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Game Theory
In game theory, a branch of mathematics, a player’s optimal strategy is to find the best move possible, taking into account the moves of the other players. The theory has been used to model everything from financial markets to nuclear deterrence.
In the classic game of chicken, two drivers race towards each other on a single-lane road. The first to swerve away is considered the chicken. The game theory approach would be to calculate the expected payoff for each driver. If both drivers believe that the other will swerve, then the payoff is zero. If one driver believes that the other will not swerve, then the payoff is the value of the car. If neither driver believes that the other will swerve, then the payoff is two cars.
In a financial market, a game theory approach could be used to model the decision-making of investors. In a two-player game, one player is the buyer and the other is the seller. The buyer is trying to maximize their payoff, while the seller is trying to minimize their payoff. The game theory approach would be to find the best possible move for each player, taking into account the other player’s moves.
In a nuclear deterrence scenario, game theory can be used to model the decision-making of two nations. In a two-player game, each nation is trying to maximize their payoff. The game theory approach would be to find the best possible move for each player, taking into account the other player’s moves.
Explain in Detail :What is the Theory of Zero-Sum Game?
The theory of zero-sum game suggests that in any situation where two or more parties are competing for a given resource, the total gain or loss of all parties is zero. In other words, the gains of one party are always offset by the losses of the other parties involved in the competition.
The Applications of Game Theory
Agency problems arise when one party, the agent, is entrusted with making decisions on behalf of another party, the principal. The agent may act in the best interests of the principal, or in the agent’s own interests. Agency problems can arise in a variety of contexts, such as in the workplace, in the market for corporate control, and in the family.
In the workplace, for example, a company may hire an employee to manage its operations. The employee may act in the best interests of the company, or she may act in her own interests, for example, by trying to maximize her own salary and benefits. Agency problems can also arise in the market for corporate control. For example, a company may hire a CEO to manage its operations. The CEO may act in the best interests of the company, or she may try to maximize her own power and wealth.
Agency problems can also arise in the family. For example, a parent may hire a nanny to take care of her children. The nanny may act in the best interests of the children, or she may try to maximize her own income and benefits.
The Classic Instance of Game Theory
One of the earliest and most famous examples of game theory is the prisoner’s dilemma. Two criminals are arrested and placed in separate cells. The police offer each criminal a deal. If both criminals confess, they will each serve three years in prison. If one criminal confesses and the other does not, the one who confesses will serve only one year in prison, while the other criminal will serve five years. If both criminals do not confess, they will both serve two years in prison.
The prisoners are each trying to maximize their own individual benefit, without knowing what the other prisoner will do. In this scenario, it is in the best interest of both prisoners to not confess. However, if one prisoner decides to confess, the other prisoner is better off confessing as well, even though it results in a longer prison sentence. This is because the one year sentence is better than the five year sentence.
