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.

Utility: The satisfaction or benefit that consumers derive from a good or service. It is a measure of how much value a person gets from making a decision. 

Homo Economicus: A concept in traditional economics that portrays humans as being completely rational and solely motivated by self-interest, making all decisions based on the maximization of utility. 

Game Theory: A mathematical framework that predicts and analyzes strategic and competitive decision-making. Assuming that all stakeholders are rational, it looks at how they make decisions based on the actions of the other stakeholders involved. 

Nash Equilibrium: In game theory, a situation in which no player can improve their outcome by changing their strategy, as long as the other players keep their strategies the same.

Subgame Perfect Equilibrium: A strategy profile in a sequential game where players’ choices form a Nash equilibrium in every stage (or subgame) of the game, ensuring decisions are optimal and credible at every point.

Prospect Theory: Explains how people make decisions under uncertainty, showing they prioritize avoiding losses over equivalent gains and tend to be risk-averse with potential gains but risk-seeking with potential losses.

The ultimatum game was created in response to game theory, which was first introduced in the mid-20th century by John Von Neumann and Oskar Morgenstern. The Princeton University mathematicians felt that the current mathematical models that were intended to be applied to the physical sciences were inadequate to explain economic theory. They were the first to create a framework for understanding strategic interactions between individuals, where the outcome of the interaction depends on the behavior and choices of the other people involved.⁵

In 1982, Werner Güth, Rolf Schmittberger, and Bernd Schwarze introduced their paper “An Experimental Analysis of Ultimatum Bargaining,” which tested the classical game theory predictions regarding rational behavior. The UG is a special type of game that is finite, with perfect information available to both players, and the final decision is isolated to two distinct outcomes: to accept or to reject. This design simplifies the bargaining process and the study of decision behavior because only one player makes the final decision while the other anticipates the next player's choice.³

The standard solution to the UG is the subgame perfect equilibrium, which was developed by German economist Reinhard Selten in 1975 to accommodate game theory. With this concept, players make choices that are optimal at every possible decision point. For example, this would mean Player 1 offering Player 2 $1 of $100, and Player 2 accepting the $1, because they are both making the optimal decision with the choices they have, given that receiving something is better than nothing. However, as the 1982 UG experiment discovered, when the equilibrium heavily favors one party, deviations from the equilibrium increase, and subjects take into account unfairness, possibly punishing both players by rejecting the offer.⁴ 

The ultimatum game has been expanded upon, notably by behavioral economist Colin Camerer. In his 2003 book Behavioral Game Theory: Experiments in Strategic Interaction, he extensively discusses how psychological factors influence decision-making in strategic contexts. Camerer's research found that in practice, people often make offers of 30-50% of the total amount rather than the theoretical minimum, and most responders often reject anything below 20-25%, instead of any amount greater than nothing. Camerer also suggested that raising the stakes, at least to a certain degree, doesn't impact the rate of rejections, because our desire for fairness is so deeply rooted and not dependent on the size of the reward. This also means that our perceived intentions play a role in whether we decide to reject or not; if the unfair offer was not in an attempt to undermine, then we may be more likely to accept it.⁶

The ultimatum game complements many of the key ideas that characterize behavioral economics. For example, prospect theory was developed in 1979 by mathematical psychologist Amos Tversky and his colleague Daniel Kahneman. It analyzes how people interpret losses and gains, showing that we tend to prioritize avoiding losses over acquiring an equivalent gain.⁷ The ultimatum game has also sparked research in neuroeconomics, like the 2003 findings from Alan Sanfey, which showed that when people receive unfair offers in the UG, emotion-related brain areas (like the insula) activate, suggesting that a decision to reject is emotionally driven, not purely rational.⁸

The ultimatum game applies across a variety of domains from education to business. Students can role-play the UG in class to see firsthand how real behavior often diverges from theoretical predictions. This interactive approach can not only make concepts more comprehensible but also spark critical thinking about the limitations of learned theories that were developed in the context of a study or experiment.

 John Von Neumann and Oskar Morgenstern

Hungarian and German-American mathematicians, respectively, who co-wrote Theory of Games and Economic Behavior in 1944. This publication largely established game theory; however, the initial roots of the concept can be traced back to Von Neumann’s work in the 1920s.⁵

Werner Güth, Rolf Schmittberger, and Bernd Schwarze

German economists who conducted the first ultimatum game experiment. They documented the process and the findings in their paper, An Experimental Analysis of Ultimatum Bargaining, which was published in 1982.³

Colin Camerer

An American behavioral economist whose research primarily covers neuroeconomics, behavioral game theory, and strategic thinking. Camerer has been at Caltech since 1994 and uses research methods from psychology and neuroscience, like fMRI, eye-tracking, and EEG, in his economic analysis.⁹

Reinhard Selten

A German economist considered one of the founding fathers of experimental economics, Selten won the 1994 Nobel Prize for his refinement of the Nash equilibrium through his work on subgame perfection and trembling hand equilibrium.¹⁰

Subfields of game theory research, like the ultimatum game, have revolutionized our understanding of human behavior and decision-making for both economists and psychologists. The Homo economicus assumption, although widely necessary for the application of most economic theories, is challenged by behavioral economics and experimental studies such as the ultimatum game. 

Strikes and price hikes

Findings from the ultimatum game can offer insights into real-world contexts like labor negotiations and pricing effects. For example, workers may reject wages if they find they are insultingly low. Even if it comes at a personal cost, they may strike and lose income to punish the perceived unfairness and maintain their dignity. This dynamic has led to structures like profit-sharing agreements and the public justification of wage decisions to ensure fairness and transparency. An understanding of the ultimatum game could have potentially prevented General Motors' 1998 strike in Flint, Michigan. It lasted 54 days and cost the company $2 billion due to workers perceiving injustice in treatment, working conditions, and wages.¹¹

The same principles can also apply for consumers, who appreciate transparent pricing policies. Companies like Uber and several airlines have experienced backlash due to surge pricing during the COVID-19 pandemic.¹² Even when price hikes are necessary, companies may raise prices excessively and are often accused of price gouging. To mitigate this, firms have introduced price cap policies, or companies have engaged in “fairness framing” to avoid consumer rejection altogether.¹³

Legal bargaining

A study by Paul Pecorino and Mark V. Van Boening compared behavior in a simple ultimatum game versus an embedded ultimatum game with a “defendant” and “plaintiff” to mimic legal bargaining. They discovered that the type of game mattered greatly in determining the outcome; offers in the embedded game were far more selfish, with a mean of 13% of the joint surplus being offered (versus 49% in the simple game). However, despite lower offers, rejection rates were lower in the embedded game at 19%, while the simple game had a rejection rate of 28%. 

The authors argue that these differences are not due to experimental protocol or social norms, but instead the framing effects of the situation. In the embedded legal game, one party starts with an endowment, unknown to the other, which creates a perceived property right. But the entire surplus is not lost if there is no agreement; a plaintiff still receives something. This results in players adjusting their sense of fairness to match the context, where senders offer less and recipients accept more, which means that there are lower offer rates without higher dispute rates.²⁰

The scope of the ultimatum game is more limited than one might think, despite its broad applicability across various industries. Since it was developed and primarily studied within specific demographics, people claim that it oversimplifies human behavior, making it less relevant than expected when dealing with most real-world bargaining situations. 

The WEIRD problem

Most experiments involving the ultimatum game are conducted with people from WEIRD populations—Western, Educated, Industrialized, Rich, and Democratic. As a result, we assume that the norms valuing fairness and punishing injustice are universal human behaviors. However, in reality, norms around sharing vary across cultures. In some tribal or communal societies, sharing resources might be required for survival, so unequal distributions are rejected more harshly, whereas in societies where hierarchies are normalized, low offers may face less protest and be more readily accepted.¹⁴

Recognizing cultural variability is key in matters like international aid negotiations or cross-cultural business deals. In international climate change discussions, some Western countries may emphasize reciprocity in the form of matching commitments, whereas non-Western countries might focus on historical responsibility. Applying a culturally sensitive approach, rather than assuming uniform standards of fairness, can help with reaching consensus and equitable agreements when it comes to bargaining.¹⁵

Oversimplification

The ecological validity of the ultimatum game frequently comes into question. It works out perfectly in artificial lab settings where conditions are crafted by an instigator, but in the real world, there are many other factors that may influence the outcome of an ultimatum, like the relationships between parties, whether there are multiple rounds of negotiation, and the presence of external pressures like law and public image.¹⁶

This can be demonstrated by the Brexit negotiations between the UK and the EU concerning issues like the financial settlement, the Irish border, and citizens’ rights. Throughout the dispute, offers were made and then rejected, as each perceived the other as being politically or economically unfair. For instance, the EU rejected the UK's proposals, which it argued were cherry-picking the benefits of EU membership without its membership obligations. Both parties faced political and domestic pressures throughout the entire process, and were also concerned with maintaining a long-term relationship for future cooperation.¹⁷ Unlike the one-shot ultimatum game, each side made incremental concessions over time, and there were multiple rounds of proposals and rejections that involved complex stakeholders and deadlines. 

Small-scale societies

As previously mentioned, one of the main criticisms of the ultimatum game and psychological research in general is that it captures the behavior of populations in Western countries but is then applied globally. To challenge this assumption, Joseph Henrich, an American anthropologist at Harvard University, sought to test whether social norms of fairness were the same in small-scale societies. Henrich used the ultimatum game as a tool and conducted experiments among 15 small-scale communities, like pastoralists and subsistence farmers across Africa, South America, and parts of Asia. 

Henrich's research found extensive variations in offers and rejection patterns across the different societies. For example, in Machiguenga, Peru, proposers often offered very low amounts, yet rejections were very rare. On the other hand, in Lamelera, Indonesia, whale hunters typically offered generous splits of around 50% or more, and low offers were widely rejected.18, 19 Henrich concluded that fairness norms and expectations strongly depended on the level of market integration and the importance of cooperation in daily life and survival. Henrich's findings showed that ideas of fairness are not completely universal but rather deeply cultural, while also highlighting the importance of conducting cross-cultural research before generalizing theories on a global scale. 

Neuroscience of fairness

What if we had physiological evidence for bargaining being much less rational than economic theory suggests? Alan Sanfey of Radboud University in the Netherlands used fMRI imaging to observe what parts of the brain were activated when people participated in the ultimatum game. Sanfey discovered a sort of neurological tug-of-war that happens when people face different offers. When an unfair offer is made and subsequently rejected, there’s increased activity in the anterior insula, a region associated with emotional processing, especially feelings like disgust or anger. This heightened emotional response to an unfair offer seems to drive the decision to reject, even though it means walking away from money.

On the other hand, accepted offers, including some unfair ones, show greater activation in the dorsolateral prefrontal cortex (DLPFC), a brain area linked to rational thinking and self-control. The DLPFC is thought to help evaluate the potential monetary benefits and maintain a task-focused mindset geared toward maximizing gain.

Interestingly, this DLPFC activity stays relatively stable regardless of how unfair the offer is, suggesting that while the rational part of the brain continuously processes the potential financial gain, the emotional response in the anterior insula increases sharply as offers become more unfair. In essence, the brain is balancing a steady, logical drive to accept money against a growing emotional reaction to perceived unfairness. 

Sanfey was actually able to use these insula activity levels to predict the likelihood of rejecting an unfair offer, providing neural evidence that people's decision-making is not purely rational and that, in economics, considering moral judgment and emotion is crucial.⁸

Game Theory

The ultimatum game was born from game theory—one of the most famous concepts in behavioral economics used to explain behavior and the decision-making process. Originally developed by John von Neumann in the 1920s, game theory has since become the foundation for research on how people really make choices. 

The Power of Narratives in Decision-Making

Fairness isn't the only thing that can impact our decisions—narratives can be powerful too. This article explains how humans naturally think using stories, and why our minds treat them as special, allowing them to guide our choices in ways that logic doesn't. This article highlights the social and emotional nature of our decision-making. 

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