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What is Game Theory?
Game theory considers how players interact and how they behave to study and explain how rational players make decision. The theory seeks to find out the decisions an individual player should take part in to maximize their success logically and mathematically. The theory was developed by Jon Von Neumann, Oskar Morgenstern and John Nash. In the model, each player has independent decisions to make; these decisions and choices will dictate the final outcome.Game theory is commonly applied in evolutionary biology, war politics, business, psychology and economic.
How is Game Theory Used?
This theory has been widely and successfully used in economics to study market practices in a bid to forecast trends in entrepreneurial anticipation. This has helped economists deal with imperfect competition that may lead to creation of monopolies.In business, Game Theory is applied in the study of competition behavior among industry players. The growth of a business is determined by the decisions the business managers make including whether to create new products, when to enter a certain market, who to hire into the companys management and much more. Using game theory, economists are able to determine the outcomes of companies strategic plans in an oligopoly.
What are the Types of Game Theory?
Game theory can be cooperative or noncooperative. In cooperative game theory, different players cooperate or work together, make decisions together and the payoff is distributed amongst the players. Noncooperative game theory studies individual rational players within an industry that work independently, make independent decisions and do not split payoffs with others. Rock-Paper-Scissors is a perfect example of noncooperative game.
Classic Game Theory Example
The Prisoners Dilemma brings out the meaning of classical Game theory clearly. In the case, two criminals are arrested but the prosecutors lack enough evidence to prosecute them. To this end, the prosecutors take the criminals into two separate rooms and make four deals with them:
- In the event both prisoners confess, they will be jailed for five years.
- If the first prisoner confesses but the second prisoner does not, the first prisoner gets a 3-year jail sentence and the second gets a 9-year jail sentence.
- If the second prisoner confesses but the first does not, the second prisoner gets a 2-year jail term and the first gets a 10-year jail term.
- In both prisoners do not confess, they will be jailed for two years.
In such a scenario, the best choice would be for the two prisoners not to confess. However, the first prisoner does not know what the second prisoner intends and they both end up confessing and being jailed for five years.
Related Topics
- Market Structure
- Perfect Competition
- Bidding War
- Complements & Substitutes
- Substitution Effect
- Imperfect Competition
- Market Power
- Price Takers
- Price Makers
- Perfect Competition and Decision Making
- X-Efficiency
- Captive Market
- Contestable Market Theory
- Highest Profit Point in a Perfectly Competitive Market
- Marginal Revenue
- Using Marginal Revenue and Marginal Costs to Maximize Profit
- Marginal Revenue Curve
- Profit Margin and Average Total Cost
- Break Even Point - Cost Curve
- Shutdown Point - Cost Curve
- Short-Run Decisions Based Upon Costs in a Perfectly Competitive Market
- Marginal Costs and the Supply Curve for a Perfectively Competitive Firm
- Long-Run Average Supply (LRAS)
- Decisions to Enter or Exit a Market in the Long Run
- Long-Run Equilibrium in a Perfectly Competitive Market
- Constant, Increasing, and Decreasing Cost Industries
- Productive and Allocative Efficiency in Perfectly Competitive Markets
- Market Efficiency
- Market Inefficiency
- Pareto Efficiency
- Market Failure
- Search Theory
- Monopoly
- Natural Monopoly
- Legal Monopoly
- Bilateral Monopoly
- Promoting Innovation through Intellectual Property
- Predatory Pricing
- How Monopolists Set Price with the Demand Curve
- Total Cost and Total Revenue for a Monopolist
- Marginal Revenue and Marginal Cost for a Monopolist
- Inefficiency of Monopoly
- Perfectly Competitive Market
- Monopolistic Competition
- Duopoly
- Oligopoly
- Differentiated Products
- Perceived Demand for a Monopolistic Competitor
- Monopolistic Competitors Choose Price and Quantity
- Monopolistic Competitors and Entry
- Monopolistic Competition and Efficiency
- Cartel (Economics)
- Game Theory
- Traveler's Dilemma
- Prisoner's Dilemma
- Iterated Prisoner's Dilemma
- Nash Equilibrium
- Diner's Dilemma
- Trembling Hand Perfect Equilibrium
- Gambler's Fallacy
- Arrows Impossibility Theorem
- Backward Induction
- Tournament Theory
- Oligopoly and the Prisoner’s Dilemma
- Forcing Cooperation in a Prisoner’s Dilemma
- Cooperation and the Kinked Demand Curve
- Corporate Merger or Acquisition
- Antitrust Laws
- Herfindahl-Hirschman Index
- Concentration Ratio
- Other Approaches to Measuring Monopoly Power in an Industry
- Restrictive Practices under Antitrust Law
- Natural Monopoly
- Cost-Plus Regulation
- Price Cap Regulation
- Regulatory Capture