What is Game Theory?

Tools and applications

Game theory (sometimes referred to as “Interactive Decision Theory”) is a collection of tools for predicting outcomes for a group of interacting agents, where an action of a single agent directly affects the payoffs (welfare or profits) of other participating agents. The term game theory stems from the resemblance these tools have to sports games (e.g., football, soccer, ping-pong, and tennis), as well as to “social” games (e.g., chess, cards, and checkers.).

Game theory is especially useful when the number of interactive agents is small, in which case the action of each agent may have a significant effect on the payoff of other players. For this reason, the bag of tools and the reasoning supplied by game theory have been applied to a wide variety of fields, including economics, political science, animal behavior, military studies, psychology, and many more. The goal of a game-theoretic model is to predict the outcomes (a list of actions adopted by each participant), given the assumed incentives of the participating agents. Thus, game theory is extremely helpful in analyzing industries consisting of a small number of competing firms, since any action of each firm, whether price choice, quantity produced, research and development, or marketing techniques, has strong effects on the profit levels of the competing firms.

Classification of games

Our analyzes in this book focus only on noncooperative games. We generally distinguish between two types of game representations: normal form games (analyzed in this appendix), and extensive form games (analyzed in Appendix B).