The Ultimatum Game

After hitting your sales target at the office, your manager rewards you and your coworker Sam with a large free pizza. The pizza arrived when you were in a meeting, so you get to it a couple of minutes later and notice that the pizza has already been divided: six of the eight slices are on Sam's plate and two are on yours. You stand there, stunned—you can't believe you were only saved two slices, despite both of you working equally as hard to meet the sales target. Frustrated and feeling disrespected, you impulsively throw both plates away—now no one gets pizza. 

This scenario is a real-life manifestation of the ultimatum game, a task used in economic and psychological research that helps us understand the complex motivations behind human decision-making. Even though, from a logical standpoint, two slices of pizza are better than none, humans care deeply about fairness, and so we don't always act rationally if we feel disrespected or exploited. Classic economic theory is based on the idea that we make rational choices in order to maximize our utility.¹ However, more often than not, this model fails because it doesn't take into account the existence of asymmetric information, social preferences like altruism, or cognitive biases. 

This is why many economists simplify their analysis with Homo economicus, the assumption that all humans are perfectly rational and act in self-interest. For example, shorter hours of labor, according to the model of Homo economicus, will reduce the volume of output. But in reality, shorter hours of labor can sometimes increase productivity, because well-rested workers may perform more efficiently.² 

Behavioral economics provides a more realistic understanding of how humans make decisions beyond the assumptions of traditional economics. The UG shows us that the cost of injustice can occasionally outweigh the value of the reward, showing that people are willing to sacrifice personal gain to uphold fairness. Here’s a simplified explanation of a common version of the ultimatum game:

• Setup: There are two players. Player 1 (the proposer) is given a sum of money of $100 and holds the power to decide how to split it between themselves and Player 2 (the responder). Player 2 can either accept the offer, and both get the proposed amounts of money, or reject it, and both get nothing. 
• Rational prediction (classical economics): Player 1 should offer the smallest amount of money possible to the other player to maximize their utility, like $1. Player 2 should accept anything more than $0 because something is better than nothing. This is based on the assumption that we are rational, self-interested agents (Homo economicus). 
• What actually happens: In real-life experiments, low offers are usually rejected by Player 2 because people value fairness, even at personal cost. Additionally, proposers often offer 30-50% of the money because they assume that completely unfair offers will be punished, and they want at least something out of the proposition.³

The ultimatum game is a tool within game theory that illustrates how real-world outcomes often don't align with theoretical predictions. Game theory assumes Homo economicus, predicting that Player 2 would accept the sum of money they are offered, no matter what the split is, because they would recognize that they are gaining something, no matter the sum. However, as aforementioned, the UG demonstrates that in practice, people tend to reject an unfair offer, even if it means sacrificing their reward.⁵

The ultimatum game plays out in many different real-world scenarios, from social interactions to political and economic negotiations. For example, during bilateral trade negotiations, a deal between countries could collapse due to perceived unfairness. While both countries may benefit from the deal, if one party feels like they may be benefiting less than the other, the deal could collapse, and both will lose out on the potential gains. This illustrates a broader truth that perceptions of fairness can be just as influential as actual outcomes, shaping decisions and determining whether cooperation succeeds or fails.