Introduction video

Problem

U.S. stock market major indexes since 2020 (Source: Statista, edited)

After a huge crash last March, the U.S. stock market recovered quicker than ever in history; the stock market index S&P 500 gained almost 80% since its lowest point by April 2021, and Nasdaq Composite, a tech-heavy index, gained more than 100%. This makes sense since more people are relying on technology for various things during the pandemic. What does not make sense, however, is that millions of people were losing their jobs at the same moment the stock market was booming. 

K-shaped recovery diagram (Source: U.S. Chamber of Commerce)

One of the answers to this question is that we are going through a K-shaped recovery. At the macroeconomic level, this is a situation where billion-dollar corporations, especially those in technology or finance sectors, will recover from this crisis and grow. On the other hand, small businesses usually in the services and retail industry will struggle to survive and take out loans. We can see that something similar will happen at the individual level. Wealthy individuals, who have the ability to use this crisis as an opportunity to buy undervalued stocks and other assets, continue to get richer, while poor individuals will be forced to sell their assets. A connection between these two levels is also quite straightforward. Many jobs in the technology and finance sectors are well-paying and can be done remotely. Many low-wage workers in the services and retail industry, however, do not have such luxury. This is definitely not a healthy nor sustainable form of recovery, especially as the wealth gap was already widening pre-pandemic.

Case Study

Let’s dive deeper into the problem by looking at two fictional, but realistic characters: Robert and John.

Robert is an engineer at a Silicon Valley technology company. Due to the COVID-19, his colleagues and he began to work from home. It was not a big deal, as he had necessary office equipment at home and all of his work can be done through a computer screen. He had to cancel his family’s summer vacation, but he was able to invest in the stock market with the money saved. At the end of the year, he received a big bonus as more people using technology lead to a large profit growth of the company. His children have well adjusted to online learning, with new laptops Robert purchased for them. When there is something the kids do not understand, they do not hesitate to ask their teachers or parents.

On the other hand, Amelia is an owner of a small restaurant in Los Angeles. Before the pandemic, her restaurant wasn’t thriving but she still earned enough money to raise a family. Due to multiple lockdowns and other restrictions, however, she is barely making any money from the restaurant after paying the rent and her workers. Some financial assistance she received from the government was not enough and taking out a loan was unavoidable to feed her family. The public school her kids attend is providing online learning, but frustrating technological problems occur occasionally in which Amelia does not know much of. Their teachers are not always available when the kids do not understand something.

We can see how this COVID-19 crisis can affect people differently based on their socioeconomic position. For people on the one side, it’s just a bit boring time. For those on the other side, however, it’s chaos changing every aspect of their lives. More importantly, this gap is not likely to close unless some strong efforts to change the situation are made.

My Response

To provide a deeper analysis of the problem and evaluation of a possible solution, I will apply a concept from game theory, or the study of mathematical models to produce a strategic decision. To be specific, I will use something called a payoff matrix. If you are not much of a math person, don’t worry – I will keep things relatively simple. As long as you know how to compare which number is greater, you should be fine.

Before we begin, it is important to keep in mind that this is an oversimplified model. The actual situation is much more complex than what we are about to see and requires multiple advanced concepts. However, the payoff matrix will still demonstrate the essential structure behind this problem.

Players & Strategies

We have to start by defining the players in this game and possible strategies they can choose to play. One player is a group of large corporations and wealthy individuals, and they have two strategies. Strategy A is to prioritize the benefit of society: this means donating money and volunteering for those in need, paying fair wages to their employees, etc. Strategy B is to prioritize their own benefit: buying undervalued assets whenever possible, spending money only for themselves, etc. I will call this player R. The other players are small businesses and poor individuals, who also have two strategies. Strategy A is to focus on the short-term: spending the entire income without saving or investing. Strategy B, on the other side, is to focus on the long-term: making an emergency fund and living below their means. I will call them player P.

Payoffs

Payoff matrix

Now, let’s see what each situation will look like to both players.

First, situation AA. This is when player R prioritizes the benefit of society, and player P prioritizes the long-term benefit. Therefore, player P can benefit from donations and other support provided by Player R. They will also have better financial stability when an economic crisis, such as the one caused by COVID-19, comes because they would have saved up money. On the surface level, this might not seem like a good situation for player R as they cannot benefit from buying undervalued assets and have less money due to donations. (I am not considering the pleasure people get from helping people in need, which can be a big factor.) Looking at the bigger picture, however, player P having better financial health means a better overall economy, which will benefit player R — when the economy is better, company earnings will improve, stock prices will rise, etc. This is the best-case scenario for both of the players, so I am assigning a payoff of 100 to each.

Situation AB is when player R is trying to benefit society, but player P only focuses on their short-term happiness. For player P, this is not a good situation as they will suffer during an economic recession. Although the help from player R might help them a bit, it will be nowhere enough the level they need. This will not benefit player R either. Because they are not acting for their own benefit, they cannot gain financial wealth from buying undervalued assets. Due to player P having bad financial management, the economy won’t be good as well. Thus, I will assign a payoff of 20 to player R and 30 to player P.

Furthermore, situation BA is when player R is focused on maximizing their own benefit, but player P is not spending all their money and instead has an emergency plan. Although player R is no longer helping player R, the small businesses and poor individuals will still be better off than situation AB because they are well prepared to survive an unanticipated economic crisis. For player R, they will try to buy undervalued assets, but there will not be as much on the market due to player P playing strategy A. Yet, they will benefit from the economy being better overall. Since this is better than the second situation but worse than the first one, player R will be assigned 60 and player P will be assigned 50.

Last but not least, situation BB is when player R prioritizes their own benefit, and player P does not save or invest any portion of their income when the economy was booming. In my opinion, this is what is going on in most places around the world. For player P, this is by far the worst outcome; they were not ready for an economic crisis and will struggle to maintain stable finance. Player R is also trying to use the crisis as an opportunity to buy undervalued assets that player P was forced to sell to survive. Moreover, their children are likely to get less efficient education than those of player R since the gap between public and private schools has widened in online learning. These wealth and education gaps are likely to last years, if not generations. On the other hand, player R can greatly benefit from this situation. Although the overall economy will not fully recover for quite a long time, they can gain a lot of financial wealth by “picking up” those undervalued assets. In fact, as discussed before, many wealthy individuals were able to invest in the stock market after its crash and gain earn large amounts of money. Therefore, I am assigning a payoff of 10 to player P and 70 to player R.

Movement Diagram

Payoff matrix with movement diagram

Before we get into analyzing the payoff matrix, you need to know what Nash equilibrium is. In simple terms, it is a situation where no players can obtain a better outcome by changing their strategy without the opponent changing his strategy. In order to find the Nash equilibrium of this game, we have to use something called the movement diagram. Basically, we illustrate using arrows which strategy one should take given that the opponent will take a particular strategy. In the table above, we can see that player P should take strategy A no matter what, while player R should take strategy A when player P takes strategy A and take strategy B when player P takes strategy B. Therefore, the Nash equilibrium of this game is situation AA. That is, we can expect both players to take strategy A.

If you read this article thoroughly so far, you might be thinking, “But wait, something doesn’t sound right. Didn’t you just say that we are experiencing the situation BB?” Well, yes. I did. The reason behind this difference is quite simple: we have assumed that all players are rational, and in the real world, people act irrationally many of the time. To be specific, player P is acting irrationally as they should play strategy A when player R is playing strategy B. But they are playing strategy B. Why is that? Because many people tend to focus too much on immediate happiness and fail to prepare for a possible emergency situation, like the COVID-19 crisis we are experiencing.

Pareto Optimal

Pareto optimal diagram

Now that you know why we are in situation BB, it is time to understand which situation is the most optimal for both player P and player R.

Shown above is something called Pareto optimal diagram. For each point, the x-coordinate represents the payoff of player R and the y-coordinate represents that of player P. To find the Pareto optimal point, we just have to look for the point farthest from the origin; in this case, it would be the point (100, 100). Since the situation that has a payoff of (100, 100) is situation AA, we know that this is the most optimal situation for both players. And this makes sense — it is the situation that has the highest payoffs out of four. 

What Can Be Done?

A quick recap: the Nash equilibrium and Pareto optimal situation of this game is situation AA, but since people are acting irrationally, we are currently situation BB. Therefore, we have to somehow encourage both players to take strategy A. For example, the government can provide tax cuts for those who donate a certain amount of money in order to encourage player R to switch to strategy A. It can also encourage player P to make an emergency fund by providing higher than usual interest rates. Furthermore, as I discussed in the case study part, the education gap is widened during the pandemic, which can lead to long-lasting effects. Therefore, the government can invest a lot of money in public education to close this gap. Below you can see more information about what policies can be used to reduce economic inequality in general.

Polices that can be implemented to reduce economic inequality (Source: Belonging Institute)

Your Response

By this point, I hope you have a good understanding of why it is difficult to achieve a sustainable economic recovery from this pandemic, why it is important to do so, and what can be done by the government to help solve this issue. And now is your turn. In the comment section below, please let me know:

  1. Have you seen or experienced any real world examples of ‘Richard’ or ‘Amelia’?
  2. What do you think are the actions can be taken at individual level to achieve a sustainable economic recovery?

“A nation will not survive morally or economically when so few have so much and so many have so little.”

– Bernie Sanders –

Here is the Works Cited Page.

2 comments

  1. Hi Ming, I loved your presentation! Using Game Theory to strategize change is a super powerful approach, and offers actionable outcomes. Yes, I have seen lots of real world examples of “Richard” and “Amelia” here in the Bay Area, where I live. The more you game out their choices, the clearer it becomes why we are experiencing a K-shaped recovery. This is even more pronounced in Brazil, where you–and I– are from. My only question, is how can you assign a number to the “emotional decision making variable?” Doesn’t this vary? Or is there a predictable rate of emotional decision making on different topics? Great work!

  2. Hi Ming, your project is super in-depth and detailed. I liked your use of graphs and other visual aids to help explain the current situation. Your proposed strategies seem well-researched. Great job!

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