Practical Usefulness and Relevance of Game Theory - Essay Example

?Practical Usefulness and Relevance of Game Theory Introduction Game theory generally refers to a strategic decision making approach. To be more specific, game theory is simply a mathematical model based on games identified as zero-games. To define, “game theory is the study of mathematical models of conflict and cooperation between intelligent rational decision-makers” (Myerson 1997, p.1). The scholarly work titled ‘Theory of games and economic behaviour (TGEB)’ by Von Neumann is generally accepted as the starting point of the game theory. Game theory is sometimes referred to as interactive decision theory. This mathematical model can be applied in a wide range of areas like economics, psychology, political science, and biology. In addition, today game theory is used in a variety of behavioural relations and is extended to both human as well as non-humans. This theoretical framework first described zero-sum games where an individual’s gains are exactly equal to the net losses of other participant(s). This paper will assess the practical usefulness and the relevance of game theory in light of the demanding assumptions behind the concept of the Nash equilibrium. Game Theory The game theory is based on the fundamental concept of zero-sum games, and a game has elements such as players, actions, information, strategies, outcomes, payoffs, and equilibria. Game theory evaluates strategic interactions where the outcome of a player’s choices greatly depends on the choices of other players. Basically, for a situation to be a game, there should be at least two rational players who consider each other’s choices while framing strategies (QuickMBA). The game theory has two distinct branches namely cooperative and non cooperative game theory. Most of the cooperative games are expressed in the characteristic function whereas extensive and normal forms are used to illustrate non-cooperative games. Games are illustrated using trees (figure 1) under the extensive form and each node or vertex represents the point of choice of players participating (Fudenberg & Tirole, 1991, p. 67). Each rational player is particularly indicated by a number specified by the vertex. The participants’ possible actions are depicted by the lines projecting out of the vertex while bottom of the tree represents the payoffs (Ibid). The authors add that the extensive form can be termed as “a multi-player generalisations of a decision tree” (Ibid). (Source: Ross, 2012) Under the normal form or strategic form, a matrix representing players, strategies, and payoffs is used for illustration. A major assumption when the normal form is used to indicate a game is that each participant makes choices without actually knowing the choices or actions of others. When players’ actions are known to other participants, generally the extensive form is used to represent the game. The characteristic function form was developed by scholars like John von Neumann and Oskar Morgenstern. The authors claim that when a union C appears, it begins to work against the fraction (N/C) as if two players were participating in a normal game. Nash Equilibrium Nash equilibrium is a complex concept associated with the game theory. As Osborne (1994, p. 9) clearly states, “Nash equilibrium is a steady state solution concept in which each player’s decision depends on knowledge of the equilibrium”. More precisely, under the Nash equilibrium, it is assumed that each player knows the equilibrium strategies of other participants and no player can gain anything by altering their own strategy. The concept of Nash equilibrium has a wide range of applications in connection with the game theory. Game theorists widely use this solution concept to interpret the outcomes realised from several decision makers’ strategic interactions. It greatly assists analysts to predict what would happen if several players are forming decisions simultaneously and if the outcome depends on others’ decisions. Nash equilibrium is potential to analyse unpleasant situations like arms races and wars and also to understand how a conflict could be resolved through repeated interactions. This concept is also useful to evaluate to what extent people with different tastes can co-operate, and whether or not they would take risks to gain a shared objective. As experts point out, Nash equilibrium has the potential to provide a detailed view on technical standards and is also used to study the occurrence of economic issues like currency crises. This theoretical framework is also helpful to organise auctions, manage traffic flow, and deal with regulatory legislation like environmental regulations. The concept of stability can be successfully applied to the Nash equilibrium, and therefore the scope of this concept can be extended further. Relevance and Usefulness While scrutinising the game theory, it is clear that this mathematical model is beneficial to understand less known aspects appearing during the times of conflicting interests. To explain, this model is able to describe certain phenomena such as coalition formation and bargaining. In addition, game theory is effective for developing a framework that would enhance the process of decision making in situations where firms’ interdependence should be taken into account. In zero-sum games, game theory suggests a quantitative scientific approach to benefit the players to choose an optimal strategy. The game theory is very relevant in modern days where the importance of choices of actions is increasing and the choices of individuals are often interdependent on one another. In addition, the fact that this mathematical framework can be used in multiple areas increases its relevance significantly. The game theory was actually developed and used by economists to explain various macroeconomic behaviours and markets. However, today this mathematical framework is also used to study different human and animal behaviours. In addition, it is also being employed to understand behaviours and trends in other areas like politics, sociology, and psychology. According to game theorists, description and modelling is considered to be the first known application of this mathematical theory. Proper game studies can predict human behaviour under various situations. However, some scholars oppose this view and claim that it is not a predictive tool and only provides an understanding of how the human population ought to behave in a particular situation. They add that this mathematical approach can be effectively used for prescriptive or normative analysis. “Game theory is a major method used in mathematical economics and business for modelling competing behaviours of interacting agents” (quickmba.com. n.d.). In economics and business, the uses of game theory can be extended to areas such as mergers and acquisitions, behavioural economics, auctions, duopolies, and oligopolies. The game theory is of considerable importance while analysing an oligopolistic market environment. Under such a market environment, each firm has the option to pursue the basic pricing structure commonly accepted in the market or to introduce a lower pricing structure. However, it is in the common interest to co-operate with other market players and this type of a logical thought process may influence the firm’s management notably. In the field of political science, game theory is used for the purpose of managing areas like fair divisions, political economy, and the public choice. This mathematical model is greatly helpful to explain the concept of democratic peace. As experts point out, game theory has multiple applications in the field of biology. Mainly, the game theory can be used to portray the evolution of the 1:1 sex ratios. It is hopeful to see that this mathematical framework is becoming increasingly relevant in the field of computer science and logic too. For instance, game theory gives a basic platform for multi-agent systems and nowadays games are also used to support interactive computations. In addition, the game theory benefits philosophers to explain different behaviours. The game theory is helpful to avoid international conflicts and to improve diplomatic relations between nations. This mathematic concept has the potential to enhance cross border trade and to improve trade relations between markets. Evidences suggest that game theory is also useful for the government to make sound decisions by considering various choices available at the moment. In short, it can play a significant role in improving the overall wellbeing of the society. The most fascinating feature of game theory is that everyone can apply this mathematical model in their daily life to earn or save more money. As Economists (2011) reports, game theory and the concept of Nash equilibrium can be useful for common people in salary negotiations as well as real estate negotiations. In addition, this mathematical model can better assist people to perform efficiently and economically in money markets and auctions (Business insider, n.d.). According to The Economist magazine, forecasting human behaviour is one of the most important practical uses of the game theory. Today numerous software programmes based on game theory are available that can help to forecast political outcomes and to hunt down terrorists. However, it must be noted that game theory is based on too many assumptions, and this weakness reduces the usefulness of this mathematical model to some extent. Conclusion From the above discussion, it is clear that game theory is extremely relevant in modern days, and its usefulness is extended to areas such as politics, economics, business, philosophy, computer science, logic, biology, and sociology. The most significant aspect of this mathematical model is that it benefits people to earn or save more money in their everyday life. Nash equilibrium is a concept associated with game theory, and good understanding of these two concepts can minimise future uncertainty to a great extent. Although too many assumptions associated with the game theory limits its scope to some extent, it has the potential to benefit different areas of everyday life. References Business insider. n. d. ‘7 Easy Ways To Use Game Theory To Make Your Life Better’. [online] Available at: http://www.businessinsider.com/how-to-use-game-theory-to-your-benefit-2012-4?IR=T#to-make-money-in-the-markets-3 [Accessed: 6 Dec 2013]. The Economist. 2011. A practical use for game theory. [online]. Sep 7. Available at: http://www.economist.com/blogs/babbage/2011/09/forecasting-human-behaviour [accessed 6 Dec 2013. Fudenberg, D & Tirole, J. 1991. Game Theory. US: MIT Press. Immediateroiconsultants.com. n.d. game theory. [online] Available at: http://immediateroiconsultants.com/game-theory/ [Accessed: 6 Dec 2013]. Myerson, R. B. 1997. Game Theory: Analysis of Conflict. US: Harvard University Press. Osborne, M. J. 1994. A Course in Game Theory. US: MIT Press. quickmba.com. n.d. game theory. [online] Available at: http://www.quickmba.com/econ/micro/gametheory/ [Accessed: 6 Dec 2013]. Ross, D. Winter 2012. ‘Game Theory’. The Stanford Encyclopaedia of Philosophy. Edward N. 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