The Nonlinear Library LW - Scaling laws for dominant assurance contracts by jessicata
Nov 30, 2023
11:57
Welcome to The Nonlinear Library, where we use Text-to-Speech software to convert the best writing from the Rationalist and EA communities into audio. This is: Scaling laws for dominant assurance contracts, published by jessicata on November 30, 2023 on LessWrong.
(note: this post is high in economics math, probably of narrow interest)
Dominant assurance contracts are a mechanism proposed by Alex Tabarrok for funding public goods. The following summarizes a 2012 class paper of mine on dominant assurance contracts. Mainly, I will be determining how much the amount of money a dominant assurance contract can raise as a function of how much value is created for how many parties, under uncertainty about how much different parties value the public good. Briefly, the conclusion is that, while Tabarrok asserts that the entrepreneur's profit is proportional to the number of consumers under some assumptions, I find it is proportional to the square root of the number of consumers under these same assumptions.
The basic idea of assurance contracts is easy to explain. Suppose there are N people ("consumers") who would each benefit by more than $S > 0 from a given public good (say, a piece of public domain music) being created, e.g. a park (note that we are assuming linear utility in money, which is approximately true on the margin, but can't be true at limits). An entrepreneur who is considering creating the public good can then make an offer to these consumers. They say, everyone has the option of signing a contract; this contract states that, if each other consumer signs the contract, then every consumer pays $S, and the entrepreneur creates the public good, which presumably costs no more than $NS to build (so the entrepreneur does not take a loss).
Under these assumptions, there is a Nash equilibrium of the game, in which each consumer signs the contract. To show this is a Nash equilibrium, consider whether a single consumer would benefit by unilaterally deciding not to sign the contract in a case where everyone else signs it. They would save $S by not signing the contract. However, since they don't sign the contract, the public good will not be created, and so they will lose over $S of value.
Therefore, everyone signing is a Nash equilibrium. Everyone can rationally believe themselves to be pivotal: the good is created if and only if they sign the contract, creating a strong incentive to sign.
Tabarrok seeks to solve the problem that, while this is a Nash equilibrium, signing the contract is not a dominant strategy. A dominant strategy is one where one would benefit by choosing that strategy (signing or not signing) regardless of what strategy everyone else takes. Even if it would be best for everyone if everyone signed, signing won't make a difference if at least one other person doesn't sign.
Tabarrok solves this by setting a failure payment $F > 0, and modifying the contract so that if the public good is not created, the entrepreneur pays every consumer who signed the contract $F. This requires the entrepreneur to take on risk, although that risk may be small if consumers have a sufficient incentive for signing the contract.
Here's the argument that signing the contract is a dominant strategy for each consumer. Pick out a single consumer and suppose everyone else signs the contract. Then the remaining consumer benefits by signing, by the previous logic (the failure payment is irrelevant, since the public good is created whenever the remaining consumer signs the contract).
Now consider a case where not everyone else signs the contract. Then by signing the contract, the remaining consumer gains $F, since the public good is not created. If they don't sign the contract, they get nothing and the public good is still not created. This is still better for them. Therefore, signing the contract is a dominant strategy.
What if there is uncertainty about how much the different consumers value the public good? This can be modeled as a Bayesi...
(note: this post is high in economics math, probably of narrow interest)
Dominant assurance contracts are a mechanism proposed by Alex Tabarrok for funding public goods. The following summarizes a 2012 class paper of mine on dominant assurance contracts. Mainly, I will be determining how much the amount of money a dominant assurance contract can raise as a function of how much value is created for how many parties, under uncertainty about how much different parties value the public good. Briefly, the conclusion is that, while Tabarrok asserts that the entrepreneur's profit is proportional to the number of consumers under some assumptions, I find it is proportional to the square root of the number of consumers under these same assumptions.
The basic idea of assurance contracts is easy to explain. Suppose there are N people ("consumers") who would each benefit by more than $S > 0 from a given public good (say, a piece of public domain music) being created, e.g. a park (note that we are assuming linear utility in money, which is approximately true on the margin, but can't be true at limits). An entrepreneur who is considering creating the public good can then make an offer to these consumers. They say, everyone has the option of signing a contract; this contract states that, if each other consumer signs the contract, then every consumer pays $S, and the entrepreneur creates the public good, which presumably costs no more than $NS to build (so the entrepreneur does not take a loss).
Under these assumptions, there is a Nash equilibrium of the game, in which each consumer signs the contract. To show this is a Nash equilibrium, consider whether a single consumer would benefit by unilaterally deciding not to sign the contract in a case where everyone else signs it. They would save $S by not signing the contract. However, since they don't sign the contract, the public good will not be created, and so they will lose over $S of value.
Therefore, everyone signing is a Nash equilibrium. Everyone can rationally believe themselves to be pivotal: the good is created if and only if they sign the contract, creating a strong incentive to sign.
Tabarrok seeks to solve the problem that, while this is a Nash equilibrium, signing the contract is not a dominant strategy. A dominant strategy is one where one would benefit by choosing that strategy (signing or not signing) regardless of what strategy everyone else takes. Even if it would be best for everyone if everyone signed, signing won't make a difference if at least one other person doesn't sign.
Tabarrok solves this by setting a failure payment $F > 0, and modifying the contract so that if the public good is not created, the entrepreneur pays every consumer who signed the contract $F. This requires the entrepreneur to take on risk, although that risk may be small if consumers have a sufficient incentive for signing the contract.
Here's the argument that signing the contract is a dominant strategy for each consumer. Pick out a single consumer and suppose everyone else signs the contract. Then the remaining consumer benefits by signing, by the previous logic (the failure payment is irrelevant, since the public good is created whenever the remaining consumer signs the contract).
Now consider a case where not everyone else signs the contract. Then by signing the contract, the remaining consumer gains $F, since the public good is not created. If they don't sign the contract, they get nothing and the public good is still not created. This is still better for them. Therefore, signing the contract is a dominant strategy.
What if there is uncertainty about how much the different consumers value the public good? This can be modeled as a Bayesi...