Introducing Game Theory: A Graphic Guide (Graphic Guides)

by Ivan Pastine

Game theory is a set of tools used to help analyze situations where an individual’s best course of action depends on what others do or are expected to do. Game theory allows us to understand how people act in situations where they are interconnected.

Game theory is useful whenever there is strategic interaction, whenever how well you do depends on the actions of others as well as your own choices.

backward induction: you can figure out your opponent’s response to your possible actions and take that into consideration before making your own move.

The primary concern of game theory is not board games like chess. Rather, its aim is to improve our understanding of interactions between people, companies, countries, animals, etc., when the actual problems are too complex to fully understand.

Game theory usually assumes rationality and common knowledge of rationality. Rationality refers to players understanding the setup of the game and exercising the ability to reason.

Human behaviour is probably better approximated by bounded rationality. That is, human rationality is limited by the tractability of the decision problem (how easy it is to manage), the cognitive limitations of our minds, the time available in which to make the decision, and how important the decision is to us.

The idea of Nash equilibrium is both simple and powerful: in equilibrium each rational player chooses his or her best response to the choice of the other player. That is, he or she chooses the best action given what the other player is doing.

One of the features of Nash equilibrium is that it is regret free.

An outcome is Pareto efficient if there is no other potential outcome where somebody is better off and nobody is worse off.