What is Game Theory?

TNN Apr 21, 2003, 01.29am IST In the broadest terms, game theory analyses how groups of people interact in social and economic situations. An accurate description of game theory is the term used by psychologists — the theory of social situations. There are two main branches of game theory: co-operative and non-co-operative game theory. Most of the research in game theory is in the field of non-co-operative games, which analyses how intelligent (or rational) people interact with others in order to achieve their own goals. It is called 'game theory' because it models individual behaviour as if two or more people were participating in a game, at the end of which either player gets a payoff (or some benefit). Thus, the game itself evolves as each player moves, or uses the strategies available to him, in order to achieve the best outcome (or the highest payoff) for himself. Who is regarded as the father of modern Game Theory? Contrary to popular perception, the father of modern game theory is not John Nash, though he did make seminal contributions to this field. Mathematical game theory was invented by John von Neumann and Oskar Morgenstern in 1944. John Nash extended and generalised the pioneering results achieved by von Neumann and Morgenstern, for which he won the Nobel Prize for Economics in 1994. He is best known by the 'Nash Equilibrium', a situation that can be described as the stable outcome resulting from two or more players adopting strategies that they think will maximise their individual gains from a situation or 'game'. Are game theoretics only this recent? Although the systematic mathematical form of game theory is owed to these two, game theoretic insights are far older than that. For example, Plato, in the Republic, at one point has Socrates worry about the following situation. Consider a soldier at the front, waiting with his comrades to repulse an enemy attack. It may occur to him that if the defence is likely to be successful, then it isn't very probable that his own personal contribution will be essential. But if he stays, he runs the risk of being killed or wounded — apparently for no point. If the enemy is going to win the battle, then his chances of death or injury are higher still, and now quite clearly to no point, since the line will be overwhelmed anyway. Based on this reasoning, it would appear that the soldier is better off running away regardless of who is going to win the battle. Of course, if all of the soldiers reason this way — as they all apparently should, since they're all in identical situations — then this will certainly bring about the outcome in which the battle is lost. So what does a commander do to prevent this rout? He changes the incentives of his soldiers by shooting all deserters, discouraging mass desertion before a shot has been fired. What are the economic applications of Game Theory? The work of von Neumann and Morgenstern led to the application of game theory in economics. Many economic situations are situations where players have to act competitively, or bargain, to achieve the best result for themselves. One example is the bidding for spectrum by cellular operators. The auctions are designed using game theory so that the highest bidder gets bandwidth without paying too much

and the nature of the arms race. and neither would want to be defenseless against the other. In the case of MAD. Are there non-economic applications as well? One of the best known applications of game theory was in the field of political science: the understanding of Mutually Assured Destruction (MAD) in the event of nuclear war . say between men and women. As a result. the socially inferior outcome (increased arms expenditure) obtains instead. . then both would end up spending on arms. because each would fear that the other will arm itself. failing which disaster would ensue for both parties. and at the micro level as to how households divide resources between various members. If two countries are faced with the choice of either spending money on welfare or on buying weapons. a game would capture how the best strategy for two nuclear powers with equally effective destructive capacity is to not launch a missile. The arms race example has the opposite effect. Therefore. the best. Some extensions of game theory try to capture the distribution of resources between various competing uses as a bargaining problem. or 'dominant' strategy for either player is to not launch a missile. This can be at the macro level as to how governments spend money between various competing uses.(avoiding the 'winner's curse'). while the socially preferable outcome would be to spend on welfare.

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