Martin Shubik


Ed. note: This story first appeared in our Dec. 15, 2010 edition. We thought it especially relevant in light of the story which you can read elsewhere on this site at about the Board of Jewish Education’s ongoing lawsuit against a family here - and the possibility that the Board may incur huge legal costs - even if it should win its lawsuit.




Why do two nations engage in a wasteful arms race when, at the end of the day, having squandered massive resources, they are no more secure than they were initially? Why do divorcing couples routinely engage in a costly legal process that destroys a substantial portion of their joint assets when they could use a less expensive and quicker dispute resolution approach?

In 1971 in the Journal of Conflict Resolution, Martin Shubik, an economist at Yale University, described a novel auction that provides valuable insights into how escalation begins and gains momentum as it proceeds.
Professor Shubik provided the following rules for auctioning a dollar. Potential buyers publicly call out their bids which proceed in increments of one or more nickels. The person with the highest final bid pays that amount to purchase the dollar. Unlike conventional auctions where unsuccessful bidders pay nothing, in Shubik’s “Dollar Auction,” they also pay the auctioneer their highest bid.

To illustrate, suppose there are only two bidders. If the first bids five cents and the second drops out, the first bidder gets the dollar for five cents, gaining ninety-five cents.
If instead the second party bids ten cents, the first bidder may decide to bid fifteen cents, hoping to gain eight-five cents, rather than dropping out and forfeiting his bid of five cents. Suppose the bidding proceeds until the first bidder has bid nine-five cents while the second bidder has bid ninety cents.
The second bidder might decide to bid one dollar instead of dropping out and losing ninety cents. The first bidder would then face the dilemma of bidding more than one dollar for a dollar, for example bidding $1.05, rather than dropping out and losing nine-five cents. He would do so in the hope that the second bidder will drop out but the second bidder might well decide to bid $1.10 rather than forfeiting his previous bid of one dollar by dropping out.
So at this point, the bidders find themselves in a lose-lose situation to which they have been lead by the lure of an easy profit.

Shubik’s dollar auction clearly illustrates how incentives can lead to escalation and a mutually destructive outcome, even in the absence of powerful psychological factors that can fuel the escalation. It has been used as a suitable metaphor to explain an arms race between two counties such as India and Pakistan, or the U.S. and the former Soviet Union. It has also been used to describe a patent race between two pharmaceutical firms, where the cost incurred on research and development by the losing firm cannot be recovered.

A striking example of escalation in the court room began in 1987 with a minor dispute between Alex and Suzi Diacou – who shared a ninth floor loft in a co-op housing unit with their young daughter – and their co-op board. In 1987, the Diacous refused to reimburse the co-op board for the $909 spent to install window bars in their loft, as required by law for apartments housing children under 10, arguing that all of the residents should share this expense.
The co-op board sued the Diacous to recover the cost of the bars and legal costs that had grown to $10,000 by 1990. The Diacous appealed to a higher court which upheld their appeal. The co-op board appealed to a still higher court.
By 1993, the Diacous finally decided to settle, agreeing to pay $30,000 of the co-op’s legal bill of $73,547 as well as their own lawyer’s bill for $30,000, the $909 owing for the window bars, and their share of the $43,547 in legal costs collectively borne by all of the co-op residents. The total cost had escalated more than ten-fold.

With twenty-twenty hindsight, Alex Diacou reportedly stated “I am a man converted. Anything you can possibly do to avoid a lawsuit, do it.” Clearly pride and principle can be very costly. However difficult it may be to concede before a fight escalates, this may well be the rational choice.