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.

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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

• 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

Other Related Topics

• Equilibrium (Economics)
• Rational of Choice Theory
  
• Recursive Equilibrium
  
• Game Theory
  
• Paradox of Rationality
  
• Rational Expectations Theory
  
• Shapley Value
  
• Mechanism Design Theory