The Folk Theorem - Folk Week

ADDITIONAL CONTRIBUTORS Jess Goulart

By Jess Goulart

Photo by malias.

As a science based on complex mathematical constructs, economics gets a bad rap for being unreasonably difficult to grasp. In the simplest terms, the discipline seeks to explain and accurately predict human interactions on both micro and macro levels–an intriguing goal even if the proofs can’t be understood with less than a PhD.

One subset of economics is Game Theory, the study of conflict and cooperation, strategy and incentives, between rational decision-makers. Spanning psychology, political science, logic, and biology, it can be used to analyze poker and Monopoly, but also “games” with a slightly larger impact, like war, the stock market, and climate change.

It’s sort of like Risk…only real, and with math.

Within Game Theory is the Folk Theorem which, when put in plain English, basically states that patience allows for long-term cooperation between competing parties when there is an outside threat. Alex Teytelboym, a postdoctoral scholar at MIT who received his PhD in Economics from Oxford, expands on the subject for BTR.

“The motivation behind the Folk Theorem is to understand why people cooperate. Because in strategic situations it seems like there are ways people should act that are going to improve their stations, and instead we’ve observed that people will cooperate over a long period of time rather than gain the advantage,” Teytelboym explains. “The results say that if both parties find themselves in a circumstance where if everybody acts in their own selfish interests the outcome is going to be very bad, and find themselves in that same place over and over again, and are patient, they will cooperate. And the threat of punishment is enough to motivate them to continue to cooperate.”

Long before any hard data existed to support it, the Folk Theorem was accepted as true in economic circles. A sort of folk wisdom, so to speak, that intuitively made sense.

For example, take two meerkats sitting in the desert, one looking East, and one looking West. Looking out is tiring for the meerkats, they’d much rather just go to sleep, but each knows that if either closes their eyes the lion will come and eat the whole colony. So they fight their natural selfish instincts and instead work together to protect their community. Easy, right? Or at least, easier than this; (1-delta) sum_{t geq 0} delta^t u_i(h_t).

Outside of the animal kingdom, the Folk Theorem can be applied to all manner of complex situations where cooperation exists.

Tetylboym explains that he often flies direct from London to Boston and there are few carriers that make this trip. The airlines that have it find themselves in a strategic situation, because at any time they can undercut the other carriers in price and gain more passengers. But they don’t. Why not?

“If everyone undercuts themselves, these companies would find they make very little profit,” says Teytelboym, “and in the end these companies end up colluding instead. All of them keep their prices higher. Everybody wants to undercut but they’re worried if they try once they’ll end up making no profit for years because the other companies will punish them.”

Folk Theorem depends greatly on imminence of punishment. As a threat gets more tangible, parties cooperate more readily. It’s difficult for people to be afraid of things they feel won’t affect them, which is possibly the reason we don’t see cooperation yet between countries in regards to emissions. For the airlines, the threat of no return for their investors is immediate, so they respond. Climate change is too far off, particularly for first worlders who don’t have immediate contact with inhabitants of the 11 islands that will shortly disappear due to rising sea levels.

The Folk Theorem is also specific to repeated circumstances. In a “one-shot” situation other theories better explain behavior. For example, the Prisoner’s Dilemma addresses two players who are facing a one-time punishment. If one player betrays the other, their punishment decreases, and vice versa. Logic dictates that both players should act in their own self-interest and betray one another to lessen their own punishment. However, people have been shown to hold a bias toward cooperation even when facing one-shot deals. A more accurate prediction of behavior takes into account people’s imagining the game being played with formed coalitions.

This empathy for your opponent or community is based on an inherent sentimentality, a concept most people think economics ignores because of its dependency on cold hard calculations. But Teytelboym assures that’s not the case.

“Folk Theorem and Prisoner’s Dilemma are classical economics that involve self-interest. But of course, humans are very different because we exhibit emotions like altruism and often act in a way that doesn’t just make us better off but people around us better off. We care about our identities and communities, so we have to take that into account when predicting economic trends. Good economics,” he concludes, “does just that.”

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