Sunday, August 26, 2012

The Economics of Kua Simi Kua

Staring incidents can be nasty. Just a few months back, one such incident sparked off a fight, and  a 17-year old boy suffered stab wounds in his back. Ouch. Despite this, Game Theory, a branch of economics applied to competition between firms, suggests that fights should never happen. I know it doesn't make sense, but let's run through the logic and see what we can learn from it.

Consider the diagram below. First a challenger decides whether to challenge an Ah Beng*, maybe by staring his girlfriend. If he decides not to stare, he does not win anything, and gets a 0 payoff. Subsequently, the Ah Beng happily hangs out with his girlfriend, and gets a payoff of 5.

*"Ah Beng" eludes simple definitions. Try Wiki for more.

However, suppose a challenge is made. The Ah Beng now has to decide whether to fight. However, nobody wins in a fight. If you don't get injured, you'll probably end up arrested. Even if neither happens, life goes on and you are no better off. As a result, payoffs are negative for both parties, at -5.

Lastly, if the Ah Beng doesn't fight, his payoff is 0. This is smaller than the "status quo" payoff of 5 - his might "lose face", and even his girlfriend. Even so, this is better than getting arrested for assault. In turn, the Challenger gets a payoff of 5 from looking at the Ah Beng's girlfriend.

From what I've said so far, I think it should be clear that the Ah Beng will never fight when challenged. Working backwards, the Challenger will find it better to challenge than not challenge. If this were true, why do we still see staring incidents, and why do we not see guys openly ogling at Ah Bengs' girlfriends?

This was exactly the intellectual hurdle faced in competition economics decades ago. Back then, firms were accused of "predatory pricing". Predatory pricing occurs when an incumbent firm, when faced with a newcomer, prices at unsustainably low levels to drive the newcomer away. Many call this unfair competition, and ultimately bad for consumers like you and me.

Many economists claimed, using theories similar to the one above, that predatory pricing cannot occur. The logic broadly proceeds in three steps:
  • Since low prices are unsustainable, the incumbent will restore them to earlier levels once the newcomer leaves. 
  • Subsequently, this attracts newcomers again, and the incumbent cannot maintain unsustainable prices for long. It will eventually have to drop its price cutting strategy. 
  • Since the incumbent will eventually cease predatory pricing, why bother to start in the first place? 

By this reasoning the incumbent and similarly the Ah Beng will never Fight.

But we still see Ah Bengs fight, and firms have been found guilty of predatory pricing. So something must be wrong with the theory, but what exactly?

Kreps and Wilson found a solution in 1982. They suggested that there must be some uncertainty as to what "sort" of competitor the firm is. The firm might be normal or mad (actually they used "strong"). Let's see how this solves our Ah Beng problem.

Let's change our model slightly and introduce the mad Ah Beng. This Ah Beng is happy to fight with the challenger, regardless of whether he gets caught by the police, or whether he gets injured. Instead of losing 5 points when fighting, he now gains 10 points. So the above diagram now becomes:

The mad Ah Beng will rather fight, to get a higher payoff. Seeing this, the Challenger  backs away from the challenge.

Key to this is that the Challenger does not know if the Ah Beng is normal, or if he is mad. Kreps and Wilson prove (in a horribly complicated fashion) that with this uncertainty, the normal Ah Beng might fight even when it doesn't benefit him. Why? By doing this, he bluffs others that he is mad, and reduces the number of challenges he faces in the future, particularly from within (power struggles in the gang) rather than without (random guy staring at his girlfriend, who is unaware of the Ah Beng's reputation).

What can we learn from the economics of kua simi kua? It tells us that firstly, normal Ah Bengs fight to build up their reputation. They fight not just in response to current challenges, but to block future challenges. As a result, while greater policing and punishments can help reduce fights, one should also break the reputation link. I leave the "how" question aside for now. Secondly, this strategy only works if there are mad Ah Bengs. Target this group, and hopefully fights among normal Ah Bengs will be fewer and fewer teenagers will get stabbed.

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