Game Theory

The Prisoner’s Dilemma Game

“Strategic thinking is the art of outdoing an adversary, knowing that the adversary is trying to do the same to you.” --Dixit and Nalebuff

Why do we play?

• Game Theory is used to explain how 2 or more players make decisions or choose actions when their actions (or strategies) affect each participant. – Each player determines his/her own best response

to the possible actions of every other player.

Strategic Thinking

• A player’s choice of strategy depends on the strategy that the player thinks other players will choose. – In some cases, these strategies reinforce each

other. In other cases, they do not.

John F. Nash, Jr.: Co-winner of Bobel Prize in Economics, 1994

• Nash Equilibrium = when the chosen strategies reinforce each other

Why is it useful?

• Game Theory provides insights into how business and government decisions are made and has numerous real-world applications. – Helped economists analyze antitrust activity, tariff,

and auctioning behavior

The Basic Elements of Game Theory

1. The players2. The strategies available to each player3. The payoffs each player receives

The Payoff Matrix