INTRODUCTION TO GAME
THEORY
By Vaishali Avinash Pillai
22UECON031
Submitted to: Dr Suma Scaria
Associate Professor and Head Department of Economic Studies and
Planning
Date:15th January 2025
TABLE OF CONTENTS
1. Introduction
2. Social dilemma
3. Social Interaction
4. Payoff Matrix
5. Nash Equilibrium
6. Prisoners’ dilemma
Introduction to Game theory
What is Game Theory?
Game theory is a theoretical framework that conceives social situations among
competing players to produce optimal decision-making in strategic situations. In
certain ways, game theory can be understood as the study of strategy,
particularly focusing on the best decision-making processes of autonomous and
rival individuals within a strategic context. The main contributors to the
development of game theory include mathematicians John von Neumann and
John Nash, along with economist Oskar Morgenstern.
Social Dilemma
Human beings are driven by two motives-
Self-interest
Concern for others
Social dilemmas arise when individuals fail to consider the impact of their
actions on others, whether those effects are beneficial or detrimental.
Such dilemmas are common in our daily lives. For instance, traffic congestion
occurs when our choice of transportation—like driving alone to work instead of
using public transit or carpooling—overlooks our role in traffic. Likewise, while
overusing antibiotics for minor ailments may provide quick relief for an
individual, it leads to the development of antibiotic-resistant bacteria, which
poses a greater threat to the wider population.
Factors that try to solve Social Dilemma are-
Altruism
Government Policies
Local Institutions
Creating policies enhancing individuals' well-being necessitates recognizing the
distinction between scenarios where self-interest contributes to overall well-
being and instances where it results in negative outcomes.
To explore this, we will present game theory, a method for representing
interpersonal interactions.
Social Interactions
In some economic models, there is just one decision-maker, but as we further
complexify, our choices become dependent on other individual choices.
Social interactions involve scenarios where two or more individuals are present,
and the decisions made by each influence not only their results but also the
outcomes of others. For instance, an individual's decision regarding the amount
of heating used in their home can impact the collective experience of global
climate change.
The 4 key components of Social Interactions are:
When people are engaged in social interaction and are aware of the ways
that their actions affect others, and vice versa, we call this a strategic
interaction.
A strategy is defined as an action (or action plan) that a person may
choose while being aware of the mutual dependence of the outcomes on
their own and others’ actions.
Models of strategic interactions are described as games.
Game theory is a set of models of strategic interactions. It is widely used
in economics and elsewhere in the social sciences.
Components of Game Theory
Game Any set of circumstances that has a result dependent on
the actions of two or more decision-makers
Players A decision-maker who is Strategic within the context of
the game
Strategy A complete action of a player will be taken given the
set of circumstances that might arise within the game
Payoff The benefit a player receives from arriving at a
particular outcome
Information set The information available or provided at a given point
in the game
Equilibrium That point in a game where both players have made
their decisions and an outcome is reached where both
players have opted for the highest payoff
Payoff Matrix
The decisions made by one player are shown in the matrix's rows, while the
other player's decisions are shown in the columns. Each cell within the matrix
indicates the payoffs for both players, with the payoffs for the row player listed
first. For instance, consider the following example of a game theory payoff
matrix:
Player 2
3 -2
1 2
Player
1
4 1
4 3
In this example, there are only four potential outcomes based on the choices
made by each player. In the first two scenarios of the matrix, the results for each
player can vary, leading to either losses or gains depending on their selections.
In the top-left scenario, player 1 incurs a loss while player 2 realizes a profit.
Conversely, in the top-right scenario, players 1 and 2 achieve a profit but not in
an equilibrium manner. In both scenarios depicted in the bottom row, both
players end up breaking even, regardless of the choices made by the other
player.
Dominant Strategy
The best response in a strategy is that strategy, which will help a player the
highest payoff from the given strategies another player selects
The dominant strategy is a decision of choice or action that will help attain a
player the highest payoff irrespective of what the other player is choosing
3 -2
1 2
4 1
Dominanat
strategy
equilibrium 4 3
Dominant Strategy equilibrium where no players want to change their
Strategies. It is defined as the outcome that each player in the game would
choose if they had a way of coordinating with each other in decision-making
Nash Equilibrium
The Nash equilibrium is an important concept referring to a stable state in a
game where no player can gain an advantage by unilaterally changing a strategy,
assuming the other participants also do not change their strategies. The Nash
equilibrium provides the solution concept in a non-cooperative (adversarial)
game.
E.g. in a game between Sara and Mira, both players can choose strategy A, to
receive $1, or strategy B, to lose $1. Logically, both players choose strategy A
and receive a payoff of $1.
Mira
A B
A
1,1 1,-1
Sara
B
-1,1 0,0
If you revealed Sara’s strategy to Mira and vice versa, you see that no player
deviates from the original choice. Knowing the other player’s move means little
and doesn’t change either player’s behaviour. Outcome A represents a Nash
equilibrium.
Prisoner’s Dilemma
The prisoner's dilemma is one of the recognized parts of game theory. Let's take
an example of two criminals who have been apprehended for a crime. The
prosecutors lack solid evidence to secure a conviction. To elicit a confession,
authorities take the prisoners out of their solitary confinement and interrogate
them individually in separate rooms. The prisoners are unable to communicate
with one another. Authorities offer four options, typically represented in a 2 x 2
matrix.
If both confess, they will each receive a three-year prison sentence.
If Prisoner A confesses, but Prisoner B does not, Prisoner A will get one
year and Prisoner B will get five years.
If Prisoner B confesses, but Prisoner A does not, Prisoner A will get five
years, and Prisoner B will get one year.
If neither confesses, each will serve two years in prison.
The optimal approach is to refrain from confessing. Nevertheless, neither party
knows the strategy of the other, and in the absence of assurance that one will
remain silent, both are likely to confess, resulting in a three-year prison term for
each. The Nash equilibrium indicates that in a prisoner's dilemma, both
participants will opt for the choice that benefits them individually, even though
it is detrimental to their collective situation.
The table below represents the dilemma, where the decision made by the
participant in the column may conflict with the choice made by the participant
in the row.
Prisoner B
B-2 B-5
A-1
A-2
Prisoner
A
B-1 B-3
A-5 A-3
For instance, both individuals could achieve the best possible result if they both
select row/column However, each faces the potential for significantly negative
outcomes if the other does not make the same choice.
References
Adams, H. (2024, June 27). Investopedia. Retrieved from Investopedia:
[Link]
The core econ Team. (2017). The Economics 2.0. The core e-books.
