46  Emotions

Emotions are mental states that signal positive or negative outcomes.

One function of emotions may be to act as a commitment device:

While this behaviour may appear “irrational”, it allows people to make credible commitments that in turn allow them to enter beneficial trades and cooperative arrangements, while being less likely to being cheated.

46.1 Punishment

Consider the following quote from Richard Nixon:

I call it the Madman Theory, Bob. I want the North Vietnamese to believe I’ve reached the point where I might do anything to stop the war. We’ll just slip the word to them that, “for God’s sake, you know Nixon is obsessed about communism. We can’t restrain him when he’s angry—and he has his hand on the nuclear button” and Ho Chi Minh himself will be in Paris in two days begging for peace.

Pushing the nuclear button is not in Nixon’s interest, and from a purely rational perspective may not be a credible threat. But if a madman has his finger on the button, the calculation changes.

46.1.1 Complaining for bad service

Recall our earlier example of a customer threatening to complain if they receive bad service. Complaining is costly.

We determined this by backward induction. At the final node for the customer, they can complain for a payoff of -1 or not complain for a payoff of 1. They will not complain.

The company, therefore, has a choice between providing good service for a payoff of 1 or bad service for a payoff of 2. They will provide bad service. The company has the same payoff for bad service regardless of the presence of the threat to complain as the threat is not credible.

For the customer’s initial choice of whether to threaten to complain, it does not matter either way. Regardless of their threat, they receive bad service.

Figure 46.1: Complaining is costly

But what if the customer gets a strong sense of satisfaction from complaining worth +3? Then their payoffs become as follows:

Figure 46.2: When the threat is credible

The threat to complain is now credible. If they receive bad service, they complain for a payoff of 2 rather than not complain for a payoff of 1.

The company now provides good service following a threat to complain. Absent that threat, they would provide bad service.

Figure 46.3: When the threat is credible

46.1.2 Chicken

As another example, recall the game of chicken. Two players are driving toward each other. Whoever swerves first loses. If neither swerves, they crash and die.

There are two pure-strategy Nash equilibria: (Straight, Swerve) and (Swerve, Straight). If the other player swerves, they want to go straight. If the other player goes straight, they want to swerve.

Now suppose player A is crazy. They are afraid of nothing and will never swerve. Player B knows this.

Player A’s craziness acts as a commitment device similar to that of removing the Steering Wheel. If player A will not swerve, player B will.

The Nash equilibrium is (Straight, Swerve). The crazy player A wins the game of chicken.

46.1.3 Receiving a faulty product

A customer received a faulty product from a firm and requested a refund as per consumer law. The customer also threatened to complain to the Department of Fair Trading if they did not receive the refund. A customer complaint would be costly to the firm as they would be required to provide a refund in addition to incurring the cost of dealing with the complaint.

The firm offered a store credit instead, believing that the customer would not complain as the time and effort involved would not be worth the potential refund.

However, the customer still complained to the Department of Fair Trading.

a) Use concepts from game theory to explain why the firm might have held that belief.

We can draw the extensive form of the game as follows:

Figure 46.4: Extensive form of the game

We work through this game by backward induction. If the cost to to the customer of complaining is greater than the benefit of obtaining the refund, the customer will not complain. In that case, the firm will offer the store credit.

As the firm believed that the cost to to the customer of complaining is greater than the benefit of obtaining the refund, the customer’s threat to complain would not normally be considered credible.

b) Use concepts from behavioural game theory to explain why the firm’s belief was ultimately incorrect.

The customer’s emotional response may lead them to complain. They might be angry or obtain satisfaction from seeing the firm punished. In that case, the customer will complain even though it is not in their material best interest to do so. Emotionally, it is worthwhile. They incur the cost of complaining but get the benefit of both the refund and the satisfaction from punishing the firm.