Game
Theory
WHAT IS GAME THEORY?
Game theory is a mathematical framework used to analyze
strategic interactions between rational decision-makers.
It is applied to situations where the outcome for
each participant depends on the actions of others.
Originated with John von Neumann and Oskar Morgenstern
in their book "Theory of Games and Economic Behavior"
(1944).
Core Assumptions:
1. Rationality of players.
2. Strategic behaviour to maximise outcomes.
KEY CONCEPTS AND TERMINOLOGY
Players: Individuals or entities making decisions (e.g., firms, consumers, nations).
Strategies: The plan of action each player can take.
Payoffs: The outcomes or rewards received based on the chosen strategies.
Games: Can be cooperative (players work together) or non-cooperative (players act
independently).
Equilibrium: A state where no player can benefit by unilaterally changing their strategy (e.g.,
Nash Equilibrium).
TYPES OF GAMES
Zero-Sum Games: One player's gain is exactly equal to another's loss (e.g., poker).
Non-Zero-Sum Games: Players' outcomes are not always directly opposite (e.g., trade
negotiations).
Simultaneous Games: Players make decisions at the same time without knowing the others'
choices (e.g., Prisoner’s Dilemma).
Sequential Games: Players make decisions one after another, considering previous moves
(e.g., chess).
Cooperative Games: Players can form coalitions and agreements (e.g., cartels).
Example:
NASH EQUILIBRIUM Two Firms Competing (Duopoly)
Firm A and Firm B decide whether to set high or low
prices.
If both set low prices, they earn lower profits.
If one sets high and the other low, the low-pricing
firm gains a larger market share.
The Nash Equilibrium: Both firms choose strategies
such that neither can benefit by changing their pricing
alone (often both setting low prices).
Significance:
Key Features:
Each player's decision is optimal, considering the Nash Equilibrium helps in predicting
decisions of others. outcomes in strategic scenarios, showing
how individual rationality can lead to
No incentive to deviate from the chosen strategy.
equilibrium, whether optimal or not.
A game can have one, multiple, or no Nash equilibria.
A CLASSIC EXAMPLE : PRISONER’S DILEMMA
SCENARIO: Two criminals are arrested and interrogated separately.
If both stay silent (cooperate): Each gets 1 year.
If one betrays (defects) and the other stays silent: Defector goes free, the
silent one gets 3 years.
If both defect: Each gets 2 years.
Key Insight: Individual rationality leads to a
suboptimal outcome for both.
Application: Explains challenges like price
wars in markets, arms races, and climate
change agreements.
SOME OTHER EXAMPLES OF GAME THEORY
STAG HUNT COVID-19 VACCINATION CAMPGAIN
Scenario: Two hunters can choose to hunt a stag Scenario: During the pandemic, individuals
together (requires cooperation) or hunt a hare decide whether to get vaccinated.
individually. If most people get
vaccinated, the virus
Hunting a stag provides a
spread reduces (herd
bigger reward but needs
immunity).
mutual trust.
If many people rely on
Hunting a hare is safer but others to get
offers a smaller reward. vaccinated, the
disease spreads more
easily.
Relevance: Explains situations requiring trust for Relevance: Highlights the conflict between
mutual benefit. individual choice and societal benefit.
Real-life Example: Collaborating on large projects
like space exploration (e.g., NASA and ESA
cooperation).
IMPORTANCE AND USES OF GAME THEORY
Business Strategy: Helps companies Environment: Supports agreements on
determine pricing, product launches, and resource sharing and climate change
competitive strategies. actions.
Negotiations: Guides decision-making in Public Health: Models behaviors in
trade deals, labor disputes, and conflict vaccination campaigns, disease
resolution. control, and healthcare planning.
Economics and Markets: Analyzes market Politics: Aids in understanding voting
behavior, auctions, and resource strategies, policy-making, and
allocation. international diplomacy.
LIMITATIONS OF GAME THEORY
Assumes rationality: Real-life decisions are often influenced by emotions, biases, and
imperfect information.
Simplifies complex situations into structured games, potentially ignoring external
factors.
Difficulty in predicting outcomes with numerous players and strategies
Overemphasis on equilibrium: Real-world scenarios may not always achieve a stable
equilibrium.
CONCLUSION: WHY GAME THEORY MATTERS
Provides valuable insights into Widely applied in various fields,
strategic decision-making in including business, politics, and
economics and beyond. international relations.
Highlights the importance of “Game theory reminds us that
considering others' actions in collaboration often leads to better
shaping outcomes. outcomes than competition.”
