Game Theory Definition

Cite this article as:"Game Theory Definition," in The Business Professor, updated March 19, 2019, last accessed June 1, 2020, https://thebusinessprofessor.com/lesson/game-theory-definition/.

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Game Theory Definition

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.

A Little More on What is Game Theory and Business

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 company’s management and much more. Using game theory, economists are able to determine the outcomes of companies’ strategic plans in an oligopoly.

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 Prisoner’s 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.

Reference for Game Theory

Academic Research on Game Theory

  • Incorporating fairness into game theory and economics, Rabin, M. (1993). The American economic review, 1281-1302. This paper studies the motivations behind cooperation or noncooperation between different players in an industry. It notes that, people are always motivated to hurt those who hurt them and help those who offer help. Any outcomes that go against these thoughts are referred to as fairness equilibria. The paper concludes that payoffs are maximum when players work together and minimum when players work against.
  •      Game theory in the social sciences: concepts and solutions, Shubik, M. (2006). This paper is a review of Weber’s work, The Protestant Ethic and the Spirit of Capitalism. In Weber’s paper, he observes that human beings are not always motivated to increase profits whenever they make decisions but there are historical explanations to this form of motivation. While the paper agrees that Weber’s work needs to be reviewed, it dismisses some of the arguments in the paper to give readers a thorough grounding when debating.
  •    Use game theory to shape strategy,The evolution of the labor market for medical interns and residents: a case study in game theory, Roth, A. E. (1984). Journal of political Economy, 92(6), 991-1016. This paper studies the changes that took place in 1951 in the labor market involving medical interns. The paper looks at how the changes occurred and the problems that came with these changes. It offers a platform for the study of such markets and offers an analysis that explains modern problems facing the market. The paper also analyzes the history of ideas and how different players in an industry arrive at ideas.
  • Superpower games: Applying game theory to superpower conflict, Brams, S. (1985). This paper examines the interactions between superpowers. It analyzes how different countries in power arrive at decisions and how these decisions affect their economic progression. It shows how game theory applies when resolving economic conflict between superpowers.
  •    Comments on the interpretation of game theory, Rubinstein, A. (1991). Econometrica: Journal of the Econometric Society, 909-924. This paper is a description of the game theory. It views game theory as a means of dealing with conflict between players and not as a means to predict behavior. The paper starts by analyzing strategy and how it is applied in different industries. It studies strategy from three different aspects; in intensive games where players have to make multiple decisions, mixed strategies and limited memory games.
  •  Progress in behavioral game theory, Camerer, C. F. (1997). Journal of economic perspectives, 11(4), 167-188. This paper analyzes the game theory in relation to psychology with the aim of predicting human behavior. The paper shows that even when players are motivated to maximize profit, they always have reciprocated social values such as the desire to revenge and to promote fairness.
  •  The economist as engineer: Game theory, experimentation, and computation as tools for design economics, Roth, A. E. (2002). Econometrica, 70(4), 1341-1378. This paper looks into the way economists can design markets. It notes that, while economists have been called upon to study markets, they have also been called upon to design the markets. The author explains that an engineering approach, and not a basic conceptual model, is needed when designing markets. He further notes that, experimental and computational economics cannot be belittled when applying game theory in markets.
  •   Essays on game theory, Nash, J. (1996). Edward Elgar Publishing. This paper is a compilation of the research papers and essays written by John Nash. It shows his contribution to the game theory.
  •    Game theory in supply chain analysis, Cachon, G. P., & Netessine, S. (2006). In Models, methods, and applications for innovative decision making (pp. 200-233). INFORMS. The author of this paper notes that game theory is highly applicable in supply chain analysis. In this paper, he examines the different ways into which the game theory is applied in the analysis of supply chain. It also examines the different ways in which game theory can be applied in future markets.
  •   Game theory and related approaches to social behavior selections, Shubik, M. (1964). (No. 301.15 S48). This paper is an analysis of the application of game theory in social sciences and the outcomes that can be expected.
  • On economic applications of evolutionary game theory, Friedman, D. (1998). Journal of Evolutionary Economics, 8(1), 15-43. This paper analyzes economic issues that may arise from the application of game theory. It offers a model that promises better predictions unlike the unorthodox models that require more extensive specifications.
  •    Co-op advertising models in manufacturer–retailer supply chains: A game theory approach, Huang, Z., & Li, S. X. (2001). European journal of operational research, 135(3), 527-544. In this paper, the author notes that in cooperative advertising, the manufacturer is always assumed as the leader and retailers the followers. However, there has been a shift in this model of cooperation and retailers are having more power. This paper examines vertical cooperative advertising and its efficiency.

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