Game Theory

Riad Sultan

Introduction
game theory is perhaps the most important tool in the economists analytical kit for studying strategic behaviour.

Strategic behaviour is concerned with how individuals and groups make decisions when they recognize that their actions affect, and are affected by, the actions of other individuals or groups. In other words, the decision-making process is mutually interdependent.

Game theory
Game theory is the study of how rivals make decisions in situations involving strategic interaction (i.e., move and countermove) to achieve an optimal outcome. A strategy is a sort of game plan. It is a decision rule that the player will apply when decisions about the next move need to be made A strategy profile represents the collection of strategies adopted by a player. A payoff represents the gain or loss to each player in a game.

Prisoners Dilemma
The Prisoners Dilemma is an example of a twoperson, noncooperative, simultaneous-move, one-shot game in which both players have a strictly dominant strategy, that is, one that results in the largest payoff regardless of the strategies adopted by any other player. The Prisoners Dilemma is an example of a noncooperative game in the sense that the players are unable or unwilling to collude to achieve an outcome that is optimal for both.

Example
In a simultaneous-move game neither player is aware of the decision of the other player until after a pair of moves has been made.

 It should be remembered that the Prisoners Dilemma is a noncooperative game. Neither suspect has any idea what the other plans to do before making his or her own move. The key element is strategic uncertainty. Since both suspects are being held incommunicado, they are unable to cooperate.

 The strictly dominant strategy equilibrium for this game is {Confess, Confess}. In this case, both suspects will receive 5 years in prison.

 The foregoing solution is called a Nash equilibrium, in honor of John Forbes Nash Jr. who, along with John Harsanyi and Reinhard Selten, received the 1994 Nobel Prize in economic science for pioneering work in game theory. A noncooperative game has a Nash equilibrium when neither player can improve the payoff by unilaterally changing strategies. Nash created quite a stir in the economics profession in 1950, when he first proposed his now famous solution to noncooperative games, which he called a fixedpoint equilibrium.

The Nash Equilibrium

A Nash equilibrium occurs in a noncooperative game when each player adopts a strategy that is the best response to what is believed to be the strategy adopted by the other players. When a game is in Nash equilibrium, neither player can improve the payoff by unilaterally changing strategies.