Bastiat's Bastions

What do economists do all day? Some of them sit around and watch game shows.

If you haven’t seen it, you’ll love the TV show called “Deal or No Deal”. It airs next on Monday, February 27th, 7pm, NBC. Here’s a link to the the official site on NBC’s page. The commercials are right – you will be screaming at the TV.

For those of you who haven’t seen it, there are 26 prizes put in 26 suitcases. Prizes range from $1 to $1,000,000. The player picks a suitcase and has no idea what prize is in their suitcase, nor does the “banker”. The player then gets to pick a number of the other suitcases, which are opened, revaling the dollar amounts. By the process of elimination (as more suitcases are opened), the contestant has more information about what might be in their suitcase. A scoreboard the displays the remaining possibilities.

Between rounds of suitcase openings, the “banker” makes an offer to the contestant. The player can take the offer from the banker and can walk away, or open some more suitcases (and later receive another offer). If the suitcases reveal small prizes (indicating a higher likelihood that the contestant’s suitcase has a big prize), the next offer from the banker will likely be for a larger amount. If the opened suitcases reveal large prizes, the banker will likely make a smaller offer. This continues until the player takes the offer (the game ends) or if there are only two suitcases remaining. If that last offer is refused, the person opens the suitcase and wins the amount shown inside.

Imagine the conundrum of only two prizes remaining – $1 and $1,000,000. Suppose the banker offerred you $475,000. Plus your wife is nagging at you – on national TV! It’s like watching a train wreck. It truly belongs on Fox.

Those of you who have taken your QBA classes will realize that is simple to calculate the probabilties and expected value of the prize in your suitcase. In economics and finance classes, we often talk about risk aversion. The idea is, that people, in most instances, are averse to risk and will pay to avoid it. Hence markets for insurance. It is important to note, in other instances, some people are risk loving, though usually for smaller stakes. Think about going to Vega$.

Here the expected value ($500K) is higher than the no-risk alterntiave ($475K). A rather risk averse person will choose the $475K, while a risk lover would open the suitcase.

This game show is interesting because it allows economists to study the way people react to risk in a situation with meaningful stakes and to measure different degrees of risk aversion. Much of the research on these types of problems are done with college kids and (sorry folks) much smaller amounts of money.

Believe it or not, this is only the latest entry in a long line of reputable economic research analyzing choices people make while on game shows. I’ve included a link to some current research done by three economist at Erasmus University Rotterdam on “Deal or No Deal”. It’s written for an academic audience – if you’re a finance major you might be ok.

The authors have analyzed the choices people made while playing Deal or No Deal in other countries. They find people, on average, are moderately risk averse, but can become risk loving after bad outcomes.

There is an interesting table in the paper relating the bankers offer to the true expected value of the suitcase as the game progresses. They give slightly lowball offers early – perhaps to increase drama later in the show? The banker usually offers an overly sweet deal after the person gets bad news, though.

If you know what a probability distrubtion and an expected value are, watch it and enjoy. If not, put it on Tivo, and pull it out after QBA 282.

–CT

This entry was posted on Wednesday, February 22nd, 2006 at 12:16 am and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.