How does game theory relate to public goods?

[lilaclouise]

In trying to write an essay I have manage to confuse myself with the connection between game theory and public goods. Game theory can surely be applied to public and private goods so why are public goods emphasised so much (particularly the 'tragedy of the commons' in my textbook on game theory?

[simplicitus]

Good question. Yes, game theory does apply to private goods as well, but it is considered anti-social to talk about it, and economists, particularly teachers, who do are likely to lose their jobs.

Public goods have the escape that the problems are so obvious that one almost can't avoid talking about it. One obvious example is the free rider problem:
http://en.wikipedia.org/wiki/Free_rider_problem
Another is, as you noted, the pollution of the commons, whether in the "Tragedy of the Commons" or in pollution of the air, of the water, etc.

You also see the same sort of discussion in the context of a few private goods, particularly insurance, where it can't be avoided:
http://en.wikipedia.org/wiki/Moral_hazard

As for the more general problem, the entire economy, as well as society, is built on trust.
http://www.forbes.com/2006/09/22/trust-e...rford.html
though some societies hold to the ideal more than others:
http://aidwatchers.com/2011/03/why-no-looting-in-japan

But as the Prisoner's Dilemma analysis points out, trust is irrational - a rational person does not trust but betrays the trust of others. So to recognize trust as the basis on which society and the economy are based is to give up on the notion of rational actors, particularly actors who act in their own best interest.

Furthermore (and this is where the politics gets very hot), if one looks at situations such as Prisoner's Dilemma, then it is clear that Samuelson's "invisible hand" doesn't work - there is no reason to believe that rationality generates optimal results and every reason to believe it doesn't.
http://http://www.propublica.org/article/the-subsidy-how-merrill-lynch-traders-helped-blow-up-their-own-firm

Some of this is hidden away under "Theory of the Firm". Firms exist because they bypass (some of) the self-interested competition between workers and make decisions beneficial for the whole.
http://krugman.blogs.nytimes.com/2011/02...ou-boeing/

Of course this can break down, sometimes spectacularly, as when managers gut the company for their own benefit:
http://www.propublica.org/article/the-su...r-own-firm

Most people sort of know this. The classic categorization of used car salesmen is one example. (The used car market is a classic example of market failure due to asymmetric information) And we've all seen the behavior of the banks with respect to foreclosures, etc. For every case of a corporation screwing the public that we've seen, how many are hidden?

When one looks closely, there are no pure competitive markets. All markets exhibit failures:
http://delong.typepad.com/sdj/2010/12/wh...ourse.html
And without perfection, there is no guarantee that the market actually works well.
http://en.wikipedia.org/wiki/Joseph_Stig..._asymmetry
In fact, the Greenwald-Stiglitz theorem proves that in the presence of either imperfect information, or incomplete markets, markets are not Pareto efficient - that is any imperfection in terms of meeting the conditions results in a less than optimum result.
http://www.princeton.edu/~dixitak/home/S..._Dixit.pdf

So what we have is an ideal of individual freedom and rational behavior that if it were realized would destroy society and is saved only by the irrational trust of most people, combined with the behavior of a few that take advantage of that trust to betray.

The evidence suggests that economists are less likely to be trusting than the rest of society. Can we afford to encourage truly rational behavior among more people by teaching them about game theory, etc.?

[Younes Lamdoun]

http://goo.gl/AtG3c
or
http://goo.gl/b32DF