Social psychologists have invented an experiment they call the Ultimatum Game, which has direct applicability to how people interact in the markets. This is how it works:
Two players are matched anonymously and at random, say over a computer network. The first player is given a sum of money to divide between the two of them. For our purposes, let’s say they have to divide $10 in whole dollar increments and a minimum offer is $1. If the second player accepts the offer then they split the money as set by the first player. If the second player rejects the offer then neither of them gets anything. For example: if the first player offers $3 and the second player rejects the $3 as too stingy, then they both get $0.
[For more of the author's recent work, read: Can We Do Better? Ethics Needs to Come Out of Hiding.]
The game is only played once so that the second player cannot refuse a low offer in the hopes the first player will be more generous in subsequent rounds. And since neither player will ever know the identity of the other they need not worry about dealing with each other outside the game.
This game was analyzed by John Nash, a mathematician and winner of the 1994 Nobel Prize in Economics for his work in Game Theory. Nash, by the way, is also the subject of the movie A Beautiful Mind. He determined that since the second player is better off accepting whatever is offered then the first player should only offer $1 and keep $9. This is referred to as the Nash Equilibrium solution.
But do normal people play so rationally?
How do you play?
Take this poll and tell us how you play. In a few weeks I will tally the results and continue the discussion of what this game reveals about rationality, fairness and trading.