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Game Theory
By: Manohar Gadre ITBM,
Prn: 9030241015
Introduction
Game theory is the study of conflict & cooperation and how people behave in
strategic situations. The Strategic term here refers to a situation in which each
person when deciding on what action to take must consider how others might
respond to that action. Game theory concepts apply whenever the actions of
several agents are interdependent. These agents may be individuals, groups, firms,
or any combination of these. The concepts of game theory provide a language to
formulate, structure, analyze and understand strategic scenarios.
Consider there are two Prisoners caught by the police namely James and Steve.
Police have enough evidence to convict James & Steve of the minor crime of
carrying an unregistered gun which would result in each of them spending 1 year in
Jail. The police as well suspect that the two criminals have committed a bank
robbery together, but they lack hard evidence to convict them of this major crime.
The Police offers to question each of the criminals in separate rooms and offer
them following deal:
“Right Now we can lock you up for 1 year. If you confess to the bank robbery and
implicate your partner, however we will give you immunity and you can go free.
Your Partner will get 20 years in jail. But if you both confess to the crime, we
won‟t need your testimony and we can avoid cost of trial, so you will each get an
intermediate sentence of 8 years”
III
John would clearly think that “I don‟t know what Steve will do. If Steve remains
silent and I confess then I will be free. However if I confess and Steve also
confesses we both will spend 8 years in prison, which is much better that spending
20 years or 1 year in prison”. So regardless of whatever Steve does I am better of
Confessing to the crime. The thought process for Steve is also similar.
In terms of game theory, it‟s termed as dominant Strategy: It is the best strategy
for a player to be followed regardless of strategies pursued by other players.
Now, both the prisoners were selfish and played to maximise their Payoffs, both of
them ended up in prison for 8 years.
Payoffs are numbers which represent the motivations of players. It may represent
profit, quantity, utility or may simply rank the desirability of outcomes (ordinal
payoffs). In all cases, the payoffs reflect the motivations of the particular player.
Moving on, this strategy of both the players to Confess has yielded them a jail
term of 8 years each. This is said to be the Nash equilibrium to this game because
given that the other player has testified/confessed, each individual regards his
own choice (Confessing) as optimal. At Nash Equilibrium no player has an
incentive to independently change his own strategy and get better payoff.
Once they are being questioned separately, the logic of self-interest takes over
and leads them to confess. Cooperation between the two prisoners is difficult to
maintain, because cooperation is individually irrational.
1. OPEC, Saudi Arabia Iraq & Iran (Enforcing a cartel, Cooperative games):
If the Soviet Union chooses to arm, the United States is better off doing the
same to prevent the loss of power. If the Soviet Union chooses to disarm,
the United States is better off arming because doing so would make it more
powerful. For each country, arming is a dominant strategy. Thus, each
country chooses to continue the arms race, resulting in the inferior outcome
in which both countries are at risk.
Thus, in both arms races and crude oil prices, the relentless logic of self-interest
drives the participants toward a non-cooperative outcome that is worse for each
party.
Conclusion
Game theory is exciting because although the principles are simple, the
applications are far-reaching. Interdependent decisions are everywhere,
potentially including almost any endeavour in which self-interested agents
cooperate and/or compete. Probably the most interesting games involve
communication, because so many layers of strategy are possible. Game theory can
be used to design credible commitments, threats or promises or to assess
propositions and statements offered by others. Concepts of game theory can find
application in at the heart of foreign policy and nuclear weapons strategies. –
References
Mankiw Economics Principles and Applications,Cengage Learning 2007
HC Petersen, W. Cris Lewis Manegerial Economics (4th Edition) (pp 370-397)
TL Turocy, BV Stengel Game theory Research Report CADM (2001)
Yale university course on Game Theory retrieved September 5, 2010.
http://www.youtube.com/user/YaleCourses#p/c/6EF60E1027E1A10B/1/qQ3kFy
dI_xQ.