1. Major attributes of markets are that they spontaneously coordinate the exchange decisions of many individuals with diverse interests and multiple goals. They do so because the process of exchange itself aggregates and reveals the relevant information needed for producers and consumers to make effective economic decisions despite the ever-moving and changing complex of relative prices.
This relative price information informs firms with multiple production possibilities and consumers with differing budget constraints so that effective decisions can be made from these price signals. While this is going on in the output markets, resources suppliers and resources users are also making mutual decisions about production using cost signals that coordinate input markets while aiding in production and consumption decisions.
Using your handout and slides on the market and government failures explain why this price/cost signal coordination is rendered allocative inefficient in markets by externalities, monopoly power and asymmetric information.
Price or cost signals in a market ensure that the unlimited wants of the consumers are satisfied and that there are minimal shortages of goods in the marker. The coordination of these price signals may be rendered inefficient way of resource allocation in markets by various factors. Some of these factors include the asymmetric information, externalities, and monopoly power (Surowiecki 298).
Externalities
Allocative inefficient in a market may arise as a result of disparities between the marginal costs and benefits. It should be noted that externalities occur when costs or benefits are experienced by either consumers or firms as a result of their actions. These externalities may be positive and negative at the same time. For instance, when a firm produces a commodity as it pollutes the nearby water bodies, it focuses on maximizing its profits without caring about the welfare of the consumers living in the neighborhood.
Negative externalities can be presented based on the private and social costs. Firms undertake their activities ignoring the social costs they cause to the society. Thus, externalities prove to be a form of market failure that causes allocative inefficiency.
Monopoly Power
In a monopolistic market, firms produce and sell differentiated products hence they tend to manipulate the prices in the market. In this regard, firms can raise the level of the prices to maximize their profits while imposing costs on the consumers. Therefore, the cost and the price coordination is seen as allocative inefficient in this scenario.
Asymmetric Information
Market failures and allocative inefficiency may be brought about by several major aspects of asymmetric information such as moral hazard. In this case, an individual imposes a cost on another person by acting in a certain way. For instance, an insured person will ignore the damage and costs he or she will cause to others by not taking preventive measures (Surowiecki 300).
2 (a). At first, the notion of using “crowd wisdom” for decision-making might seem foolish. After all, why not ask multiple experts on a decision and average their answers. We certainly would not use crowd wisdom to build a house or repair a car. Would not experts always produce a superior answer than asking a random group of people? What is the key circumstance that makes crowd wisdom actually wiser than experts and why?
It is always believed that there is significant power in numbers. The truth in this saying is revealed in most of the day to day aspect of life where decision making is fundamental. It should be noted that ideas developed from a crowd always thrive than that of a single expert. Besides, most scholars recommend crowd wisdom as the best and effective strategy for accomplishing a project or a task since it incorporates different ideas. The independent and different ideas enhance a better understanding of a particular issue under study. In this regard, the crowd wisdom is a crucial tool for decision making and problem solving as the people are differently equipped to tackle a project, unlike a single expert. The collective knowledge and independence of ideas regarding uncertainties in a decision is the primary key circumstance that makes crowd wisdom to be wiser than ideas from an expert.
b. Given that circumstance, what are the four conditions that must hold for a wise crowd to exist according to Surowiecki in WoC?
The four major conditions necessary for the existence of a wise crowd include the following;
Aggregation – This condition involves the collection of different views and opinions from different individuals in group to come up with a concrete solution
Diversity – This condition holds when the people in the group have a different interpretation of a situation or judgement necessary in formulating a final decision.
Decentralization – For a wise crowd to exist, the people in the group should draw their information and views from various locations while making important decisions.
Opinion should be independent – It is important to note that the ideas and views of any member of the group should be independent of the other person’s ideas. The opinion of one individual should not be influenced by the judgement of another member of the wise crowd (Surowiecki 303).
c. Explain why each of these four conditions is needed to obtain a wise crowd
and give an example where each is violated so that the crowd decision in question is “unwise”.
A group does not necessarily need to include every member who is well informed and smart for it to be wise. Instead, any crowd can make wiser decisions and solve problems amicably as long as the four major aforementioned conditions hold. However, these conditions can be violated leading to the failure of a crowd to come up with wise decisions. Therefore, the following are the different reasons why the four conditions are needed in a wise crowd and how the conditions can be violated leading to unwise decisions.
Diversity – This condition is useful in a wise crowd since it is crucial to come up with variety of thoughts from the members. It is from these diverse ideas that one can choose the best opinion necessary to generate an outcome. However, this condition can be violated in some circumstances hence affecting the final decision. For instance, when the people of the wise group selected are all smart people may lead to unwise decisions. This because these people may have a similar way of thinking and influence a particular outcome.
Independent opinion is essential in a wise crowd since it enables the best decision to be made. An individual may be irrational or biased towards a certain conclusion, but he or she should not influence the decisions made by the other people in a wisdom crowd. It should be noted that group members might have personal contacts with each other and exert an influence which might make the decisions from a crowd unwise. For example, a lot of members in a group may adopt a certain idea or strategy hence making the decision made to stop making sense.
Aggregation – This condition is important to ensure that the crowd wisdom continues to make good decisions. The violation of the condition by making decisions based on the former knowledge of people will lead to unwise decisions.
Decentralization – It is worth noting that many people make decisions based on their own specific and local knowledge. Therefore, aggregating these decentralized ideas in a wisdom crowd influences a good decision. For instance, a good decision can be made if a person is made to be closer to the problem (Surowiecki 298).
3 a. The idea of effective decisions made with a wise crowd was adapted from the purely competitive model of markets in standard economics because one or more of the four perfectly competitive market assumptions are not realized in the real world. What are the four characteristics of a purely competitive model, and which do not hold in the circumstance in which a wise crowd works?
Free entry and free exit - New companies can easily join the firm because there is a low barrier of entry into the business while the existing firms are free to leave anytime at the expense of their comfort. There are no legal procedures that can stop the sellers from selling their goods in a purely competitive model.
Standardization of products - All goods sold in a purely competitive model are substitutes for each other and therefore, buyers will not be choosy in buying those products. That is, they can choose any product because all products are same in this market.
All sellers are equal -This is because the majority of the producers in the market offer the same product at the same time. Therefore, there is no seller above the other neither there is no seller below the other.
Price of the products is determined by consumer’s demand - That is, firms do not try to control the price, it can only be determined based on consumer’s wants. No supplier influences the market prices; a condition which is referred to as price taking. Suppliers only have the option of adjusting to the market price since they can’t change it.
b. Both purely competitive markets and wise crowds can be thought of as spontaneous coordination mechanisms that can produce fairly efficient outcomes, but under different circumstances. Explain why?
In purely competitive markets the consumers are guaranteed of a standardized product regardless of where they purchase the product. For instance, a client who wants to buy some coffee in a certain city will not have to travel to that city if they are far from it because the nearest city will still offer the same quality of the coffee. The price of the product is also the same in these markets irrespective of their location.
On the other hand, wise crowd works emphasize the principle of diversity while dealing with product market. This is covered in the second chapter of wise crowd’s work where it states that if everyone thinks alike, then they are less likely to come up a better solution to a problem. The success of the market is obtained by different suppliers selling their commodities at a price they think is comfortable with them. Supplier’s thoughts are different and therefore, the prices and quality of their products different in various locations. In wise crowds, there is higher competition among the suppliers, and therefore, if a client wants a certain product at a certain place, they will have to move to that place or an alternative place that is affordable and comfortable based on their interest (Kozinets et al. 340).
4. Explain the dilemma of the “El Farol” bar situation.
Technology can sometimes solve economic problems such as the case of GPS systems finally privatizing the public good problem associated with light houses. Explain how cell phones might be able to ameliorate (but not eliminate) the “El Farol” bar problem but perhaps only gradually (this is not a slam dunk solution; think about it).
[If you want to play a version of the El Farol Bar problem go to the following: http://ccl.northwestern.edu/netlogo/models/ElFarol ]
El Farol dilemma is a form of a game involving more than two finite participants where the dilemma lies between an individual staying at home and going to the bar for a Thursday night. El Farol refers to a small bar where most people prefer going on Thursday nights. The place is less fun whenever it is crowded therefore an individual may be torn between going or not going at the bar. The game indicates that the outcome of each cause of action that a player undertakes either benefits or costs him or her. For instance, the individual will have much fun only if less than 60% full. Otherwise, the person will have less fun than staying at home for the night.
The problem of El Farol dilemma can be solved by the innovation in technology such as use of cell phones. It is important to note that an individual can make a phone call at the place they wish to visit just like the El Farol bar. In this regard, one will be well informed about his or her outcome following a particular cause of action. Thus, decisions can be influenced by the use of cell phones (Chen and Umberto 60).
5. In WoC Surowiecki refers often to decision markets and believes that internal decision markets would improve firm performance in terms of sales and profits. What are decision markets, how would they work in a firm, and give three reasons why firms have been so reluctant to use them?
Decision markets are always referred to as a platform that aggregates and collect relevant random knowledge from a diverse group of people regarding a particular concept in the bid to make predictions. In a firm, decision market participants invest money or points to support their answers based on their knowledge on a certain subject. These participants are usually requested to make a judgment on a future outcome, and after the outcome are rewarded accordingly. That is, those whom predictions are almost accurate are given more rewards than those whom predictions are ineffective (Surowiecki 197).
It should be noted that firms are always reluctant to use decision markets due to different reasons such as;
Lack of numeracy – All future reality is a probabilistic phenomenon thus decision markets predictions cannot be rated 100%.
It requires substantial skills and effort – For decision markets to operate efficiently there must be professional participants who are highly skilled personnel to obtain effective and dependable results. These professionals sometimes are rare to find as a result of lack of trainers to train them accordingly. However, the few available professionals demand higher payments making it difficult for firms to hire them.
Hard evidence – It is only through feedback that humanity’s technology and methods can be improved. This is because every prediction can be tested against hard reality, and every single bad performance is likely to be debunked as a problem.
6 a. Thinking about trust
in economic terms, economists note that trust significantly reduces the cost of economic exchange. What exactly is “trust” and how does it significantly reduce the cost of economic exchange?
Trust in economic terms is referred to as an arrangement where a firm legally grants an individual or an institution fiduciary control of a property in the bid to benefit them. Trust can significantly reduce the cost of economic exchange in several ways.
The Significance of trust in the reduction of the cost of economic exchange
It reduces the transaction costs – In cases where trust is found, trading partners spend fewer resources on supervision to check if the trustees are meeting the standards of their agreement. That is, both parties have confidence in each other and believe that neither will fail each other.
Enhances information sharing between the supplier and the buyer – High trust between the two parties creates a ground for the supplier to share more information with the buyer regarding the features of a commodity.
On the hand, this relationship between the supplier and the buyer motivates the buyer to market the commodities of a supplier therefore attracting more clients to the supplier. As a result, this reduces the struggle for marketing firm’s commodities (Surowiecki 299).
It prompts the firms to make investments in productive sectors – A firm that is composed of high trust among the parties has a high chance of advancing in technology. This is because the leaders do believe in the capability of the clients. Also, the clients on the other hand feel safe because they are guaranteed of protection and various benefits from the firm
b. In WoC Surowiecki notes that “It may be that, in the end, a good society is defined more by how people treat strangers than by how they trust those they know.” (p. 118). In ancient times and throughout the Middle Ages in Europe, people in towns, villages, and manors knew each other well and had a level of trust (different for different folks) in each other based on extensive knowledge of a person and their attributes. Strangers were distrusted. As more cities developed, the anonymity characteristic of cities, the lack of specific knowledge of people, created distrust. Ironically, perhaps, the development of capitalism that depends on people rationally pursuing their own material self -interest, actually promoted a more generalized trust among strangers, an attribute uncommon before the advent of capitalism. Explain why?
The desire to be more successful – After the advent of capitalism, the needs of people have continuously grown as a result of growth in technology. This results in competition between individuals and firms as they strive to meet all the needs and in the process of striving they find it easier to trust in strangers who are not part of the competition. In some cases, it is out of desperation to achieve more than others.
Emotions such as anxiety and guilt – For instance, guilty individuals are more likely to get into good terms with strangers because they are the only ones who don’t understand their previous scenarios that is, their mistakes and weaknesses.
The mentality that strangers cannot rob them off – For instance, gambling people tend to believe that those people with clear knowledge will play tricks on the game and take away their money or they will be choosy as they make decisions on the winner. On the other hand, the stranger has less knowledge and therefore he or she will make the decision based on facts without discriminating.
7. a. Trust
can be engendered by crowd wisdom through multiple reviews on web sites such as eBay, Craigs List, and Amazon. Explain why using the four features of crowd wisdom as they are or are not revealed in each of these.
Decisions are made by independent individuals – Surowiecki supposes that when mass decisions are made by individuals, they must be willing to trust each other to be able to produce and more accurate results. This, in turn, prompts them to feel confident about each other as a result of working closely thus engendering trust among them.
Opinions are made by a group of individuals rather than a single expert – Crowd wisdom shows that superiority can only be attained if opinions are given by many individuals who are working together thus, making it possible for people in the firms and institutions to trust each other.
A large number of people aggregate possible answers to problems – That is, the majority usually represent almost everyone to whom the problems are being experienced. Those who are not contributing in proposing possible solutions keep expecting good results from those representing them thus building trust among them.
Presence of decentralization – Decentralization allows people to act freely and independently of each other. This forms a ground for them to interact and produce desired results because there trust each other. It also assists in solving problems from different people with diverse cultures and therefore at the end of it all a good rapport is created among people with different cultures, and thus high trust is molded (Galton 450).
b. However, the potential crowd wisdom associated with reviews can be stymied by tactics designed to “game” the belief in crowd wisdom. Explain how in each case and indicate what is done by each of these sites to regain trust.
Amazon – It is said that rating systems can be used by crowd wisdom to offer useful insights but they can also portray a bad picture if only a small number of votes are used to rate the crowd wisdom because people will always go for something that has more votes. This game can be solved by incorporating mechanisms designed to control the quality of ratings by allowing voters to vote where necessary.
eBay – Through the use eBay which uses the internet, a range of questions and tasks are in a position to be crowdsourced and the product is always efficient in that it can be answered by a knowledgeable person or an expert in a crowd. The experts share this knowledge for free and in other cases at a low price facilitating them to share information to as many as possible therefore trust issues available are in ability to be regained easily as the information is shared widely.
Craig’s List – This site has its requirements for instance, no sales of illegal merchandise. As a result of this requirement, it is easy for one’s listings to be flagged based on the opinions of people. Besides, f they do complain about it then it is deleted. This creates trust issues which can only be solved by moderating the crowd to restore trust among the followers (Simmons et al. 12).
8. Nonetheless, trust can be exploited and frequently is in business (and personal relations). For example, contrast “new customer discounts” with “loyalty discounts”. Which is more profitable for the firm and why? Also, explain how reputation, once earned, can also be exploited by producing inferior goods compared to the past. Part of the material success of these ethically questionable strategies can be explained by a universal human cognitive predisposition called inertia
that often leads to the status quo bias. Is the status quo bias core rational? Explain why or why not? Can you speculate as to why human inertia might be rational from a natural selection evolutionary perspective?
Most of the business not only in the United States but also in the world at massive offer discounts to loyal and new customers. Offering discounts to new customers increase the number of clients who will be willing to use the product of business. However, by offering these new customer discounts reduces the margin of profits in most companies. On the other hand, it is profitable to provide loyalty discounts since the business experiences higher operating margins when dealing with loyal clients unlike with new customers. Besides, the discount given to the loyal customers helps the business to retain the buyers of their products thus maintaining their profit margins (Reinartz et al. 90).
It is important to note that most of the businesses and companies in the market strive to earn a good reputation from the customers. However, the reputation can be exploited once the business is particular about the loyalty of its customers on their products.
The status quo bias core is rational since the consumers in a markets aim at maximizing their utilities. For instance, they will prefer sticking to their old strategies to embracing change provided that they maximize utility. Many researchers and scholars study the emotions and behavior of humankind in an evolutionary perspective. The human inertia might be rational since the human being is often interested in making decisions that benefit them. Evolutionary thinking also has transformed the business world as a result of human inertia which shapes the characteristics and how humans behave. Besides, the evolutionary dynamics forces the mind to solve various problems in a bid to maximize utilities (Marbach et al. 796).
9. “At the outset, the Internet was expected to be an open, democratic source of information. But algorithms, like the kind used by Facebook, instead often steer us toward articles that reflect our own ideological preferences, and search results usually echo what we already know and like. The danger [of internet algorithms] is that increasingly you end up not seeing what people who think differently see and in fact not even knowing that it exists."
<https://www.npr.org/sections/alltechconsidered/2016/07/24/486941582/the-reason-your-feed-became-an-echo-chamber-and-what-to-do-about-it>
a. The reality described in the above quotes from NPR may call into question the wisdom of crowds for critical thinking, a hallmark of what a liberal arts education is supposed to be about, and the logic of democracy itself as an effective governance system. Explain why?
The wisdom of the crowd is necessary for addressing the quote from NPR as it protects individuals from bad arguments. Indeed, an individual is entitled to his or her own opinion. Every individual has space to deliberate and think about what he or she cares about and believes. This is a true indication of democracy. A liberal democratic society gives freedom and voice to the people through critical thinking of each and every individual. Thus, an effective governance system should be characterized by a liberal and democratic society where the wisdom of the crowd is important.
b. One could argue against the argument you just made in a. Do so using sound reasoning and any evidence you find pertinent.
Liberal arts and critical thinking may tend to be two different ideologies. Unlike the liberal arts which advocate for free minds of citizenship, critical thinking is an intellectual component of democracy. For instance, critical thinking in the wisdom of crowd might distinguish personal opinions from facts and identify assumptions.
10. a. Wikipedia, the website encyclopedia has a lot of the features of crowd wisdom, but some subjects are not effectively addressed by crowd wisdom. Explain why?
Most scholars attribute the success of the Wikipedia to its feature that is associated with the wisdom of crowds. The independence, diversity, and decentralization of the wisdom of crowds help the web encyclopedia to be wise. However, some features of the Wikipedia have not been properly addressed hence making it sometimes to be unwise. For instance, the question and answer platform assume that everyone knows everything which is not the case in the wisdom of the crowd. Besides, some of the features in the web site encyclopedia disrupt the value, economy, and culture of the people through the social websites (Kittur and Robert 40).
b. Contributions to Wikipedia on subjects they address can come from anyone regardless of one's educational background. Is this a positive or negative feature regarding bringing about crowd wisdom? In the end, Wikipedia does not satisfy all of the crowd wisdom assumptions needed to produce accuracy. Explain clearly and indicate what measures or features of the site attempt to deal with the accuracy issue. Do you think it is successful?
The Wikipedia website has been identified as one of the major platforms that strive to bring about the wisdom of crowds and making it relevant than answers from experts. It allows the contribution of different thoughts from individuals and aggregates all their reasoning to come up with a final idea. The answers from the website can be averaged to get a perfect idea which the experts cannot offer. However, Wikipedia sometimes often ignore some of the assumptions of the wisdom of crowds that enhance accuracy such as independence of the opinions from the participants. Features such as articles with collaborative efforts enable the Wikipedia to enhance accuracy successfully.
Works Cited
Chen, Shu-Heng, and Umberto Gostoli. "Coordination in the El Farol Bar problem: The role of social preferences and social networks." Journal of Economic Interaction and Coordination 12.1 (2017): 59-93.
Galton, Francis. "Vox populi (The wisdom of crowds)." Nature 75.7 (1907): 450-451.
Kittur, Aniket, and Robert E. Kraut. "Harnessing the wisdom of crowds in wikipedia: quality through coordination." Proceedings of the 2008 ACM conference on Computer supported cooperative work. ACM, 2008: 37-46.
Kozinets, Robert V., Andrea Hemetsberger, and Hope Jensen Schau. "The wisdom of consumer crowds: Collective innovation in the age of networked marketing." Journal of Macromarketing 28.4 (2008): 339-354.
Marbach, Daniel, et al. "Wisdom of crowds for robust gene network inference." Nature methods 9.8 (2012): 796.
Reinartz, Werner, and V. I. S. W. A. N. A. T. H. A. N. Kumar. "The mismanagement of customer loyalty." Harvard business review 80.7 (2002): 86-95.
Simmons, Joseph P., et al. "Intuitive biases in choice versus estimation: Implications for the wisdom of crowds." Journal of Consumer Research 38.1 (2010): 1-15.
Surowiecki, James. "The wisdom of crowds: Why the many are smarter than the few and how collective wisdom shapes business." Economies, Societies and Nations
296 (2004).
