Summary

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)… Read TextPreview

- Subject: Macro & Microeconomics
- Type: Essay
- Level: Undergraduate
- Pages: 6 (1500 words)
- Downloads: 2
- Author: elmohodkiewicz

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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
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