Those who have been following this blog know I often try to understand complex situations like the AI Bubble and Trumpās Tariffs through the lens of game theory. This concept had me so fascinated, I wanted to dig deeper. So, here Iām starting a series to explore game theory and its different concepts.Ā
I love writing case studies and analyses, so those will be continued. After all, using real-world examples is the best way to learn, and it also deepens our understanding of the world and its affairs.
What is Game Theory?
Game theory is a framework for analyzing the situation, the involved entities, and the available information to anticipate future moves and take strategic actions to maximize benefits. It is useful for understanding complex situations, forecasting, and decision-making across āmany fields such as business, computer science, politics, and psychology.
The name of this concept is rooted in competitive games where players take interdependent decisions and are constantly trying to outplay each other. Game theory is not a science to understand what your opponent is thinking, or even about choosing the best possible option. It is a model to explore possible options and predict likely outcomes at the end of each path.Ā
John von Neumann and Oskar Morgenstern developed this theory to solve problems in economics. It is not a single mathematical theory or principle, but rather a collection of different theories applicable in different situations.
Fundamental Building Blocks of Game Theory
Like any competitive game, game theory also consists of the following foundational blocks:
| Block | Description |
| Game | The given set of circumstances or a situation where the outcome is determined by the actions of two or more decision-makers. |
| Player | A decision-maker and an involved entity in the game. |
| Strategy | A plan prepared by the player in the context of the rules or interdependencies of the situation to influence the outcome in their favor. |
| Payoff | The payout a player receives at the end of the game. The payoff is always quantifiable and can come in any form relevant to the nature of the game or its domain. |
| Information | The available data at any given point in the game is known as the information set. Widely useful in sequential games to make informed decisions and take strategic actions. |
| Equilibrium | It is a point in the game where every involved playerās interests align, and there is no reason for any of them to change their moves. It just shows stability in the game and does not necessarily mean the best outcomes for everybody. |
Types of Games in Game Theory
In game theory, games can be classified based on the number of players as well as the nature of the games.
Types of Game Theory by Nature of Games
By the nature of games, it means how games are played between players. It defines how players, strategies, and information function within the game.Ā
Cooperative
When multiple players with distinct interests start working together to achieve a common goal or solve a common problem, it is dubbed a cooperative game. For the time being of the game, the players wouldnāt be in direct competition, but each would have individual objectives to achieve to ensure the groupās success. Cooperative games are about groups and communities working towards a common cause.Ā
Non-cooperative
In non-cooperative games, every player moves as per their individual interest without cooperating with other players. Instead of forming a group that competes together, the competition is largely within the group itself. Here, one player wins at the expense of another, which is the complete opposite of the cooperative game, where the whole group wins together.Ā
Symmetric
When all the players in the game are matched evenly, it is called a symmetric game. No player has any specific advantage or disadvantage over other players. All of them would have equal power, status or set of information. Symmetric games ensure every player has an equal chance of winning. Such games are more focused on equilibrium strategies.Ā Ā
Asymmetric
When a player in the game has more influence on others. Or if any one of them is at an advantage or disadvantage in the given situation, then the game is called asymmetric. Access to a better set of information also gives players an advantage over others in many situations.Ā
Simultaneous
In this type of game, every player makes a simultaneous move without actually knowing othersā strategies. Every player here is just guessing āwhat others might do. However, if these games, such as rock-paper-scissors, are repeated for a longer period, players can have enough data to anticipate othersā moves.Ā
Sequential
It is a kind of game where the players take turns in making their moves. This way, one player already knows the moves made by others and can anticipate their strategy. The actions of players influence the upcoming moves or game strategy of another.Ā
Game Types by Number of Players
Apart from their nature, games can be categorized by the number of persons playing them, such as one-person games like parlor games, two-person games like chess, and n-person games like carrom. It is important to mention that the player is not necessarily always an individual but a team, company, or a nation as well.Ā
What is the Importance of Game Theory?
Game theory is important because of its usefulness in understanding the complexities of:Ā
Human behavior
It helps predict how people are going to act or behave in any given situation, especially a competitive one. Knowing human behavior helps you take the best course of action against competition when achieving your goals or solving a specific problem.Ā
Market dynamics
Game theory is quite helpful in unraveling the way the market works. It helps understand what specific behavior or action drives the market. Businesses use this information to create marketing campaigns, customer acquisition and retention strategies. It also helps acquire new technologies and train staff to offer better services.Ā
Decision-making
Game theory helps us decode how decisions are made or how certain decisions were made. It also enables you to assess the impact of the decisions on other players, teams, or communities. Game theory is also known as a decision-making model. It helps predict possible scenarios and make an informed choice.Ā
Real-world Use Cases
Game theory is a model useful in every field of research and analysis. Because it does not depend on a single principle or equation, game theory is flexible enough to be applied to a wide range of situations, such as:Ā
Economics
Game theory was created as a mathematical model to understand the behaviors and strategic interactions of competing players and solve complex problems. In the field of economics, game theory is used across various phenomena such as mergers and acquisitions, auctions, voting systems, oligopolies, and duopolies.
The most common assumption when applying game theory in economics is that the player is rational. So, every game theory strategy or mathematical model is focused on achieving equilibrium.Ā
Business
Businesses have to make strategic moves to gain a competitive advantage in the market. Game theory can be applied to both fronts in business. First, to compete against external forces or other players in the market. Second, to set and achieve internal goals with maximum impact and efficiency.Ā
Apart from that, companies are always competing for better technological resources, talent, and customers’ attention. In business, game theory looks like a tree where a company starts by making a choice and acts upon it through various decisions. However, the outcomes and payoffs often remain unknown until the very end.
Project Management
A project involves different personalities with different motivations working on a common goal. Game theory is used here to ensure frictionless progress, timely delivery, and efficient outcomes. In project management, game theory is also used to predict potential risks, take preventive measures, or come up with solutions to resolve issues.Ā
Political Science
Researchers are applying game theory to understand situations involving āplayers like politicians, voters, states, and special interest groups. It is widely used to predict outcomes of war bargaining, political economy, public choice and to apply fair division.Ā
Game theory can also explain democratic peace between nations and the stability of any form of political government, whether in a democracy or a monarchy.
Biology
“Paradoxically, it has turned out that game theory is more readily applied to biology than to the field of economic behaviour for which it was originally designed,” says Maynard Smith in the preface of the book Evolution and the Theory of Games.Ā
It is true because game theory is used in biology to explain evolution, communication between animals, and to understand how organisms behave in a certain way under specific situations.
Computer Science and Logic
Game theory plays a critical role in computer science and logic. Even a simple observation will reveal that many logical theories are rooted in āgame semantics. Computer scientists also use games to model interactive computations.Ā
Game theory-based models are actively used to design and optimize online algorithms, mitigate risks, analyze complex systems, and solve problems.
Limitations of Game Theory
Despite bringing so many benefits and helping in understanding complex situations across various fields, just like any other problem-solving model, game theory is not without problems.Ā Ā Ā
Assumption-based
Game theory uses mathematical models and computational logic, but mostly it is assumption-based. These assumptions are derived from past records or patterns to ensure they are close to reality. But nonetheless, it often fails to reflect the real world accurately.
The biggest assumption made in game theory is that all players are rational and act competitively in a given situation. But the truth is, not all players always act rationally. Moreover, they are often not driven by competition but by their emotions.
Limited scope
Not every problem can be solved using game theoryās simple mathematical models. These models are limited. They canāt factor in too many players, their possible actions and outcomes. It only works for probability and rational actions; there is no concept in game theory that can help understand chaos or predict emotion-driven actions or behavior.
Subject to misinterpretation
Many people assume that game theory is useful in competitive scenarios only. So they never consider factors other than competitive ones influencing the situation. Such misinterpretation can lead to incorrect use of game theory, which in turn would be responsible for making incorrect decisions or strategies doomed to fail.
Uncertainty
Just like game theory canāt explain chaos, it canāt predict or explain uncertainty and black swan events. Because game theory mostly works with information, perfect or imperfect, derived from past actions and patterns. And then use it to predict future behavior.
Even if it anticipates a change, the prediction is rooted in the shifts made in the past. There is no way to explain complete uncertainty or predict a black swan. If we were able to do so, they wouldnāt be named accordingly.
Conclusion
In simpler terms, Game Theory means applying the logic of games in real-world scenarios to understand how players behave, predict possible moves, and influence results in your favor. As we discussed, game theory is not a single equation or a principle but rather a collection of various theories and mathematical concepts used to solve complex problems across various domains.
There are many things that werenāt covered in this blog, such as popular concepts, common strategies, etc., and I tried to write them as well, but realized it’s better to explain them in separate articles. So, thatās all for now.
What kind of situations or problems do you think game theory explains really well, and where it falls behind?
Kushalam 