Housefull Economics

Paresh Rawal Plays the Ultimatum Game

Our weekly explainer on economics using lessons from popular culture. In Installment 36, Malamaal Weekly demonstrates the Ultimatum Game.

In the film Malamaal Weekly, Paresh Rawal discovers fellow villager Anthony dead clutching a winning lottery ticket worth 1 crore. Obviously seeing an opportunity to claim the money for himself, he tries to pry it out of the dead man’s finger, when Om Puri walks in. So Rawal lets him in on the plan and promises to share the winnings with him. As the movie progresses, more and more villagers find out the truth and have to be convinced by Rawal to cooperate in fooling the lottery commission. If they all cooperate, they will all get money that they otherwise would not have.

There is a problem, however. A couple of villagers refuse to play along, ask for a bigger cut, or they will tell the lottery commission the truth. Unless everyone thinks they are getting a fair share, no one will get a penny. In the finest Bollywood tradition, the movie was plagiarized from an Irish movie Waking Ned Devine, and its producers must be waiting for their share of the profits from Malamaal Weekly.

Both movies are examples of something called the Ultimatum Game, which calls into question the Homo Economicus assumptions that most traditional Economics is based on. The game is simple and involves two players. Let’s call them Pinky and Rinky. I give Pinky 100 rupees. It is up to Pinky how much of the 100 rupees she wants to share with Rinky. Whatever offer she makes, if Rinky accepts it, they both get to keep their respective shares and walk away. But if Rinky declines, both of them leave empty-handed. So both of them making money hinges on two decisions – how much Pinky decides to offer Rinky, and whether Rinky accepts the division.

Homo Economicus assumptions suggest a straightforward solution – Rinky should accept whatever offer is made, because getting even 1 rupee is better than refusing the offer and getting nothing. And so Pinky should offer Rinky the least amount possible, say 1 rupee. However, almost every time this game has been played, from 1982 onwards when it was first introduced by Guth, Schmittberger, and Schwarze in a paper in the Journal of Economic Behavior & Organization, the results upend the assumptions. The average offer tends to be much larger than the minimum, usually in the 30-40% range. And the second person frequently rejects small offers, even if it means walking away with nothing, presumably because they consider it unfair. As the father of behavioral economics and recent Nobel laureate Richard Thaler once wrote in his paper on the Ultimatum Game, “notions of fairness can play a significant role in determining the outcomes of negotiations.”

And this brings us to the concept of fairness that seems hardwired into our mental make-up as human beings. (In fact, these results have also been replicated among chimpanzees.) The assumption that we will rationally and objectively make decisions in any situation to maximize our utility or gain does not seem to work, be it in the ultimatum game or in public policy or in life in general. Punishing someone else or preventing them from getting what we consider is an unfair reward seems to be common, even if we don’t personally benefit from it. After all, Suraj Randiv had no rational, tactical, or even selfish reason to bowl a deliberate no-ball to deny Virender Sehwag a century in a 2010 cricket match.

Versions of the Ultimatum Game and resulting decisions driven by notions of fairness are all around us. You flag down an auto rickshaw outside a multiplex after a late night movie show, and the driver demands 500 rupees instead of the 250 rupees you know it will be if he goes by the meter. You turn him down or haggle with him, not necessarily because the extra 250 rupees is a prohibitive cost for you, but because the demand seems unfair. The driver on his part could be thinking that if you can afford to pay 250 rupees for a movie ticket, why not share some of that wealth with him too? Both of you think you are Rinky and the other is Pinky.

Progressive taxation, where a higher income attracts a higher tax rate, is another real life variant of the Ultimatum Game. Wealthy people may end up using loopholes or tricks to effectively pay the same tax rate as a middle class person (or sometimes no tax at all like in the case of Donald Trump). But progressive taxation remains the norm in most countries in the world, because it seems fair, even if it might not end up being the most optimal way, and encourages tax evasion. Electorates and politicians around the world prefer to levy 40-50% in taxes on the wealthy, even if it means most of them not paying nearly as much in the end.

With growing interest in neuroeconomics and behavioral economics, researchers are trying to understand the antecedents of fairness. Scholars in fields such as cognitive neuroscience, evolutionary biology, and evolutionary game theory are using the Ultimatum Game and other similar experiments towards that end. In the Dictator Game, the recipient has no say on how the cash is split. In the Pirate Game, there are multiple players, majority voting, and eliminations every round.

As research progresses, we should get a better idea of where the innate sense of fairness comes from and how economic decision-making works.

About the author

Gaurav Sabnis

Gaurav Sabnis is an Assistant Professor of Marketing at the School of Business, Stevens Institute of Technology in New Jersey. He got his PhD in Business Administration at Penn State and previously worked in IBM in Sales & Marketing.