A Keynesian beauty contest is a concept developed by
John Maynard Keynes
John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...
and introduced in Chapter 12 of his work, ''
The General Theory of Employment, Interest and Money
''The General Theory of Employment, Interest and Money'' is a book by English economist John Maynard Keynes published in February 1936. It caused a profound shift in economic thought, giving macroeconomics a central place in economic theory and ...
'' (1936), to explain
price fluctuations in
equity
Equity may refer to:
Finance, accounting and ownership
* Equity (finance), ownership of assets that have liabilities attached to them
** Stock, equity based on original contributions of cash or other value to a business
** Home equity, the dif ...
markets
Market is a term used to describe concepts such as:
* Market (economics), system in which parties engage in transactions according to supply and demand
* Market economy
*Marketplace, a physical marketplace or public market
Geography
*Märket, a ...
. It describes a beauty contest where judges are rewarded for selecting the ''most popular'' faces among all judges, rather than those they may personally find the most attractive.
Overview
Keynes described the action of rational agents in a market using an analogy based on a fictional newspaper contest, in which entrants are asked to choose the six most attractive faces from a hundred photographs. Those who picked the most popular faces are then eligible for a prize.
A naive strategy would be to choose the face that, in the opinion of the entrant, is the most handsome. A more sophisticated contest entrant, wishing to maximize the chances of winning a prize, would think about what the majority perception of attractiveness is, and then make a selection based on some inference from their knowledge of public perceptions. This can be carried one step further to take into account the fact that other entrants would each have their own opinion of what public perceptions are. Thus the strategy can be extended to the next order and the next and so on, at each level attempting to predict the eventual outcome of the process based on the reasoning of other
rational agent
A rational agent or rational being is a person or entity that always aims to perform optimal actions based on given premises and information. A rational agent can be anything that makes decisions, typically a person, firm, machine, or software.
Th ...
s.
"It is not a case of choosing those acesthat, to the best of one's judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees." (Keynes, ''General Theory of Employment, Interest and Money'', 1936).
Keynes believed that similar behavior was at work within the
stock market
A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include ''securities'' listed on a public stock exchange, as ...
. This would have investors pricing shares not based on what they think an asset's
fundamental value
In finance, the intrinsic value of an asset usually refers to a value calculated on simplified assumptions. For example, the intrinsic value of an option is based on the current market value of the underlying instrument, but ignores the possib ...
is, or even on what investors think other investors believe about the asset's value, but on what they think other investors believe is the average opinion about the value of the asset, or even higher-order assessments.
Example contests
In 2011,
National Public Radio
National Public Radio (NPR, stylized in all lowercase) is an American privately and state funded nonprofit media organization headquartered in Washington, D.C., with its NPR West headquarters in Culver City, California. It differs from other n ...
's ''
Planet Money
''Planet Money'' is an American podcast and blog produced by NPR. Using "creative and entertaining" dialogue and narrative, ''Planet Money'' claims to be "The Economy Explained."
History
The podcast was created by Alex Blumberg and Adam Davids ...
'' tested the theory by having its listeners select the cutest of three animal videos. The listeners were broken into two groups. One selected the animal they thought was cutest, and the other selected the one they thought most participants would think was the cutest. The results showed significant differences between the groups. Fifty percent of the first group selected a video with a kitten, compared to seventy-six percent of the second selecting the same kitten video. Individuals in the second group were generally able to disregard their own preferences and accurately make a decision based on the expected preferences of others. The results were considered to be consistent with Keynes' theory.
See also
*
Comparative advantage
In an economic model, agents have a comparative advantage over others in producing a particular good if they can produce that good at a lower relative opportunity cost or autarky price, i.e. at a lower relative marginal cost prior to trade. Comp ...
*''
Family Feud
''Family Feud'' is an American television game show created by Mark Goodson. It features two families who compete to name the most popular answers to survey questions in order to win cash and prizes.
The show has had three separate runs, the ...
''
*
Focal point (game theory)
In game theory, a focal point (or Schelling point) is a solution that people tend to choose by default in the absence of communication. The concept was introduced by the American economist Thomas Schelling in his book ''The Strategy of Conflict'' ( ...
*
Guess 2/3 of the average
In game theory, "guess of the average" is a game that explores how a player’s strategic reasoning process takes into account the mental process of others in the game.
In this game, players simultaneously select a real number between 0 and 100, ...
*
Tactical voting
Strategic voting, also called tactical voting, sophisticated voting or insincere voting, occurs in voting systems when a voter votes for another candidate or party than their ''sincere preference'' to prevent an undesirable outcome. For example, ...
Notes
References
*
*
*{{cite journal , last=Nagel , first=Rosemarie , year=1995 , title=Unraveling in Guessing Games: An Experimental Study , journal=
American Economic Review
The ''American Economic Review'' is a monthly peer-reviewed academic journal published by the American Economic Association. First published in 1911, it is considered one of the most prestigious and highly distinguished journals in the field of ec ...
, volume=85 , issue=5 , pages=1313–1326 , jstor=2950991
External links
The State of Long-Term Expectation Ch 12. General Theory of Employment Interest and Money
Behavioral finance
Game theory
Keynesian economics
Social science experiments