Overcoming Prisoner's Dilemmas through tough bosses

What does the economic theory of group behavior - including the underlying precepts of rationality - have to do with the direct interest of MBA students who seek to run businesses and direct the work of others? In a word, "plenty." Throughout the rest of this book, we demonstrate how the "logic" is central to how competitive markets (and cartels) work (or don't work), and we discuss a multitude of ways to apply the "logic" directly to management problems. For now, we can stress a maxim that emerges from the economic view of group behavior: people often rationally spurn tough jobs, unless compensated for the personal cost and displeasure involved in them. Being a tough boss is one such job that is difficult, but a boss who isn't tough might not be worth much. And because tough bosses are valuable and lenient bosses are not, existing organizational arrangements are likely to discipline pain-avoiding bosses to ensure that they impose strict discipline on the workforce. Competition will press firms to hire tough bosses, and, as we shall show in this chapter, the owners of the fU"ID, or their manager-agents, not workers, will tend to be the bosses. That is to say, owners or their agents will tend to boss workers, not the other way around, for the simple reason that worker-bosses are not likely to survive in competitive markets. Workers may not like tough-bossed firms but, as we explain, workers can be better off with tough bosses - and will rationally seek to work in firms that employ tough bosses.

Take this job and ...

Though probably overstated, common wisdom has it that workers do not like their bosses, much less tough bosses. The sentiment expressed in Johnny Paycheck's well-known country song "Take This Job and Shove It" could be directed only at a boss. Bosses are also the butts of much humor. There is the old quip that boss spelled backward is "Double SOB." If it were not for an element oftruth contained in them, such comments would be hopelessly unfunny. Bosses are often unpopular with those they boss. But tough bosses have much in common with foul-tasting medicines for the sick: you don't like them, but you want them anyway because they are good for you. Workers may not like tough bosses, but they willingly put up with them because tough bosses mean higher productivity, more job security, and better wages. The productivity of workers is an important factor in determining their wages. More productive workers receive higher wages than less productive workers. Firms would soon go bankrupt in competitive markets if they paid workers more than their productivity is worth, but firms would soon lose workers if they paid them less. Many things, of course, determine how productive workers are. The amount of physical capital they work with, and the amount of experience and education
67

68

Microeconomics for MBAs The inclination to shirk on the job

Other workers None shirk Some shirk All shirk

Table 2.1

.,

Jane

Don't shirk Shirk

100 125

75 100

25 30

(human capital) they bring to their jobs are two extremely important, and commonly discussed, factors in

worker productivity. But how well the workers in a firm function together as a team is also important. An individual worker can have all the training, capital, and diligence needed to be highly productive, but productivity will suffer unless other workers pull their weight by properly performing their duties. The productivity of each worker is crucially dependent upon the efforts of all workers in the vast maj ority of firms. Although each worker wants other workers to work hard to maintain the general productivity ofthe firm, each worker recognizes that (at least in very large firms) her contribution to the general productivity is small. By shirking some responsibilities, she receives all the benefits from the extra leisure, but suffers only a very small portion of the productivity loss, which is spread over everyone in the firm. She suffers, of course, from some of the productivity loss when other workers choose to loaf on the job, but she knows that the decisions others make are independent of whether she shirks or not. And if everyone else shirks, little good will result for her, or for the firm, from diligent effort on her part. So no matter what she believes that other workers will do, the rational thing for her to do is to capture the private benefits from shirking at practically every opportunity. With all other workers facing the same incentives, the strong tendency is for shirking on the job to reduce the productivity and the wages of all workers in the furn, and quite possibly to threaten theirjobs by threatening the firm's viability. The situation just described is another example of the general problem of the logic of group behavior - or, more precisely, a form of the Prisoner's Dilemma that we considered earlier.

Game theory: Prisoner's Dilemma games in the workplace

Consider a slightly different form of the Prisoner's Dilemma that is described in the matrix in table 2.1, which shows the payoff to Jane for different combinations of shirking on her part and that of her fellow workers. No matter what Jane believes others will do, the biggest payoff to her (in terms of the value of her expected fmancial compensation and leisure time) comes from shirking. Clearly, she hopes that everyone else works responsibly so that general labor productivity and the Principles of rational behavior in society and business Table Shirking in large worker groups 2.2
Other workers None shirk Jane Don't shirk Shirk Some shirk All shirk

100 95

75 70

25 0

firm's profits will be high despite her lack of effort, in which case she receives the highest possible payoff that anyone individual can receive, 125. Unfortunately for Jane, all workers face payoff possibilities similar to the ones she faces (and to simplify the discussion, we assume that everyone faces the same payoffs). So, everyone will shirk, which means that everyone will end up with a payoff of 30, which is the lowest possible collective payoff for workers. Workers are faced with self-destructive incentives when their work environment is described by the shirking version ofthe Prisoner's Dilemma. It is clearly desirable for workers to extricate themselves from this Prisoner's Dilemma. But how? In an abstract sense, the only way to escape this Prisoner's Dilemma is somehow to alter the payoffs for shirking. More concretely, this requires workers to agree to subject themselves collectively to tough penalties that no one individual would unilaterally be willing to accept. Although no one likes being subjected to tough penalties, everyone can benefit from having those penalties imposed on everyone, including themselves.

The situation here is analogous to many other situations we fmd ourselves in. For example, consider the problem of controlling pollution that was briefly mentioned in chapter 1. Although each person would fmd it convenient to freely pollute the environment, when everyone is free to do so, we each lose more from the pollution of others than we gain from our own freedom to pollute. So, we accept restrictions on our own polluting behavior in return for having restrictions imposed on that of others. Polluting and shirking may not often be thought of as analogous, but they are. One harms the natural environment and the other harms the work environment. Workers may not like bosses who carefully monitor their behavior, spot the shirkers, and ruthlessly penalize them, but they want such bosses. The penalties on shirkers must be sufficiently harsh to change the payoffs in table 2.1 and eliminate the Prisoner's Dilemma. If Jane had a boss tough enough to impose 30 units of cost on her (and everyone else) for shirking, her relevant payoff matrix would be transformed into that shown in table 2.2. Jane may not like her new boss, but she would cease to fmd advantages in shirking. And with a tough boss monitoring all workers, and unmercifully penalizing those who dare shirk,

69

B
70 Microeconomics for MBAs

Jane will fmd that she is more than compensated because her fellow workers also have quit shirking. Instead of being in an unproductive firm, surrounded by a bunch of other unproductive workers, each receiving a payoff of 30, she will fmd herself as part of a hard-working, cooperative team of workers, each receiving a payoff of 100. The common perception is that bosses hire workers, and in most situations this is what appears to happen. Bosses see benefits that can be realized only by having workers, and so they hire them. But because it is also true that workers see benefits that can be realized only from having a boss, it is not unreasonable to think of workers hiring a boss, and preferably a tough one. [See online Video Module 2.3 Monitoring workers]

Actual tough bosses

Even highly skilled and disciplined workers can benefit from having a "boss" who helps them overcome the shirking that can be motivated by the Prisoner's Dilemma. Consider the experience related by Gordon E. Moore, a highly regarded scientist and one of the founders of Intel, Inc. Before Intel, Moore and seven other scientists entered a business venture that failed because of what Moore described as "chaos." Because of the inability of the group of scientists to act as an effective team in this initial venture, Moore said that "The first thing we had to do was to hire our own boss - essentially hire someone to run the company" (Moore 1994). Pointing to stories and actual cases where the workers hire their boss is instructive in emphasizing the importance of tough bosses to workers. But the typical situation finds the boss hiring the workers, not the other way around. We will explain later why this is the case, but we can lay the groundwork for such an explanation by recognizing that our discussion of the advantages of having tough bosses has left an important question unanswered. An imp ortant job of bosses is to monitor workers and impose penalties on those who shirk, but how do we make sure that the bosses don't shirk themselves? How can you organize a firm to make sure that

bosses are tough? A boss's work is not easy or pleasant. It requires serious effort to keep close tabs on a group of workers. It is not always easy to know when a worker is really shirking or just taking a justifiable break. A certain amount of what appears to be shirking at the moment has to be allowed for workers to be fully productive over the long run. There is always some tension between reasonable flexibility and credible predictability in enforcing the rules, and it is difficult to strike the best balance. Too much flexibility can lead to an undisciplined workforce, and too much rigidity can destroy worker morale. Also, quite apart from the difficulty of knowing when to impose tough penalties on a worker is the unpleasantness of doing so. Few people enjoy disciplining those they work with by giving them unsatisfactory progress reports, Principles of rational behavior in society and business reducing their pay, or dismissing them. The easiest thing for a boss to do is not to be tough on shirkers. But the boss who is not tough on shirkers is also a shirker. A boss can also be tempted to form an alliance with a group of workers who provide favors in return for letting them shirk more than other workers. Such a group improves its well-being at the expense of the firm's productivity, but most of this cost can be shifted to those outside the alliance. Of course, a firm could always hire someone whose job it is to monitor the boss, but two problems with this solution immediately come to mind. One, the second boss will be even more removed from workers than the first boss, and so will have an even more difficult time knowing whether the workers are being properly disciplined. Second, and even more important, who is going to monitor the second boss and penalize him or her for shirking? Who is going to monitor the monitor? This approach leads to an infmite regress, which means it leads nowhere. A solution to the problem lies in the observation that workers should want their bosses to be rewarded for remaining tough in spite of all the temptations to concede in particular circumstances for particular workers. Jack Welch, the former chief executive officer (CEO) of General Electric (GE), is an example of the central point of this "organizational economics and management" section because he surely qualifies as a tough boss. Indeed, Fortune once named Welch "America's Toughest Boss" (Tichy and Sherman 1993). Welch earned his reputation by cutting payrolls, closing plants, and demanding more from those that remained open. Needless to say, these decisions were not always popular with workers at GE. But today, GE is one of America's most profitable companies, creating far more wealth for the economy and opportunities for its workers than it would have if the tough and unpopular decisions had not been made. In Welch's words: "Now people come to work with a different agenda: They want to win against the competition, because they know that ... customers are their only source of job security. They don't like weak managers, because they know that the weak managers of the 1970s and 1980s cost millions of people theirjobs" (Tichy and Sherman 1993, 92).

Game theory: the battle of the sexes

In the previous section we pointed out how workers could benefit from tough bosses who help them
overcome the Prisoner's Dilemma that workers face. The Prisoner's Dilemma is an example of the type of situation that is analyzed by game theory - the study of how people make decisions when the benefit each person realizes from the decision she makes depends on the decisions others make in response. But there are "games" besides the Prisoner's Dilemma that also explain how managers can be useful as tough bosses or tough leaders. An interesting game that falls into this category is commonly called the "battle of the sexes." The name of this game comes 71

B
I,

72 Microeconomics for MBAs Table 2.3 The battle ofthe sexes

Tom

Shakespeare in Love Saving Private Ryan

Marsha

Shakespeare in Love Saving Private Ryan

100 \ 75 40 \ 40 60 \ 60 75 \ 100

from conflict between the sexes, but it illustrates a more general conflict that is best resolved by managers who can make tough decisions. Let's consider first the conflict between the sexes. Tom and Marsha have just started dating and enjoy each other's company. Both also like going to the movies, preferably together. But they have different tastes in films - Marsha prefers romantic films while Tom prefers war films, They are planning to go out on Saturday night, but Marsha wants to see Shakespeare in Love and Tom wants to see Saving Private Ryan. The value each receives from going out on Saturday night depends on what movie he/she sees and whether he/she sees it with Marsha/Tom, or alone. The payoffs for Tom and Marsha are given in table 2.3, which shows the different possible outcomes for Saturday, with the first number in each box representing Marsha's payoff and the second number representing Tom's payoff. As shown, if both go to Shakespeare in Love, Marsha will receive a payoff of 100 and Tom gets a payoff of 75. If both go to Saving Private Ryan, Marsha receives a payoff of 75 and Tom gets the 100 payoff. If each goes to their choice of movies, but goes alone, then both receive a payoff of 60. And in the highly unlikely event that they each go alone to the other's favorite movie (but in the throes of romance, men and women do strange things) each will receive a payoff of 40. As opposed to the Prisoner's Dilemma game, in which the best choice for each (the noncooperative choice) is the same no matter what the other is expected to do, in the battle-of-thesexes game, the best choice for each varies, depending on what the other person is expected to do. For example, if Marsha can convince Tom that she is defmitely going to see Shakespeare in Love, then the best choice for Tom is to see the same movie and get a payoff of 75 instead of 60. But it may be difficult for Marsha to convince Tom that she is going to her preferred movie, come what may. Tom knows that if he can convince Marsha that he is definitely going to see Saving Private Ryan, then that will be Marsha's best choice. So making a credible commitment may be difficult for both Marsha and Tom. Further aggravating the problem is that both may decide that it is worth going to a movie alone (reducing their payoff by 15 this time) rather than acquiescing to the Principles of rational behavior in society and business stubbornness of the other. By doing so, each can hope to establish a reputation for making credible threats that will improve the chances of getting his/her way in the future. The result can be a lot of time and emotion expended negotiating over which movie to attend when the most important thing is for both to attend the same movie - something that may not happen despite costly negotiation.

Workers routinely confront their own battle-of-the-sexes problems on the job, although these problems have nothing to do with gender-based preferences or the movies. Workplace decisions often have to be made about issues for which workers have different preferences, but that will yield the greatest payoff to all workers if they all accept the same decision. For example, some workers will prefer to start working at 6:30 a.m., have a one-hour lunch, and leave at 3:30 p.m. Others will prefer to start at 7 :00 a.m., take no lunch, and leave at 3 :00 p.m. Others will prefer to start at 10:00 a.m., take a two-hour lunch, and leave at 8:00 p.m. Indeed, there will probably be as many different preferences as there are workers, with these preferences changing from day to day. But typically, it is best for everyone in a frrm to be in at the same time every workday. Some may prefer to resolve such individual differences "democratically" in these situations, with everyone being able to make their case until an agreement on a decision emerges, with this consensus decision most likely to be the best one. But agreement may never emerge and even if it did, the cost would probably far exceed the benefit from a better decision. At some point fairly early in the discussion, the best approach is for a manager to assume leadership and make a decision on the starting time for work that everyone has to accept. There are a lot of characteristics that go into making a good leader, and certainly one of the first is the ability to make good decisions. And obviously it's better to have a leader who makes good decisions than one who doesn't. But keep in mind that often the most important thing in making a good decision is not the decision that is made, but getting everyone to accept it. It is hard to argue that the decision to have everyone drive on the right-hand side of the road is better than having everyone drive on the left-hand side. Either decision is a good one as long as everyone abides by it. And getting everyone to accept a decision can require a tough-minded leader who imposes his/her will on others. Ideally, leaders will get the job done through gentle persuasion rather than bull-headed arrogance. But if the former doesn't work, it's nice to have the latter in reserve. [See online Video Module 2.4 Battle of the sexes]

The role of the residual claimant in abating Prisoner's Dilemmas in large groups
Every good boss understands that he or she has to be more than just "tough." A boss needs to be a good "leader," a good "coach," and a good "nursemaid," as well as
73

B
B
74 Microeconomics for MBAs

many other things. The good boss inspires allegiance to the firm and the commonly shared corporate goals. Every good boss wants workers to seek the cooperative solutions in the various Prisoner's Dilemmas that invariably arise in the workplace. Having said that, however, a good boss will invariably be called upon to make some pretty tough decisions, mainly because the boss usually stands astride the interests of the owners above and the workers below. The lesson of this section should not be forgotten: "Woe to the boss who simply seeks to be a nice guy." But firms must structure themselves so that bosses will want to be tough, but appropriately tough. How can that be done?

In many firms, the boss is also the owner. The owner/boss is someone who owns the physical capital (such as the building, the land, the machinery, and the office furniture), provides the raw materials and other supplies used in the business, and hires and supervises the workers necessary to convert those factors of production into goods and services. In return for assuming the responsibility of paying for all of the productive inputs, including labor, the owner earns the right to all of the revenue generated by those inputs. Economists refer to the owners as residual claimants. As the boss, the owner is responsible for monitoring the workers to see whether each one of them is properly performing her job, and for applying the appropriate penalties (or encouragement) if they aren't. By combining the roles of ownership and boss in the same individual, a boss is created who, as a residual claimant, has a powerful incentive to work hard at being a tough boss. The employees who have the toughest bosses are likely to be those who work for residual claimants. But the residual claimants probably have the toughest boss of all - themselves. There is a lot of truth to the old saying that when you run your own business, you are the toughest boss you will ever have. Small business owners commonly work long and hard because there is a very direct and immediate connection between their efforts and their income. When they are able to obtain more output from their workers, they increase the residual they are able to claim for themselves. A residual claimant boss may be uncomfortable disciplining those who work for her, or dismissing someone who is not doing thejob, and indeed may choose to ignore some shirking. But in this case the cost of the shirking is concentrated on the boss who allows it, rather than diffused over a large number of people who individually have little control over the shirking and little motivation to do anything about it even ifthey did. So with a boss who is also a residual claimant, there is little danger that shirking on the part of workers will be allowed to get out of hand. When a residual claimant organizes productive activity, all resources - not just labor - tend to be employed more productively than when the decision makers are not residual claimants. The contrast between government agencies and private
Residual claimants are people who have legal claim to any residual (commonly referred to as profits) that remains from the
sales revenue after all the expenses have been paid.

Principles of rational behavior in society and business

funs managed by owner/bosses, or proprietors, is instructive. Examples abound of the panic that seizes the managers of public agencies at the end of the budget year if their agencies have not spent all of the year's appropriations. The managers of public agencies are not claimants to the difference between the value their agency creates and the cost of creating the value. This does not mean that public agencies have no incentive to economize on resources, only that their incentives to do so are impaired by the absence of direct, close-at-hand residual claimants. The problem is that taxpayers gain little to nothing by incurring the personal costs associated with closely monitoring the public agencies (Tullock 1972, chapter 7). To make the point differently, assume that as a result of your management training you become an expert on maximizing the efficiency of trash collection services. In one nearby town the trash is picked up by the municipal sanitation department, financed out of tax revenue and headed by a government official on a fixed salary. In another nearby town the trash is picked up by a private firm, financed by direct consumer charges and owned by a local businessperson who is proud of her loyal workers and impressive fleet of trash trucks. By applying linear programming techniques to the routing pattern, you discover that each trash service can continue to provide the same pickup with half the number of trucks and personnel currently being used. Who is going to be most receptive to your consulting proposal to streamline their trash collection - the

bureaucratic manager who never misses an opportunity to tell of his devotion to the taxpaying public, or the proprietor who is devoted to her workers and treasures her trash trucks? On the other hand, the proprietor will hire you as a consultant as soon as she becomes convinced that your ideas will allow her to lay off half of her workers and sell half of her trucks. The manager who is also a residual claimant can be depended on to economize on resources despite her other concerns. The manager who is not a residual claimant can be depended on to waste resources despite her statements to the contrary. No matter how cheaply a service is produced, resources have to be employed that could have otherwise been used to produce other things of value. The value of the sacrificed alternative has to be known and taken into account to make sure that the right amount of the service is produced. As a residual claimant, a proprietor not only has a strong motivation to produce a service as cheaply as possible but also has the information and motivation to increase the output ofthe service only as long as the additional value generated is greater than the value forqone elsewhere in the economy. Having the residual claimant direct resources is, understandably, an organizational arrangement that workers should applaud. The residual claimant can be expected to press all workers to work diligently so that wages, fringes, and job security can be enhanced. Indeed, the workers would be willing to pay the residual claimants to force all workers to apply themselves diligently (which is what workers 75

B
effectively do); both workers and residual claimants can share in the added productivity from added diligence. But we have sidestepped in this discussion the issue of why workers aren't typically residual claimants, or owners, of their firms. Why do owners tend to be the capitalists (or providers of investment funds to be used to buy firms' capital, or plant, equipment, and other assets)? Because of space limitations, as noted earlier, we have decided to provide answers to those questions online in Reading 2.3 for this chapter.

Practical lessons for MBAs: profits from optimal shirking

One of the more important lessons from the analysis in this chapter is that size matters in business: as firms expand, shirking can be a growing problem. Firms will have to incur growing monitoring costs with growing firm size, which means that bosses will have to become progressively tougher or incentives will have to overcome workers' inclinations to shirk, which means not doing what they know they are supposed to do. To keep the analysis clear in this chapter, we have discussed shirking as if it were all "bad," always and everywhere a net drain on corporate profits. Hence, the task of managers is, in such a world, relatively simple: eliminate any and all shirking by monitoring and "cracking the corporate whip." While our approach has been useful to highlight key points, we need to stress before closing the chapter that shirking on the job, at least up to a point, can be viewed as a worker fringe benefit, something that has intrinsic value to workers. To the extent that this is the case, some shirking can actually increase company profits because it leads to a greater supply of good workers willing to work for the firm that allows some shirking and that permits a reduction in the firm's wage rates. The company's lower productivity can (up to a point) be more than offset by its lower total wage bill. Indeed, the workers can also be "better off" with some shirking. This is because the intrinsic value of some shirking on the job can afford them more utility than the additional money wages they could receive if some shirking were not allowed. Shirking up to a point, that is, can be a win-win for both workers and firm owners. The win-win nature of some shirking is

obvious in most offices and plants as workers- even highly respected workers- can be seen relaxing around vending machines, gossiping in hallways, and taking unscheduled breaks. Of course, so long as on-the-job shirking has value to workers, firms would not want to eliminate all shirking even if doing so required them to incur zero monitoring costs. The elimination of shirking could raise the company's wage bill by more than it raises the workers' productivity. In short, as in all things, managers face a complicated problem, one of seeking an optimum amount of shirking. That is, they should allow shirking to mount so long as the reduction in the wage bill exceeds the lost productivity. But then, shirking that is mutually beneficial to workers and owners alike is not really "shirking." Accordingly, for the Principles of rational behavior in society and business

77
rest of the book, we will relegate "shirking" to those things workers don't do that are not mutually beneficial and, hence, not mutually agreed upon by workers and owners.

Further readings online

Reading 2.1 Disincentives in poverty relief (along with the accompanying online video module) Reading 2.2 Management snooping Reading 2.3 Risk taking, risk aversion, and firm ownership Reading 2.4 "The mathematics of voting and political ignorance," by Gordon Tullock

R The bottom line

The key takeaways from chapter 2 are the following: The concept of rational behavior means that the individual has alternatives, can order those alternatives on the basis of preference, and can act consistently on that basis. The rational individual will also choose those alternatives whose expected benefits exceed their expected costs. 2 Traditionally, economics has focused on the activities of business firms, and much of this book is devoted to exploring human behavior in a market setting. However, the concept of rational behavior can be applied to other activities, from politics and government to family life and leisure pursuits. Any differences in our behavior can be ascribed to differences in our preferences and in the institutional settings, or constraints, within which we operate. 3 Rational behavior implies that people have choices, and choices imply that there is a cost to anything.

4 All choices involve cost-benefit calculations. 5 The timing and riskiness of options will affect their present value. The more distant into the future benefits will be received or costs incurred, the lower their present values. The more risky options are, the greater their cost (or the lower their net value). 6 The importance of the "cause" or the groups' "common interest" can significantly affect the willingness of group members to cohere and pursue the common interest of the membership. However, a "cause" or "common interest" can more effectively motivate a "small" group than a "large" group. This suggests that, given other considerations, an increase in group size beyond some point can have an adverse effect on the motivation that group members have to pursue their group's common interest. 78 Microeconomics for MBAs

7 The logic of collective action can explain the growth in employee shirking and the misuse of resources as firms grow. The logic can also explain why firms divide their operations into small groups, including departments and teams. 8 The basic problem of managers can be construed as one of overcoming the large-group problem that, at its heart, is one of overcoming Prisoner's Dilemmas. 9 A boss who is tough on employees can have supporters among employees as well as owners. There is, however, both an optimal amount of toughness on the part of bosses and an optimal amount of shirking on the part of workers. 10 A boss who is not tough on shirkers is also a shirker. 11 Leadership in the form of setting a course for all to follow can be productive since it can reduce the haggling over what course of action all should take. 12 Residual claimants have powerful incentives to encourage firms to minimize costs and maximize profits since such claimants have claims to any firm resources after all other claims have been fulfilled. 13 Companies are typically controlled by the owners of capital because they would otherwise have to fear that their capital, once deployed in companies, would be subject to appropriation by workers.

Review questions
What are the costs and benefits oftaking this course in microeconomics? Develop a theory of how much a student can be expected to study for this course. How might the student's current employment status affect her studying time? 2 3 Some psychologists see people's behavior as determined largely by family history and external environmental conditions. How would "cost" fit into their explanations? Okay, so no one is totally rational. Does that undermine the use of "rational behavior" as a means of thinking about markets and management problems? 4 How could drug use and suicide be considered "rational"? 5 6 If your firm were consistently dealing with "irrational behavior" among the owners and workers, what would happen to correct the problem? More to the point, what might you do to correct the problem? Develop an economic explanation for why professors give examinations at the end of their courses. Would you expect final examinations to be more necessary in undergraduate courses or MBA courses? In which classes - undergraduate or MBA - would you expect more cheating? Principles of rational behavior in society and business

79
7 8 Explain why the "free-rider" problem is likely to be greater in a large group than in a small group. The common interest of people who are in a burning theater is to walk out in an orderly fashion and avoid a panic. If that is the case, why do people so frequently panic in such situations? Use rational 9 10 11 behavior and the logic of collective action in your answer. Discuss the costs of making collective decisions in large and small groups. What do these costs have to do with the viability of large and small groups? In what ways do firms overcome the free-rider problems discussed in this chapter relating to large groups? How do market pressures affect firm incentives to overcome these problems? You may have a class in which the professor grades according to a curve, whereby the professor adjusts the grading scale to fit the test results. Assume the class is one in which all the students would prefer notto learn as much as they can. If you are in such a situation (or can imagine one like it), the

10

"common interest" of the class members can be for everyone to study less. The same grading distribution can be obtained, and everyone can receive the same relative grade for less effort. Why do class members not collude and restrict the amount of studying they do? Would you expect collusion against studying to be more likely in undergraduate general education courses, core classes in your MBA program, or elective classes in your MBA program? 12 All MBA programs have courses that are considered "bad" (in terms of lack of content and rigor and in terms of delivery) by students and/or faculty and administrators. Should MBA programs offer a "money-back guarantee" on "bad" courses? A "money-back guarantee" would mean that business schools would offer to repay students some pre-set dollar amount (all or a portion) of the tuition students have paid for the identified "bad" courses (with "bad" also carefully predefined and determined by the dean or some panel of faculty members and/or students). What would be the economic consequences of instituting such a money-back guarantee? Would students be expected to be better or worse off with such a guarantee? Or when would they be better off and worse off? If a money-back guarantee is deemed mutually beneficial for the students and school, how generous should it be? 13 Many bars have begun to serve glasses of wine to customers by first pouring the wine into a small carafe and then pouring the wine from the carafe into a larger wine glass? Given the extra dishwashing involved and added time in pouring, why do bars use carafes? Why do some bars use the carafes while others don't?

11