How is Game Theory applied in Economics?

Game theory is the process of modeling the strategic interaction between two or more players in a situation containing set rules and outcomes. While used in a number of disciplines, game theory is most notably used as a tool within the study of economics. The economic application of game theory can be a valuable tool to aide in the fundamental analysis of industries, sectors and any strategic interaction between two or more firms. Here, we'll take an introductory look at game theory and the terms involved, and introduce you to a simple method of solving games, called backwards induction. As an introduction to Game Theory, an important concept in Economics, It is actually highly mathematical - another reason it's so attractive to academics, who seem to be turning economics into applied maths. Economists study how societies allocate resources between competing uses. Conventionally, they study how this is achieved by the movement of prices paid in markets bringing supply and demand into equilibrium. The standard model assumes the buyers and sellers in those markets are each so small they have no effect on the prices being paid. In reality, many markets are dominated by a few big companies which do have the ability to influence the price. So game theory began as an alternative way of studying the behaviour of the many ''oligopolies'' that characterise modern economies. Game theory is the study of how people or firms behave in ''strategic'' situations - those where each player in a market, when deciding what to do, has first to consider how others might respond to that action. So, like a game of chess, the ''games'' economists study have a set of players, a set of moves or strategies available to those players and a range of ''payoffs'' (consequences) of each combination of strategies. Economists use game theory to describe, predict and explain people's behaviour. They've used it to study auctions, bargaining, merger pricing, oligopolies and much else. Unlike conventional analysis, game theory allows the possibility of ''multiple equilibria'' - more than one possible outcome the participants regard as satisfactory. And it studies ''decision-making under uncertainty'' - having to make decisions without knowing what the future holds. Game theory is also able to study co-operative games (where players may form coalitions in competing with other players) as well as non-co-operative games (where all players compete as individuals). For the most part, however, game theory retains the conventional (unrealistic) assumption of ''rationality'' - people know what's in their best interests and that's what they do. Game theory began with simple two-player, ''zero-sum games'' - if I win, you must lose. It's moved on to multiple-player, positive-sum games - games where all players may gain because of the ''gains from trade'' (exchange) between people. The classic game is ''the prisoner's dilemma'', where two prisoners must separately decide whether to co-operate with the other (by admitting nothing) or to ''defect'' (dob in the other in the hope of a lighter sentence). It shows why, in the absence of trust between them, the prisoners may choose not to co-operate (the ''rational'' choice for each), even though it's in their best interests to do so. This game is so famous because it studies the great problem of civilised societies: how to deal with ''free-riders'' - people who take advantage of others' willingness to co-operate. Game theory seeks to explain how people act in everyday economic situations that involve strategizing, so as to get a good outcome for themselves. In the simplest form of game theory, one person loses and another wins, leading to a zero-sum equilibrium. However, in real life this is not always the case, and everyday situations can be more complex. Thus John Nash, the famous mathematician, came up with his own contribution to game theory in the form of the Nash equilibrium that looked at a broader range of outcomes. For instance, two parties could co-operate so as to get the optimal outcome for both of them, resulting in a win-win outcome. To get to a Nash equilibrium, each person makes decisions taking into account the other person’s possible actions. It’s not just thinking about your own move, but also about factoring in your opponent’s possible responses and how best you can get the outcome you want given your opponent’s likely reactions. An equilibrium comes about in this context when both parties don’t have anything to gain by changing their strategies. Nash was awarded a Nobel prize for his insights on game theory. Let come to your Question Regarding the Banking . Lets take example of ATM in Bank . ow game theory help to get the better Location for the ATM Machine. Few banks have explored the science behind ATM locations. Part of this is practical: When determining ATM locations, most banks use more general geographic and demographic divisions such as ZIP codes and municipal boundaries. While these divisions tell you where people live, work or shop in a particular area, they don’t get down to the granular level necessary to predict traffic flows, or explain how people get from one point to another. And when site selection is determined by distribution teams that are also responsible for channel performance, decisions are often dominated by personal bias and conventional wisdom rather than firm data about traffic flows, user behavior and competitive dynamics. This was The Atlantis Report . Please Like. Share. And Subscribe . Thank You ...


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