What makes a game? Players, strategies, pay-offs and common knowledge are what makes a game. Players have common knowledge of the structure of the game and they make rational decisions about strategies which lead to their best expected pay off. Each player chooses a strategy, these strategies interact and game play off to its conclusion.
Game Theory is the study of strategic interaction among rational players.
Let me simplify the above paragraphs. Your boss (Player 1) has asked you (player 2) to complete a report by the end of the week. But you both know that this is an impossible task (common knowledge). Your boss and you both know that the report is not due until the end of month (common knowledge). But your boss is mitigating risk by advancing the report submission deadline and is adopting a tough line against you (your boss’s strategy). You recognize that any rational suggestion to postpone the deadline for the report will fall on deaf ears and therefore you agree to submit draft by the end of the week. But you produce a report that is a half baked with fudged figures downloaded from google to keep your boss happy (your strategy). You know your boss is an idiot to expect a good quality report this early and your boss knows you are a cheat to produce a report this early to him, but you both do not discuss about it (common knowledge). J
Practical application of The Game Theory (TGT) includes negotiation management, conflict management, threat making, making threats credible, co-opetition, brinkmanship etc. Von Neumann a mathematician par excellence and a poker enthusiast was one of the early pioneers of TGT. He tried to apply TGT to the game of poker and wondered if he could capture something that is quintessentially fundamental to human nature as bluffing in to a mathematical model.
Let me give you some definitions. A player is somebody who is a decision maker in the game usually having a stake in the game and in the outcome of the game. A strategy is a specification of decision for each possible situation in which the player finds him/herself in to. Payoff is the reward or penalty that the players experiences as a result of their strategies interacting with each other. Common Knowledge is multiple-multi layered awareness of the rules of the game.
Most decisions that humans make are ex-post rationality i.e. people look backward to see how earlier situation could have been done better than they are to look forward to look forward to examine the current situation in current light. Awareness of TGT could help avoid the ex-post rationality trap. An excellent example that captures ex-post rationality is Max Bazerman’s ‘Winner’s Curse’ auctions. See: http://ingrimayne.com/econ/Efficiency/NastyAuction.html
What winner’s curse tells us is: at first people start off with the desire to win and win big, then they rationalize their expectations to just winning, then they re-rationalize to loosing small and finally by the time they become aware of their flawed rationality they turn in to big losers. That is, most people unwillingly put themselves in a ‘war of attrition’. In economics we call them depleting return on investment.
But Game Theory is no panacea. It has its own limitation and the first and foremost decision is ‘how we define rationality’. There are many others which I will discuss in my next few articles. Then there are many different types of games – games of incomplete information or pursuit-evasion games. Here signaling and signal jamming are critical i.e. how you make yourself believable. In my upcoming articles I will discuss many interesting ideas including what TGT has to say about threats, promises and commitments.
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