Question

The Ultimatum Game: A and B are two individuals who are to divide $100. A (chosen randomly by a coin toss) makes an offer to B. There is a minimum offer of $10. Assume, for simplicity, that offers must be evenly divisible by 10 (i.e., A can offer $10, or $20, or $30 etc.) B can either accept or reject the offer. If B accepts, they split the $100 as per the amount offered. For example, if A offers $20, and B accepts, then B gets $20 and A gets $80. Both players have full knowledge of the payoffs and rules of the game. If B rejects, both get nothing and the game ends. Assume that A and B have never met before and will never meet or play this game again, and both know it. Suppose you won the coin toss and you are A. Answer the following: What offer do you make? Why? What did you assume about B's motivation(s)?

Comment on the implications of assuming rational self-interest as the most important motivator for economic choices.

Answer 1

Assuming that both players have full knowledge of the game and are rational, I (as A) would have to make an offer to B that is in both our self interests. Given so, the offer should be such that B can't reject it, since if he rejects it, both of us get nothing. Since B is aware that the total amount is $100, the offer that I'd make would be of $50. This way, since B knows that he cannot get more than that (I am rational), he, as a rational individual will accept it. Both of us will walk away with $50 each.

Rational self-interest is when both the parties are better off than they were before the exchange since both of them is acting so as to maximize their own benefit. For any economic analysis, we have to assume that all parties are rational, they will take actions based on their utility. That is the ultimate motivator because that is what decides the payoffs. Rationality means individuals will attempt to maximize their payoffs.