The document discusses the economics of trust through analyzing examples like the pin factory and the trust game. It explains that modern economies rely on division of labor which requires trust across parties. Trust is the willingness of one party to rely on another despite risks. In the trust game, player 1 must decide whether to trust player 2 to cooperate for mutual higher rewards or not trust and receive only a smaller reward, though player 2 may defect for an even higher reward. Building and maintaining trust provides benefits but can also involve costs if trust is lost.

1. Managerial Economics<br />An essay on application of Microeconomics<br />By:<br />Sandip Kr. Biswas<br />G11043<br />The Economics of Trust<br />Adam Smith had argued that wealth was built on the division of labor. He gave the famous example of the pin factory in which one worker drew out the pin wire, another cut the wire, a third added the pin head, a fourth sharpened the pin to a point and so on. But the pin factory achieves nothing if the workers can’t trust each other, and a modern global economy relies on a division of labor and the accompanying trust that spans the continents many times.<br />Hence trust is the willingness of one party (trustor) to rely on the actions of another party (trustee).So there is a reasonable confidence of the trustor that the trustee will behave in a way beneficial to the trustor though there is a risk of harm to the trustor if the trustee will not behave accordingly.<br />Trust is like a pot of money. When we do something for other people, we put money in the pot. When they do things for us, they take money out of the pot. The problem is that when we act in an untrustworthy manner, we are fined a huge amount and we can even become bankrupt. And when trust is lost, it requires an even larger investment over a period of time to restore.<br />Individually, we have trust capital with the people around us, which determines how much they trust us and how quickly they will act to help us when we ask things of them. Companies and groups also have trust capital within them, which is the aggregate trust level of the people within the company.<br />There is also an external trust capital, which approximates to the internal levels. This is the brand value of the company, which is the aggregate of the trust placed in the company by all of its external stakeholders, including customers, shareholders and suppliers. When I buy a Santro, I trust the Hyundai brand that it will be safe.<br />The Trust Game<br />The trust game has two players - Player 1 and Player 2 - and can be used to model an interaction where individuals are relying on the trustworthiness of others. <br />2509284228718P100P1<br />27325684744900221157247108<br />17989551765300033598881738870 Don’t Trust P2 Trust P2<br />1077595229870P 1 Payoff =sP2 Payoff =s00P 1 Payoff =sP2 Payoff =s<br />411416522479000316801520383500357378015240P200P2<br />272796021971000465772518542000 Defect Cooperate<br />2208530149860P 1 Payoff =0P2 Payoff =100P 1 Payoff =0P2 Payoff =14479290161290P 1 Payoff =rP2 Payoff =r00P 1 Payoff =rP2 Payoff =r<br />The Trust Game S is the reward for both players if P1 doesn't trust P2 and is more than zero but less than r (the reward for both provided they trust each other). r is in turn less than 1 which is the reward for P2 for betraying P1's trust.<br />In the gane, Player 1 decides to play first. If Player 1 doesn't trust Player 2, they both get a small reward. Player 1 has to trust Player 2 so that both of them get a bigger reward. But Player 2 will get an even bigger reward if he betrays Player 1's trust thus leaving him with nothing. The best thing for Player 2 to do under such circumstances is to take advantage of Player 1 (if he knows he will be trusted)<br />So if Player 1 and Player 2 interact only once, Player 1 should never have trusted Player 2 because he will always take advantage of this trust. Instead Player 1 should first settle and share a small reward with Player 2.<br />Conclusion<br />As per Fortune magazine “trust between managers and employees is the primary defining characteristic of the very best workplaces.”<br />Thus Trust means confidence. It can be concluded that our behaviour can inspire trust. We can, if we try, establish, grow, extend and restore trust and by increasing trust, we can speed up things and cut transaction costs. Trust is essential to prosperity, joy, happiness and professional success. Thus in the words of former US President Ronald Reagan- “Trust, but verify”<br />