SBCs as a Dynamic Commitment Problem: an Explanatory Note

This note gives a brief explanation of the model by Dewatripont and Maskin (1995). A plethora of models have evolved around the basic idea set out in the above mentioned paper, but we will focus on the main ideas. The model is a game-theoretical model, which means that we study the behaviour of economic agents, when (strategically) interacting with each other (cfr. playing chess is about anticipating strategies of your opponent). This as opposed to neo-classical economic theory which focuses on the behaviour of one economic agent e.g. one utility maximising consumer decides over consumption, one enterpreneur maximises pro…ts and chooses production or prices accordingly. The structure of the model is as follows (a graphical representation of the game is presented in Figure 1): ² There are 2t ime periods: 1 and 2 ² There are 2 players: an enterpreneur (E) and the government (G)