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.

Why is it called “game theory”? Game theory is the study of strategic interaction. Strategic interaction is also the key element of most board games, which is where it gets its name. Your decision affects the other player’s actions and vice versa. Much of the jargon of game theory is borrowed directly from games. The decision makers are called players. Players make a move when they make a decision.

We can circumvent this complexity by creating simplistic structures, called models.

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

A classic example is Keynes’ Beauty Contest, in which English economist John Maynard Keynes (1883–1946) likens investment in financial markets to a newspaper competition in which readers have to choose the “prettiest face”; the readers who choose the most frequently chosen face win.

If you can predict the behaviour of the average investor, you can make a killing.

More people go to the movies in December than October, which makes a December release attractive to both studios.

The moment one expects the other to clean up, the incentive to free-ride rises to the surface.

One way out of the free-rider problem is to change the payoffs in the payoff matrix.

The imposition of a moral cost

A way out of this free-rider problem is to sign an international treaty that legally commits countries to pay monetary fines if their CO2 emissions are in excess of mutually agreed limits.

if Amy and Bob go to the football match, Amy gets a payoff of 5 (A:5). If they both go dancing, Amy gets a payoff of 10 (A:10).

patriarchy (a society structured around male advantage),

bank run (where everybody tries to withdraw their money at the same time).

“scissors”, and “paper” wraps around “rock”. This is a zero-sum game: if one person wins, the other loses.

This is known as a war of attrition. The term is borrowed from military strategy. Long and damaging fights can occur in these types of games even when the prize may be small in relation to the accumulated costs.

decision nodes, dots that represent a point at which a decision can be made.

This game has first-mover advantage, but not all sequential-move games have this feature. There are many games where making an early commitment puts a player at a disadvantage.

However, if the bank were to extend the credit, once the applicant received the funds, she would compare her expected payoff from the safe project to her expected payoff from the risky project. So, she would choose the risky project, breaking her promise. This is called the time-inconsistency problem: the decision maker does not find it optimal to follow the original action plan.

Financial markets often use collateral as a commitment device.

It seems like wages should eventually adjust downward to the point where the number of people who want to work equals the number jobs.