Game Theory

Many important and interesting situations can be studied as if they were games. Consider bidding for an item listed on eBay. How much should you bid and when should you make your bid? In this case, the success of the decision depends on the choices made by other bidders. Game theory provides a way of thinking about this and similar situations of interactive decision making.

Jon Guest, Senior Lecturer, Coventry University

Image by vinduhl on Flickr

Imagine the following situation. It’s a penalty shoot out and you have been chosen to take a penalty. You are faced with a key decision: do you shoot to the right, to the left or straight down the middle? Your success depends not only on which of these three options you pick but whether the goalkeeper decides to dive to the left, the right or simply stay where he is. In other words, the success of your penalty depends not only on what you do but also on what the goalkeeper decides to do.

But it is important not to be misled by the word ‘game’. The analysis is not specific to sport – in fact, as economists, we are interested in a whole variety of games from the decisions made by companies competing in a market (or in several markets) to those made by individuals about whether to cut back on the amount of pollution they generate.

If you think strategically then you will take into account the possible actions of your rivals when making your decisions. Thinking back to the football example, if the penalty taker thinks strategically they will try to work out what they think the goalkeeper will do. Likewise, the goalkeeper should be trying to predict what the penalty taker will do. The central message here is that in order to predict someone else’s behaviour you need to think about what the other person/player thinks you are going to do!

This may sound very complicated and beyond any reasonable analysis. But game theory helps you to analyse and understand these situations. It can even predict the outcome of some of these situations by identifying actions you should always take or actions you should never take.

If you study game theory at university, you will analyse a number of different types of strategic environment. You will learn the differences between static (one-off) and dynamic (repeated) games – and learn that outcomes in the latter can be very different than the former if players are able to establish a reputation for themselves. And you will learn the differences that we would expect between games that are played simultaneously (where each player cannot observe the actions of the other) and sequentially (where one player sees the other move first).

Studying this type of game may illustrate something that might seem rather strange. For example, deliberately restricting your options in a strategic situation may be to your advantage. Studying strategic interaction formally will give you the theoretical background to make insights into a wide range of applied economics – from environmental economics to competition policy.

Web Links

Wikipedia’s entry on game theory., another resource for students: