Revisiting Nobel Prize Winning Economic Theories
Game theory the most underrated yet used in every aspect of the life got the attention when the Nobel Prize winner John C. Harsanyi, John F. Nash Jr. and Reinhard Selten has come with the strategic model for the decision making process. It is used in different field of study such as economics, international relations and politics, and psychology to analyze and predict the behaviour and decisions of the players.
This is widely used in the business world where the pricing decision of the one firm will depend upon the other given they produce the same goods and services. Game theory analyzes the circumstance in which the well-being of each agent depends not only on their own actions but also on the behaviour of others; and when choosing their actions, all agents take these interdependencies into consideration (McMillan, 1989). In this game, if you loose you are bankrupt.
Games can be analysed in two ways
1. Non-cooperative analysis of games focuses on the strategies that would be undertaken by each player to maximize their own payoff and the subsequent balance that would be achieved when all players do so (Chander, 2018).
One such non-cooperative game was played recently by US and China. If we see game theory in international relations, a trading nation’s welfare depends on other countries tariff decisions. Last year, US imposed three rounds of tariffs on more than $250bn worth of Chinese goods. China hit back by imposing tariffs ranging from 5% to 25% on $110bn of US products including chemicals, coal and medical equipment (BBC, 2019).
There are two pure strategies in the tariff war between US and China: increase the tariffs or to abolish this tariff structure. When US increased its tariff on $250 billion worth of Chinese products. China hit back with the $110 billion tariffs on US products. This tariff war game is still going back and forth. If the US decides to abolish its tariff protection, China will be better off in demolishing this trade war.
Even if people or companies rationally follow their own self-interest, the best outcome is hard to reach when they can’t or don’t cooperate.
2. Cooperative analysis of games focuses on how incentives can be designed such that the players will adopt the strategies to achieve the outcome with the maximum total payoff (Chander, 2018).
The most relevant cooperative game is applied in the climate change action. Kyoto protocol, Paris Agreement, where most countries collided to take actions against the climate change.
In the case of the climate change problem there is definite room for applying cooperative game analysis as the sum of benefits (i.e., damages prevented) from controlling climate change outweighs the total costs of controlling climate change. However, though the total benefits exceed the total costs, the benefits and costs may not be spread out evenly among the countries in that the costs may be higher than the benefits for some countries unless the countries are identical. Since in reality the countries are indeed not identical, not every country would be willing to engage in controlling climate change (Chander, 2018).
In real world, Game Theory gets lot more complicated when there is interaction of many players. Game theory is a classic theory which applicable almost in all the fields. The main significance of game theory is to formulate the alternative approach to compete with each other and in the same way, it is an important tool for decision making process according to fluctuations in relevant situations. In competitive situation or non-cooperative situation, game theory can tell you how to be smart and in cooperative situation, game theory can tell you how to be fair. Even though game theory focuses on rational decision making, but sometimes human behaviour can limit it from getting 100% accuracy. However, the breakthrough of game theory opened the field to a wider range of applications and different scenarios to be studied.
BBC. (2019, June 29). A quick guide to the US-China trade war. BBC News.
Chander, P. (2018). Game Theory and Climate Change. Columbia University Press.
McMillan, J. (1989). A Game-Theoretic View of International Trade Negotiations: Implications for the Developing Countries. Springer Link, 26-44.