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International Game Theory Review

Vol. 15, No. 3 (2013) 1340011 (8 pages)

c World Scientific Publishing Company
DOI: 10.1142/S0219198913400112

APPLICATIONS OF GAME THEORY TO ECONOMICS

GUILLERMO OWEN
Department of Applied Mathematics
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Naval Postgraduate School, 1 University Way

Monterey, CA 93943, USA
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gowen@nps.edu

Received 31 August 2011

Revised 4 October 2011
Accepted 18 March 2013
Published 8 July 2013

We look at the basic applications of cooperative game theory to economic situations.

These include bargaining and cooperative equilibria, especially as the number of players
increases without bound. The core and the Shapley value are the fundamental tools for
these applications. We consider the relation between these two concepts. A comprehen-
sive bibliography of work published over the last decade is included.

Keywords: Game Theory; economics; core; value; bargaining.

Subject Classification: A10, C70, C71

1. Introduction
Originally, the theory of games was developed to look at (parlor) games. The
groundbreaking work by Zermelo [1913] referred to one particular game chess
though it was clearly applicable to such other games as checkers and tic-tac-toe
(two-person zero-sum games with perfect information). Such games, of course, have
solutions in pure strategies. Later, Borel [1924] and von Neumann [1928] introduced
the idea of mixed strategies. Both of these pioneering articles were clearly concerned
with games as such.
It was not until von Neumann teamed with Morgenstern that the theory consid-
ered applications to economics. Their monumental work [von Neumann and Mor-
genstern, 1944, 1947, 1953] made it clear that economic situations could be modeled
as games. To quote the book:
The purpose of this book is to present a discussion of some fundamental
questions of economic theory which require a treatment different from that
which they have found thus far in the literature. (. . . )
Our considerations will lead to the application of the mathematical
theory of “games of strategy” developed by one of us in several successive

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stages in 1928 and 1940–1941. After the presentation of this theory, its
application to economic problems in the sense indicated above will be
undertaken. It will appear that it provides a new approach to a number of
economic questions as yet unsettled.
We shall first have to find in which way this theory of games can be
brought into relationship with economic theory, and what their common
elements are. It will then become apparent that (. . . ) this theory of games
of strategy is the proper instrument with which to develop a theory of eco-
nomic behavior. (. . . )
We hope to establish (. . . ) that the typical problems of economic behav-
ior become identical with the mathematical notions of suitable games of
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strategy.
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Thus the founders of game theory as a science clearly meant it to be an economic

tool. Now, what is the difference between game theory and economics? What are
their common elements?
As concerns economics, Aumann and Drèze [1986] point out that “Economic
models have two basic components, the objective and the subjective.” Among the
objective they include resources and technology; the subjective deals with utility
or preferences.
As for game theory, we know that it can be applied to any type of compet-
itive activity. This includes games, warfare, voting situations, interpersonal bar-
gaining, evolution and network theory. We will disregard all these and concentrate
on economics. In their approach to this, Gambarelli and Owen [2004] consider four
paradigms. The first one looks at pure economic activity, with no optimization
included. The second looks at optimization. In the third, a decision maker looks at
other people’s preferences, in order to optimize on the basis of their reactions. The
fourth paradigm deals with the matter of game theory: competing decision makers
must take each other’s preferences into account. It is this fourth paradigm that
interests us.
We are interested, then, in economic situations which allow for strategic behav-
ior on the part of more than one individual. Alternatively, we consider games whose
characteristic function is defined in terms of commodities, technologies, and pref-
erences.
With more than two players, an important question is whether cooperation is
allowed. Thus the obvious (and very important) distinction between cooperative
and noncooperative economic situations.
For noncooperative situations, we find a precursor in the work of Cournot [1838]
who developed the notion of equilibrium behavior in an oligopoly. Of course only
a special type of function was considered; this allowed for the existence of pure-
strategy equilibria. Nash [1950a, 1951] proves the existence of a mixed-strategy
equilibrium, and this regardless of the type of payoff function. In this sense, Nash
opens the way for economic applications of the noncooperative theory.

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We concentrate here on the cooperative situations.

Perhaps the simplest situation deals with two traders, trading two commodities.
In fact, Edgeworth [1881] had treated this situation in some detail; the Edgeworth
Box is one of the precursors to the economic theory of games. Shubik [1959] shows
the relation very clearly. In particular this article shows how the characteristic
function of such a (two-commodity) game is constructed.
Frequently, game theory is used as a tool to determine equilibria of economic
situations. The strong equilibrium required corresponds to the game-theoretic core
[Gillies, 1959]. It may be, however, that the core contains nonequilibrium points,
though in a case of a perfect market, this should not happen. We discuss this
below. Also of great importance is the Shapley [1953] value as it corresponds to a
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reasonable “fair” outcome of economic situations. We will also discuss this.

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Originally, most game-theoretic work was on economic situations with a rela-

tively small number of players. In particular, we find Nash [1950b, 1953] dealing with
pure bargaining situations between two players. Certainly bargaining has its place
in economics. However, we are generally more interested in cases where there are
several possible interactions, and this will require more than two players. Harsanyi
[1957] considers the problem of multi-payer bargaining. A simple but interesting
example can be found in Owen [1995a, Example X. 4.4] which considers a small
market consisting of a seller and two buyers. As is pointed out there, the core of
that game corresponds to the set of equilibrium prices. Also in that book, Example
X. 4.5 studies a larger market with m buyers and m sellers.
Now, for very large games, the limiting situation (perfect competition with mar-
ket equilibrium) is relatively simple. However, as von Neumann and Morgenstern
[1944, 1947, 1953] points out,

(. . . ) it is clear that if certain great groups of participants will — for any

reason whatsoever — act together, then the great number of participants
may not become effective; the decisive exchanges may take place directly
between large “coalitions”, few in number, and not between individuals,
many in number, acting independently. Any satisfactory theory (. . . ) will
have to explain under what circumstances such big coalitions will or will
not be formed — i.e., when the large number of participants will become
effective and lead to a more or less free competition.

As game theory progressed, then, more complicated economic situations had

to be considered; in particular, games with large number of players had to be
treated. Best known of these is perhaps the glove (or shoe) game, which considers
a large number of players dealing with two complementary commodities. It is easy
enough to compute the core for such a game, as it corresponds to the equilibrium
price; the (Shapley) value is another thing. In fact, Shapley [1967] gives an exact
result, which shows how the value differs from the core. As a consequence of this,
much of game-theoretic work on large economies has focused on four important

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questions:
(1) Under which conditions is the core nonempty?
(2) Has the core any points other than the competitive equilibria?
(3) How can the value be computed?
(4) How close is the value to being in the core?

2. Nonemptiness of the Core

As to the first of these questions, it is not difficult to see that the core is nonempty
under suitable concavity-convexity conditions (concave utility functions and tech-
nologies, convex commodity spaces).
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If the economy lacks the concavity-convexity conditions, the core might well be
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empty. Nonetheless, Aumann and Shapley [1974] point out that, for a nonatomic
economy with reasonable conditions, not only is the core nonempty, but it actually
reduces to a single point that coincides with the value. The reasonable conditions
state, in essence, that the economy has constant returns to scale.
The obvious question is whether this statement holds true for large but finite
economies. The problem, of course, is that a nonatomic economy can only be con-
sidered a limiting case of a large finite economy. As Aumann and Drèze [1986]
points out, “The continuum is too rough a tool; it obliterates the fine structure of
the problem, and so leads to inconclusive results... what prevents the continuum
approach from achieving a more satisfactory result is that ‘small’ coalitions play no
role.”
We see then that the main problem in applying game theory to market situations
has lain in the difficulty of making the individual player important enough that
his actions will have some effect for others, and not merely for himself. Several
approaches are available.
One possibility is to replicate the market. A market with n traders, each with a
given endowment, is replicated k times. There will then be a total of kn traders, with
k of each type. All those of a given type have the utility function and endowment
of one of the original n traders. This was first seen in Debreu and Scarf [1963];
see also Shapley [1975] and Aumann [1979]. If the original (nonreplicated) market
has a nonempty core, then the replicated markets will also have nonempty cores.
Of course, if the original market has an empty core, the replicated markets might
nevertheless have nonempty cores.
More generally, game-theoretic models — rather than replicating one set of
players many times — consider nested sequences of sets of players. In the limit the
sets are infinitely large. There must however, be some sort of regularity as to the
new players “entering” the game; they cannot be much larger (in endowment) or
much more efficient (in their technologies) than previous players. Nor, on the other
hand, can they be much smaller or much less efficient. As an example (of what
should not be allowed to happen), we should not consider situations in which each
new player is twice as large as any previous player as the effect of this is that the

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analysis would, in effect, reduce to considering the interplay among the new players,
with the older players essentially becoming near-dummies. Contrariwise, we should
not consider situations in which the new players are so small that the endowments
form a convergent series. Hence both upper and lower bounds (on the endowments)
are required.
In doing this, finally, some care must be taken. It frequently happens that, for
any finite game, the core is nonempty. Hence the question is whether, as the number
of players increases, the core will, in the limit, be nonempty. From a set-theoretic
point of view, this is of course a meaningless question: in what sense can it be said
that a sequence of empty sets has a nonempty limit?
The answer, given in Flåm et al. [2005], lies in defining a quantity, the core
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deficit, which is zero if and only if the core is nonempty. If this deficit approaches a
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limit of zero (as the number of players increases) then it is meaningful to say that,
in the limit, the core is nonempty.
One approach, found in the same Flåm et al. [2005], assumes that it is never
efficient for any player to go outside a certain compact set Q of trades. Moreover,
the players’ endowment sets are uniformly bounded. Under these circumstances, it
can be shown that the deficit is bounded above. Now, if we can assume that the
sum of all endowments forms a divergent series, it will follow that, by comparison
with the total endowments, the deficit becomes infinitesimally small. If, moreover,
the utility and production functions are uniformly continuously differentiable, then
the absolute deficit approaches zero as a limit. In this sense, then, it can be said
that the infinite (limiting) economic situation has a nonempty core.
A somewhat different approach is found in Wooders [1992], which assumes a
small coalition property: almost all gains from coalition formation can be achieved
by coalitions no larger than a certain size. In this case once again, and with condi-
tions similar to those of Flåm et al. [2005] it can be shown that, in the limit, the
deficit converges to zero, either relatively or absolutely.

3. Nonequilibrium Points in the Core

A related question is as to the existence of nonequilibrium points in the core. In
general these articles study the rate of convergence of the core to the competitive
allocations, i.e., market equilibria. An interesting example is found in Owen [1975a]
which considers a purely linear (and hence concave-convex) model. In this case,
linear programming is used to develop the characteristic function of the game;
the dual linear program gives equilibrium prices for the commodities. In turn, the
equilibrium prices give points in the core (though not all the core can be obtained
in this way). An interesting result is that, when the maximization point is unique,
a sufficiently large-scale replication of the economy will cause the core to reduce to
a single point. If, on the other hand, the equilibrium prices are not unique, there
may be some nonequilibrium points in the core, even if the number of replications
is arbitrarily large.

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Shapley [1975] considers this problem and shows that, with k -fold replicated
economies, even with strictly concave utility functions, convergence
√ of the core to
the equilibrium can be extremely slow — slower, say, than 1/ k. Thus nonequilib-
rium points will be in the core no matter how large k may be.

4. Computation of the Shapley Value

The problem of computing the value is of course quite important. Shapley [1953]
gives the usual formula, and alternative methods, which are quite useful for small
games. An important technique is based on the players’ marginal contributions:
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The players (. . . ) agree to play the game v in a grand coalition, formed in

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the following way: 1. (. . . ) the coalition adds one player at a time (. . . ). 2.

The order in which the players are to join is determined by chance, with all
arrangements equally probable. 3. Each player (. . . ) is promised the amount
which his adherence contributes (. . . ).

This is, of course, the standard permutation technique, where each player
obtains the (expected value of) his marginal contribution. For small games, it is
easy enough to list all n! permutations of the players. For large games, it is clearly
out of the question to do so, but in many cases the symmetry of the game will
simplify the calculations.
An alternative approach is given by the method of multilinear extensions Owen
[1972]. The advantage of this is that well-known properties of random variables
can then be used. We see this in Owen [1975b] which is not however an economic
application. We also see it in Owen [1993] which looks at a very special game with
two commodities, and then in Owen [1995b] which generalizes this to larger games
on two measures (i.e., two commodities). While this gives good approximations, a
generalization of this to more than two measures seems to give rise to complications;
essentially requiring O(2k ) computations to take into account all the interplays
among the k commodities involved.

5. Convergence of the Value to the Core

Granted that the two concepts, value and core, represent important economic ideas,
the obvious question is as to the relation between the two concepts. As noted above,
Aumann and Shapley [1974] has a nonatomic market game with a core consisting
of a single point that coincides with the value. In general, however, the value need
be nowhere near the core (assuming that the core is nonempty). In the three-person
game mentioned above [Owen, 1995a, Example X. 4.4], the value lies well outside
the core. Of course a game with just three players is too small to be thought of as a
real-life market situation. Nevertheless, mere number of players is no guarantee of
core-value coincidence. Owen [1993] shows that, in the shoe game, there are games
with arbitrarily large numbers of players in which the value differs substantially

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from the sole core point. It is only when the number of players increases, with some
regularity as to the type of players involved, that the value will converge to the
core.

6. Other Interesting Ideas

Apart from this, there are interesting ideas, dealing with certain types of games,
that are well studied in the game-theoretic literature. We mention among these:
(1) Matching games. This was first studied in Gale and Shapley [1962] and later
in Gale and Sotomayor [1985]. A good survey appears in Roth and Sotomayor
[1990].
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(2) Auction games. A good study is found in Milgrom and Weber [1982].
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(3) Markets with Satiation or Fixed Prices. This studies economic situations where,
because of price rigidity, a market does not clear. A good development is found
in Aumann and Drèze [1986].
We find that there is a large amount of work published on the subject. We give
below a listing of recent game-theoretic applications to economics, as it appears in
the literature.

References
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versity Press).
Aumann, R. J. [1979] On the rate of convergence of the core, Int. Econ. Rev. 20, 349–357.
Aumann, R. J. and Drèze, J. [1986] Values of markets with satiation or fixed prices,
Econometrica 54, 1271–1318.
Borel, É. [1924] Sur les jeux où interviennent le hasard et l’habileté des joueurs, Théorie
des Probabilités, Librairie Scientifique, Paris (in French).
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