What is Game Theory?

Game Theory is principles on optimal decision-making in a strategic setting among rational players. Game Theory looks into how competing groups of people interact according to their own preferences and strategies available and further examines how these strategies can impact the end result. Although it might sound that Game Theory is solely focused on a niche economic field, the model is applicable to various different scenarios and fields, including psychology, biology, war, strategy, and business.

Game Theory Definitions

Game: A situation in which the action of two or more players will impact the end result.

Players: Decision-makers within the game (i.e. participants)

Actions: Set of choices available to players. This is how players choose to play.

Strategy: A complete set of actions

Payoff: Outcome of the players’ actions and behavior. This might be something tangible (e.g. money) or intangible (e.g. utility).

Information Set: Information available at a specific time during the game.

Equilibrium: The point in which players made their actions and an outcome is reached.

Cooperative and Non-Cooperative Game Theory

The Cooperative Game Theory examines how individuals interact to form a team or a group and how payoffs are later shared within this group. Within this type of game theory, players are allowed to form strategic alliances, cooperation models and binding commitments.

The Non-Cooperative Game Theory investigates how rational individuals interact when trying to achieve their own goals. Within this context, players cannot form strategic alliances or partnerships to reach a mutual goal. Therefore this type of game theory how players interact with each other in order to achieve their personal goal and a real-world example is Rock-Paper-Scissors.

The Prisoners’ Dilemma

The Prisoner’s Dilemma is one of the most popular examples of Game Theory and it is explained briefly below:

Two criminals are arrested and questioned separately. None of the prisoners can communicate with the other one. Each one of them can either confess or keep silent. The police present to them four alternative options, displayed in a 2×2 box.

  1. If both confess, they will serve a five-year prison sentence.
  2. If suspect A confesses, but suspect B does not confess, suspect A will get 3 years but suspect B will receive 9 years.
  3. If suspect B confesses, but suspect A does not confess, suspect A will get 10 years but suspect B will receive 2 years.
  4. If neither confesses, they will receive a two-year prison sentence.

The Prisoner’s Dilemma is a representative example of a Cooperative game. Both players would be better off if they cooperate and do not confess. Yet, players are not aware of the other’s decision, and if one of the players breaks down the cooperation and confesses, then this will result in a long-run loss. This game has received increased popularity among game theorists since it is a good representation for different life scenarios and situations in which either an egocentric or a collective decision must be made.