Game Theory

Game theory is a branch of mathematics and economics that studies strategic interactions among rational decision-makers. It provides a framework for analyzing situations in which players (participants in the game) make decisions that are interdependent, where the outcome for each participant depends on the choices of others.

A game theory model generally includes:

1. Players: These are the decision-makers in the game. They can be individuals, groups, organizations, or even nations.
2. Strategies: A strategy for a player is a plan of action that prescribes how to act in every possible situation in the game. Each player chooses a strategy based on the information available to them.
3. Payoffs: The outcomes or rewards that players receive at the end of the game. These can be in terms of profit, utility, satisfaction, or any other metric relevant to the players.
4. Information: The knowledge that players have about the game, including the strategies and payoffs of other players, and how this information is distributed among them.
5. Equilibrium Concepts: This refers to a state in the game where no player has an incentive to change their strategy given the strategies of other players. The most famous equilibrium concept in game theory is the Nash Equilibrium.

Game theory models can be classified into different types, such as:

• Cooperative vs Non-Cooperative: In cooperative games, players can form binding commitments or coalitions, while in non-cooperative games, they cannot.
• Symmetric vs Asymmetric: In symmetric games, the strategies and payoffs are the same for all players. In asymmetric games, they differ among players.
• Zero-Sum vs Non-Zero-Sum: In a zero-sum game, one player’s gain is another’s loss. In non-zero-sum games, it’s possible for all players to benefit (or lose) simultaneously.
• Static vs Dynamic: Static games are played in a single step, while dynamic games involve a sequence of moves.
• Perfect vs Imperfect Information: In perfect information games, all players know the moves that have been made by other players. In imperfect information games, some information is hidden.

Game theory has wide applications in economics, political science, biology, computer science, and many other fields. It helps in understanding and predicting the behavior of individuals, organizations, and even nations in various strategic scenarios.

A simple game theory model is the famous “Prisoner’s Dilemma.” This model illustrates the conflict between individual rationality and collective rationality, and it’s a classic example in game theory.

The Prisoner’s Dilemma Game:

Context:
Two criminals (Player A and Player B) are arrested and imprisoned. Each prisoner is in solitary confinement with no means of communicating with the other. The prosecutors lack sufficient evidence to convict the pair on the principal charge but have enough to convict both on a lesser charge. The prosecutors offer each prisoner a bargain.

Choices:
Each prisoner has two options: to betray the other by testifying that the other committed the crime, or to cooperate with the other by remaining silent.

Outcomes and Payoffs:

1. If A and B each betray the other, each of them serves 2 years in prison.
2. If A betrays B but B remains silent, A will be set free, and B will serve 3 years in prison (and vice versa).
3. If A and B both remain silent, both of them will serve only 1 year in prison (on the lesser charge).

Here is the payoff matrix for the game:

Analysis:

• Nash Equilibrium: In this game, the Nash equilibrium occurs when both players betray each other. Even though mutual cooperation yields a better outcome, the fear of receiving a longer sentence if the other player betrays leads each player to betray the other.
• Dominant Strategy: For both players, betraying the other is the dominant strategy. It’s the better strategy for each player regardless of what the other player does.
• Insights: This game illustrates the challenges of achieving cooperative outcomes in scenarios where individual incentives lead to non-cooperative behavior. It’s used to explain various social and economic phenomena.

This model is simplistic but effective in demonstrating how game theory can be used to analyze strategic interactions in various scenarios.

Let’s create another example using a different game theory concept. This time, we’ll use the “Battle of the Sexes” game, which illustrates a situation where players have conflicting interests but also a common interest to cooperate.

The Battle of the Sexes Game:

Context:
Two players, Alex and Taylor, are planning their evening. Alex prefers to go to a basketball game, while Taylor prefers to go to a concert. However, both prefer going to the same event together rather than going to different places alone.

Choices:
Each player has to independently choose to go to either the basketball game or the concert without knowing the other’s choice.

Outcomes and Payoffs:

1. If both choose the basketball game, Alex is happier (gets more payoff), but Taylor is less happy (gets less payoff).
2. If both choose the concert, Taylor is happier, but Alex is less happy.
3. If they choose different events, both are least happy since they value being together.

Here is the payoff matrix for the game (the numbers can be arbitrary to represent happiness or utility):

Analysis:

• No Dominant Strategy: Unlike the Prisoner’s Dilemma, there is no dominant strategy in this game. The best decision for each player depends on what they think the other player will do.
• Multiple Nash Equilibria: This game has two Nash equilibria: (Alex Chooses Basketball, Taylor Chooses Basketball) and (Alex Chooses Concert, Taylor Chooses Concert). Both are stable outcomes where neither player benefits from changing their strategy unilaterally.
• Coordination Problem: The challenge here is coordinating the decision without communication. If they could communicate, they might reach a compromise or alternate between choices on different occasions.

This game illustrates how game theory can be applied to scenarios where players have to coordinate their choices in the absence of communication, a common situation in real-life social interactions and economic decisions.

Test your knowledge here.