22. Repeated games: cheating, punishment, and outsourcing

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Game Theory (ECON 159)

In business or personal relationships, promises and threats of good and bad behavior tomorrow may provide good incentives for good behavior today, but, to work, these promises and threats must be credible. In particular, they must come from equilibrium behavior tomorrow, and hence form part of a subgame perfect equilibrium today. We find that the grim strategy forms such an equilibrium provided that we are patient and the game has a high probability of continuing. We discuss what this means for the personal relationships of seniors in the class. Then we discuss less draconian punishments, and find there is a trade off between the severity of punishments and the required probability that relationships will endure. We apply this idea to a moral-hazard problem that arises with outsourcing, and find that the high wage premiums found in foreign sectors of emerging markets may be reduced as these relationships become more stable.

00:00 - Chapter 1. Repeated Interaction: The Grim Trigger Strategy in the Prisoner's Dilemma (Continued)
29:21 - Chapter 2. The Grim Trigger Strategy: Generalization and Real World Examples
37:56 - Chapter 3. Cooperation in Repeated Interactions: The "One Period Punishment" Strategy
53:09 - Chapter 4. Cooperation in Repeated Interactions: Repeated Moral Hazard
01:13:53 - Chapter 5. Cooperation in Repeated Interactions: Conclusions

Complete course materials are available at the Open Yale Courses website: http://open.yale.edu/courses

This course was recorded in Fall 2007.