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Solving Real Life Problems with Game Theory

Game theory is the study of situations where one person’s success is based on the choices of others. It is a subject of tremendous interest to economists, businessmen, policy makers and students in this course. Game theory principles can carry so much weight that, in fact, new computer programs are using it to make remarkable predictions worth billions of dollars.

Bruce Mesquita has used game theory to make some stunningly accurate political predictions. He correctly predicted the fall of Egypt’s president, Hosni Mubarak and Pakistan’s president, Pervez Musharraf. He also correctly predicted the successor of Iran’s Ayatollah Khomeini. Mesquita makes these remarkable predictions by evaluating the motives of the players involved and creating a payoff matrix. Afterwards, he uses a computer to predict how the game will be played. This method is very effective in situations where people make rational choices, but can be thrown asunder by “non-rational” emotions. It is particularly effective at predicting economic outcomes, since money is a simple and powerful motivator.

Paul Migrom is a consultant who uses game-theory software to help companies win auctions cheaply. In one auction, his software recognized that large bundles of goods were being valued more than their component parts. He used this information to save two of his clients $1.2 billion. Auction software also has important applications on a smaller scale, to help users make extra money from online auction sites such as eBay.

Mediation software is under development that will help resolve conflict effectively. Each party provides the computer with their secret, bottom line information and the computer proposes an optimal agreement. This is far better than a randomly proposed solution and cheaper than a professional mediator. One day, similar software may be used to resolve wars without fighting. Using secret information about the military capabilities and motives of both sides, the software may be able to predict the outcome a military conflict and broker an agreement without bloodshed.

These examples show game theory has valuable practical applications. It has the potential to end wars and save billions of dollars. Game theory as a field, however, is still relative young. It was created less than a hundred years ago. Not even Mesquita can predict what game theory will be able to accomplish a hundred years from now.

Read more: http://www.economist.com/node/21527025

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