MODULE MANAGERIAL ECONOMICS
CHAPTER 10: Game Theory
Objectives:
a. use Game Theory to gain a better understanding
of interactions and outcomes within them.
Game Theory
Game theory: The science of strategic decision-making
Consider the following scenario: You are driving on the road and another driver is driving
towards you from the opposite direction. You are on a collision course; one person must swerve
or both may die in the crash. But if you swerve you are called a chicken or a coward.
This scenario where both players prefer not to yield to each other but the worst possible
outcome occurs if they don’t, is an important model of conflict in the game theory.
Game theory, a branch of mathematics, is the study of strategic decision-making. It is a field
which affects every one of us and has wide-ranging applications in the fields of business,
politics, economics, computer science, biology and even war. This discipline is used to analyse
the decisions rational people make under a framework of strict rules and where each player gets
a payoff based on the decisions of all other players.
Businesses are increasingly using game theory to help make pricing, product, merger and
acquisition and labour negotiation decisions. The discipline came into prominence in the 1940s
due to the work of John von Neumann, a mathematician and Oskar Morgenstern, an economist
who wrote a book, “Theory of Games and Economic Behavior”.
They concentrated on zero-sum games where one player’s gain is another player’s loss and
cooperative ones where binding commitments can be made and enforced. Real world situations
do not fall into either category.
Enters mathematician John Nash in the 1950s, who changed the world of game theory. His
most important result known as the Nash equilibrium is that in any game with any number of
players each player has a strategy available to him that he has no interest in changing so long
as all the players stick to their choices.
Nash’s contribution provides a focus for understanding real world problems rooted in conflict
and failure of cooperation.
The importance of the discipline has been recognised since Nash’s contribution to the field and
since then nine game theorists inclusive of him have won the Nobel Prize. Nash became
popular outside his field due to the Oscar winning movie, “A Beautiful Mind” on his life released
in 2001. He recently passed away in an unfortunate car accident along with his wife in New
Jersey.
Applying game theory
Big organisations such as Microsoft and Chevron reveal that they use game theoretic
frameworks to help them make difficult and risky decisions. The discipline provides an insight
into the strategic options available to players and the likely outcomes that they would follow.
This can also help them avert outcomes that could potentially lead to conflict.
let’s take an example.
Put yourself in the shoes of Walter White from Breaking Bad (a professor-turned-drug-lord) and
you have an accomplice (Jesse!) in your sweet little crime.
You are under investigation by the DEA (Drug Enforcement Administration) after they managed
to trace the whole gamut of illegal activities you were involved in over the period of last two
years. But they have insufficient proof and hence they require a testimony from either of you to
go ahead with the prosecution.
Both of you are interrogated separately and do not come in any kind of contact whatsoever. You
don’t want to end up rotting in jail, obviously. Now here are the rules of the game decided
MODULE MANAGERIAL ECONOMICS
behind your back:
1. If you plead not guilty and Jesse confesses (defects), Jesse will be released and you might
have to stay in the jail for twenty years.
2. Similarly, if Jesse pleads not guilty and you confess, you will be released and Jesse might
have to stay in the jail for twenty years.
3. If nobody makes any implications and hold their ground (i.e. both co-operate),
both might receive the maximum sentence of six months (good!)
4. If both of you decide to plead guilty and implicate the other (i.e. both defect), both will
receive a sentence of eight years (not so good).
The complicated situation cited above is an example of a game analyzed in game theory, called
the prisoner’s dilemma.
For more knowledge please follow the link provided;
https://www.youtube.com/watch?v=MHS-htjGgSY&feature=youtu.be
Game Theory.
Game theory is the study of the ways in which interacting choices of economic agents produce
outcomes with respect to the preferences (or utilities) of those agents, where the outcomes in
question might have been intended by none of the agents
Game Theory refers to a set of mathematical tools used to analyze strategic interaction.
Game theory is often applied in economics, political science, and military science,…
but game theory is not commonly applied to ordinary games like chess or tennis.
In game theory,
o
o
o
players (decision makers)…
adopt strategies (complete plans of action)…
and receive payoffs (rewards or punishments), which depend on the strategies of
all of the players.
There must be at least two players in a game, but games with any number of players can be
analyzed.
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Coordination in Business
Sometimes firms can increase profits by coordinating their strategies.
Example: If a men’s clothing shop and a women’s clothing shop locate in the same mall, both
may attract more customers.
There are many other examples where firms can increase profits by coordinating.
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One firm supplies inputs to another firm precisely when they are needed.
All firms in a shopping center stay open during the same hours. [Why?]
All car thieves steal cars on the same day, so that police are spread thin.
For more knowledge please follow the link provided;
https://www.youtube.com/watch?v=t9Lo2fgxWHw&feature=youtu.be
https://www.mbacrystalball.com/blog/economics/game-theory/
MODULE MANAGERIAL ECONOMICS