Game Theory in Economics

Topics: Game theory, Nash equilibrium, Economics Pages: 6 (2080 words) Published: November 1, 2014
Game Theory in Economics
Game theory is a concept of decision making that considers more elements beyond just benefits minus costs. Specifically, it includes the interaction between participants. In economics, the theory attempts to predict the participants’ optimal decisions. It has found a core place in economic decision-making and policy-making for its inherent ability to predict reactions in resource allocation, business negotiation, and other economic aspects. Game theory is mostly associated with decision-theory and other contexts such as cooperation and negotiations. From its definition, it is evident that the game theory is largely used in the study of the human decision making processes. In psychology, its equivalent is known as the theory of social situations. In economics, however, game theory tends to focus on sets of outcomes known as equilibrium that represent the most rational solutions to each situation. Game theory emanates from the complexity of human interactions; thus, in a situation where an individual is dealing with an inanimate object such as a tree, he or she does not expect the tree to fight back or respond (Leyton-Brown and Shoham 51). The environment can also be considered neutral to what is done to the tree, at least in direct and rational response. In human interactions, however, each action by an actor emanates from a situation and elicits a response. Each actor must thus recognize how his of her interaction with other rational actors works so as to foster cooperation and stem conflict.

Every game is primarily dependent on a core strategic interdependence. Strategic interdependence is defined by two major types, namely simultaneous and sequential ones. In simultaneous strategy, the players act at the same time or at different times but without perfect knowledge-essentially what the other players are doing. In the latter strategy, however, the players move in sequence, with knowledge of all the past actions by the other players. Sequential-strategy games allow each player to review the past moves and rationalize his next move with more information (Osborne 30). He or she can also use that information to anticipate the responses to his or her move as well as how he or she will have to respond after that. In practice, this information comes together during the process to select the best solution as each player must view the board from several different angles, including how the other player views all his or her moves. Sequence-strategy games are different as they are based on a logical circle. Although either player in the Prisoner’s Dilemma, for example, is unaware of the other’s actions and vice versa, he or she knows that the other prisoner has been presented with the same choices in the same situation. The game is thus a logical circle that requires the individual actor to review his position without sufficient information. A game in strategic form possesses no temporal component. Instead, each player must choose his or her strategy without knowing the other players choice or move. As a matter of fact, this is the central tenet of the Prisoner’s Dilemma. In a game with accurate information, however, there are no simultaneous moves as each player moves at a time. Where the game is in extensive form, each player is at any particular point during play also aware of all the previous choices of the other players. The epitome of a game in extensive form is the quality choice with commitment game tree as represented below.

Figure 1: Quality choice with commitment game tree
Any player a move makes is represented above as the next node. The tree starts at the root and ends at the terminal node where players’ playoffs can be determined. In the example above, Player I is the service provider who makes the first move by choosing to provide either high or low quality service. Player II is the customer who is then aware of that choice and can thus whether buy or not buy in either case (Osborne...

Cited: Gintis, Herbert. Game Theory Evolving: A Problem-Centered Introduction to Modeling Strategic Behavior. Princeton: Princeton University Press, 2000. Print.
Harrington, Joseph E. Games, Strategies, and Decision Making. Birmingham: Worth, 2008. Print.
Leonard, Robert. Von Neumann, Morgenstern, and the Creation of Game Theory. New York: Cambridge University Press, 2010. Print.
Leyton-Brown, Kevin, and Yoav Shoham. Essentials of Game Theory: A Concise, Multidisciplinary Introduction. San Rafael: Morgan & Claypool Publishers, 2008. Print.
Osborne, Martin. An Introduction to Game Theory. New York: Oxford University Press, 2003. Print.
Papayoanou, Paul. Game Theory for Business. New York City: Probabilistic Publishing, 2010. Print.
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