Game Theory and Strategic Behavior în New Economics and Knowledge-Based Society

SUMMARY

Game theory is a branch of applied mathematics that is used in the social sciences, most notably in economics, as well as in biology (most notably evolutionary biology and ecology), engineering, political science, international relations, computer science, and philosophy. Game theory attempts to mathematically capture behavior in strategic situations, in which an individual's success in making choices depends on the choices of others.

Conventional economics takes the structure of markets as fixed. People are thought of as simple stimulus-response machines. Sellers and buyers assume that products and prices are fixed, and they optimize production and consumption accordingly. Conventional economics has its place in describing the operation of established, mature markets, but it doesn’t capture people’s creativity in finding new ways of interacting with one another.

Game theory is a different way of looking at the world. In game theory, nothing is fixed. The economy is dynamic and evolving. The players create new markets and take on multiple roles. They innovate. No one takes products or prices as given. If this sounds like the free-form and rapidly transforming marketplace, that’s why game theory may be the kernel of a new economics for the new economy.

It would seem that such thinking about thinking must be so complex and subtle that its successful practice must remain an arcane art. Indeed, some aspects such as figuring out the true motives of rivals and recognizing complex patterns do often resist logical analysis. But many aspects of strategy can be studied and systematized into a science — game theory.

Game theory and strategic behaviour in new economics and

knowledge-based society

Game theory is a branch of applied mathematics that is used in the social sciences, most notably in economics, as well as in biology (most notably evolutionary biology and ecology), engineering, political science, international relations, computer science, and philosophy. Game theory attempts to mathematically capture behavior in strategic situations, in which an individual's success in making choices depends on the choices of others. While initially developed to analyze competitions in which one individual does better at another's expense (zero sum games), it has been expanded to treat a wide class of interactions, which are classified according to several criteria. Today, "game theory is a sort of umbrella or 'unified field' theory for the rational side of social science, where 'social' is interpreted broadly, to include human as well as non-human players (computers, animals, plants)" (Aumann 1987).

Traditional applications of game theory attempt to find equilibria in these games. In an equilibrium, each player of the game has adopted a strategy that they are unlikely to change. Many equilibrium concepts have been developed (most famously the Nash equilibrium) in an attempt to capture this idea. These equilibrium concepts are motivated differently depending on the field of application, although they often overlap or coincide. This methodology is not without criticism, and debates continue over the appropriateness of particular equilibrium concepts, the appropriateness of equilibria altogether, and the usefulness of mathematical models more generally.

Although some developments occurred before it, the field of game theory came into being with the 1944 book Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern. This theory was developed extensively in the 1950s by many scholars. Game theory was later explicitly applied to biology in the 1970s, although similar developments go back at least as far as the 1930s. Game theory has been widely recognized as an important tool in many fields. Eight game theorists have won the Nobel Memorial Prize in Economic Sciences, and John Maynard Smith was awarded the Crafoord Prize for his application of game theory to biology

Prisoner's Dilemma

-Case Study-

The prisoners’ dilemma is the best-known game of strategy in social science. It helps us understand what governs the balance between cooperation and competition in business, in politics, and in social settings. This dilemma represents a common problem in achieving cooperation in any number of social settings. The dilemma “illustrates the tendency toward noncooperative behavior, despite general advantage from cooperation” (Lee & McKenzie, 2006, p.233).

In the traditional version of the game, Tanya and Cinque have been arrested for robbing the Hibernia Savings Bank and placed in separate isolation cells. Both care much more about their personal freedom than about the welfare of their accomplice. A clever prosecutor makes the following offer to each. “You may choose to confess or remain silent. If you confess and your accomplice remains silent I will drop all charges against you and use your testimony to ensure that your accomplice does serious time. Likewise, if your accomplice confesses while you remain silent, they will go free while you do the time. If you both confess I get two convictions, but I'll see to it that you both get early parole. If you both remain silent, I'll have to settle for token sentences on firearms possession charges. If you wish to confess, you must leave a note with the jailer before my return tomorrow morning.” The concept of the prisoners’ dilemma was developed by RAND Corporation scientists Merrill Flood and Melvin Dresher and was formalized by Albert W. Tucker, a Princeton mathematician.

Real world applications of game theory

Game theory analysis has direct relevance to our study of the behaviour of businesses in oligopolistic markets – for example the decisions that firms must take over pricing of products, and also how much money to invest in research and development spending. Costly research projects represent a risk for any business – but if one firm invests in R&D, can another rival firm decide not to follow? They might lose the competitive edge in the market and suffer a long term decline in market share and profitability.The dominant strategy for both firms is probably to go ahead with R&D spending. If they do not and the other firm does, then their profits fall and they lose market share. However, there are only a limited number of patents available to be won and if all of the leading firms in a market spend heavily on R&D, this may ultimately yield a lower total rate of return than if only one firm opts to proceed.