Game Theory

What is ‘Game Theory’

Game theory is the study of human conflict and cooperation within a competitive situation. In some respects, game theory is the science of strategy, or at least the optimal decision-making of independent and competing actors in a strategic setting. The key pioneers of game theory were mathematicians John von Neumann and John Nash, as well as economist Oskar Morgenstern.

Explaining ‘Game Theory’

Game theory creates a language and formal structure of analysis for making logical decisions in competitive environments. The term “game” can be misleading. Even though game theory applies to recreational games, the concept of “game” simply means any interactive situation in which independent actors share more-or-less formal rules and consequences.

Impact on Economics and Business

Game theory brought about a revolution in economics by addressing crucial problems in prior mathematical economic models. For instance, neoclassical economics struggled to understand entrepreneurial anticipation and couldn’t handle imperfect competition. Game theory turned attention away from steady-state equilibrium and toward market process.

An Example of Game Theory

Suppose executives in charge of Apple iOS and Google Android are deciding whether or not to collude and exert duopolistic power over the market for smartphone operating software. Each firm knows that if they work together and do not cheat each other, they will be able to restrict output and raise prices, thereby enjoying above-normal profits.

Further Reading