52 54 57 58 60 61 63 64 65

7 49 55 59 62 65 67 68 70 71 73 74

8 55 62 66 70 72 75 77 78 80 81 83

9 61 69 73 77 80 83 85 87 88 90 91

10 67 75 81 85 88 90 93 95 97 98 100

12

For example:

Suppose the consumer buys a total of 5 units of Red Stuff and 8 units of Blue Stuff.

The consumer’s total happiness is 54.

0 1 2 3 4 5 6 7 8 9 10

0 0 1 2 2 3 3 3 4 4 4 4

1 8 10 11 12 13 14 14 15 15 15 16

2 15 18 20 21 22 23 24 25 25 26 26

3 22 26 28 30 31 33 34 34 35 36 37

4 29 34 36 38 40 41 43 44 45 45 46

5 36 41 44 46 48 50 51 53 54 55 56

6 42 48 52 54 57 58 60 61 63 64 65

7 49 55 59 62 65 67 68 70 71 73 74

8 55 62 66 70 72 75 77 78 80 81 83

9 61 69 73 77 80 83 85 87 88 90 91

10 67 75 81 85 88 90 93 95 97 98 100

13

For example:

Consumer starts with $50.

Suppose that the price of Red Stuff is $2.00 per unit and that the price of Blue Stuff is $6.00 per unit.

What can the consumer buy?

0 1 2 3 4 5 6 7 8 9 10

0 0 1 2 2 3 3 3 4 4 4 4

1 8 10 11 12 13 14 14 15 15 15 16

2 15 18 20 21 22 23 24 25 25 26 26

3 22 26 28 30 31 33 34 34 35 36 37

4 29 34 36 38 40 41 43 44 45 45 46

5 36 41 44 46 48 50 51 53 54 55 56

6 42 48 52 54 57 58 60 61 63 64 65

7 49 55 59 62 65 67 68 70 71 73 74

8 55 62 66 70 72 75 77 78 80 81 83

9 61 69 73 77 80 83 85 87 88 90 91

10 67 75 81 85 88 90 93 95 97 98 100

14

($2.00) (1 Red) + ($6.00) (8 Blue) = $50

($2.00) (4 Red) + ($6.00) (7 Blue) = $50

($2.00) (7 Red) + ($6.00) (6 Blue) = $50

($2.00) (10 Red) + ($6.00) (5 Blue) = $50

For example:

Of these possibilities, the combination of 10 Red and 5 Blue yields the greatest happiness.

That is the combination the consumer should buy.

0 1 2 3 4 5 6 7 8 9 10

0 0 1 2 2 3 3 3 4 4 4 4

1 8 10 11 12 13 14 14 15 15 15 16

2 15 18 20 21 22 23 24 25 25 26 26

3 22 26 28 30 31 33 34 34 35 36 37

4 29 34 36 38 40 41 43 44 45 45 46

5 36 41 44 46 48 50 51 53 54 55 56

6 42 48 52 54 57 58 60 61 63 64 65

7 49 55 59 62 65 67 68 70 71 73 74

8 55 62 66 70 72 75 77 78 80 81 83

9 61 69 73 77 80 83 85 87 88 90 91

10 67 75 81 85 88 90 93 95 97 98 100

15

($2.00) (1 Red) + ($6.00) (8 Blue) = $50

($2.00) (4 Red) + ($6.00) (7 Blue) = $50

($2.00) (7 Red) + ($6.00) (6 Blue) = $50

($2.00) (10 Red) + ($6.00) (5 Blue) = $50

Accounting Phase

After all trading is done, players add up their chips.

Consumers report:

• Units of Red Stuff purchased.• Units of Blue Stuff purchased.

Firms report:

• Units of stuff remaining (i.e., unsold).• Money earned.

16

Trading Rules

Firms must remain in their seats.

Firms display cards indicating their ask prices.

Consumers may only purchase 1 unit of stuff at a time.

Purchase the unit, takes it back to your seat, go back and purchase another unit, etc.

17

Ready to begin…

18

Consumers: Spend all your $.

Firms: Only sell if it is profitable to do so.

19

= 1 unit of Blue Stuff

= 1 unit of Red Stuff

= 1 dollar

Stuff

$

Stuff

= 50 cents (each)

Accounting Phase

Workers report:

• Income earned• Unsold labor

Firms report:

• Blue labor hired• Red labor hired• Money remaining

20

Publicly Provided Good

The government has taxed each consumer $30. The government used the tax revenue to provide each consumer with 8 units of Blue Stuff.

Each consumer begins this round with 8 units of Blue Stuff.

Each Blue firm begins this round having already sold 16 units of Blue Stuff.

21

Ready to begin…

22

Consumers: Spend all your $.

Firms: Only sell if it is profitable to do so.

23

= 1 unit of Blue Stuff

= 1 unit of Red Stuff

= 1 dollar

Stuff

$

Stuff

= 50 cents (each)

Calculation Round

Workers report:

• Income earned• Unsold labor

Firms report:

• Blue labor hired• Red labor hired• Money remaining

24

Results…

25

0

20

40

60

80

100

120

Round 1 Round 2

Red Consumed Blue Consumed

26

0

20

40

60

80

100

120

140

160

180

Round 1 Round 2

Red Consumed Blue Consumed

27

$0.00$0.10$0.20$0.30$0.40$0.50$0.60$0.70$0.80$0.90$1.00

Round 1 Round 2

Red Price (per unit) Blue Price (per unit)

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$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

Round 1 Round 2

Red Price (per unit) Blue Price (per unit)

29

0

50

100

150

200

250

300

350

400

450

Round 1 Round 2

Happiness (odd, total) Happiness (even, total)

30

790

800

810

820

830

840

850

860

870

880

890

Round 1 Round 2

Happiness (odd, total) Happiness (even, total)

31

0

10

20

30

40

50

60

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Happiness Round 1 Happiness Round 2

32

-$140

-$120

-$100

-$80

-$60

-$40

-$20

$0

Red

1

Red

2

Red

3

Red

4

Red

5

Red

6

Red

7

Blue

1

Blue

2

Blue

3

Blue

4

Blue

5

Blue

6

Blue

7

Profit Round 1 Profit Round 2

33

When the government taxes to provide a good publicly, it forces consumers to consumer a quantity of the good that

they may not want to consume.

34

For non-economic reasons, it may be desirable to force consumers to consume a specific quantity of a

product.

But, it is important to be aware of the tradeoffs – what do you force the

consumer to give up?

35

What has been happening to the cost of health care over time?

36

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

1980

1981

1982

1983

1984

1985

1986

1987

1988

19

8919

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

06

Price of Medical Care Consumer Prices Excluding Medical Care

37

Source: Bureau of Labor Statistics (www.economy.com)

Price of medical care has increased 349% since 1980 versus 135% for other consumer prices.

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

450.0

500.0

1980

1981

1982

1983

1984

1985

1986

1987

1988

19

8919

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

06

Price of Physicians Services

Price of Hospital Services

Price of Prescription Drugs and Medical Supplies

38

Source: Bureau of Labor Statistics (www.economy.com)

Hospital services + 576%

Drugs and supplies + 402%

Physician services + 282%

Other consumer prices+ 135%

-800%

-600%

-400%

-200%

0%

200%

400%

600%

Co

lle

ge

Tu

itio

n

Me

dic

al C

are

Sta

te/L

oca

l Go

v't

(pe

r-c

ap

ita

)

Fed

era

l Go

v't

(pe

r-c

ap

ita

)

Ho

usi

ng

Foo

d

Ga

soli

ne

Ne

w C

ars

1 G

Hz

of

Co

mp

uti

ng

Po

we

r

Gro

wth

in P

rice

s 1

98

0

-20

06

39

Source: Bureau of Labor Statistics (www.economy.com)

The cost of health care is only one-half of the transaction.

What has been happening to the quality of health care?

40

41

7.5

8.0

8.5

9.0

9.5

10.0

1960

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Deaths per 1,000 People

Source: Statistical Abstract of the United States, 2008, Table 77.

0.0

5.0

10.0

15.0

20.0

25.0

30.0

1960

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Infant Mortality per 1,000 Live Births

42

Source: Statistical Abstract of the United States, 2008, Table 77.

0.0

10.0

20.0

30.0

40.0

50.0

60.0

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Deaths by Influence and Pneumonia (per 100,000 population)

43

Source: Statistical Abstract of the United States, 2008, Table 110.

How does one measure the quality of health care?

1. What is “quality?”

2. How do we account for health care that has become routine but didn’t exist in the past (e.g., pre-natal care)?

3. How do we weigh qualities across different types of care (e.g., dental, catastrophic, preventative)?

44

How does one measure the quality of health care?

An easy measure of the effectiveness of health care is the mortality rate.

Some health care may have little or no impact on the mortality rate (e.g., orthodonture).

But, it is not unreasonable to assume that the quality of other types of health care grow at the same rate as types of health care that directly contribute to reductions in the mortality rate.

45

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

1960

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Mill

ions

Actual Deaths in the Current Year Deaths at the 1960 Mortality Rate

46

Source: Derived from Statistical Abstract of the United States, and the Bureau of Economic Analysis.

Measuring quality of health care is difficult. We can use changes in the mortality rate as a proxy for changes in the quality of health care.

0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Health Care Share of GDP per 100,000 Lives Saved vs. 1960

47

Source: Derived from Statistical Abstract of the United States, and the Bureau of Economic Analysis.

In 1974, it was necessary to spend more than 9% of GDP on health care to reduce mortality by the equivalent of 100,000 lives (versus the mortality rate for 1960).

By 2006, spending less than 4% of GDP on health care reduced mortality by the equivalent of 100,000 lives (versus the mortality rate for 1960).

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

48

Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau.

The percentage of the population that is uninsured has remained stable over time.

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

1999 2000 2001 2002 2003 2004 2005 2006

Under 18 18 to 24 25 to 34 35 to 44 45 to 54 55 to 64

49

Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau.

Percentage of uninsured in each age group has remained relatively constant for the young and the old – the two groups for whom there is the least incentive to tradeoff of health care for spending on other things.

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

Under 18 18 to 24 25 to 34 35 to 44 45 to 54 55 to 64

Change in % of Uninsured 1999 to 2006

50

Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau.

Pattern of uninsured is commensurate with the hypothesis that, as the price of health care rises, the more healthy willingly choose not to be insured.

51

The Games Economists Play: Interactive Public Policy

Pennsylvania Capital CampusMarch 19, 2008

copies of this presentation can be found atwww.business.duq.edu/faculty/davies