Game Theory and its Real World Applications
Link to the article referenced in this blog post: http://www.economist.com/blogs/economist-explains/2016/09/economist-explains-economics?fsrc=scn/fb/te/bl/ed/theeconomistexplainseconomicswhatisthenashequilibriumandwhydoesitmatter
This article is a part of a continuing column published by “The Economist” that seeks to explain academic topics in a relatable way and connect them to major developments in the world today. The article highlights the Prisoner’s Dilemma by explaining each prisoner’s options. If both prisoners remain silent, they will each serve a one-year sentence. However, if one confesses and the other does not, the confessor faces no jail time while the other prisoner serves life in jail. If both admit to the crime, then both prisoners will spend ten years in jail. The Economist provides this infographic for visualization:
It is important to highlight that the prisoners cannot communicate with each other and therefore cannot coordinate their decisions. Furthermore, we assume that both prisoners will act in their own self-interest. The author of the article introduces the concept of “Nash Equilibrium” and explains that a rational prisoner realizes that remaining silent is a bad idea, regardless of what the other prisoner chooses to do. Therefore, the only “stable” outcome, according to the author is for both prisoners to admit guilt. The article goes on to discuss how game theory dynamics provide economists with insights on individual decision making and how good individual decisions can be bad for the group. Economists applied Nash Equilibrium to save countries considerable sums of money by altering auction policies to make the individual’s best strategy to bid high early.
The Prisoner’s Dilemma scenario is unlike the “Hawk-Dove scenario” or the “Coordination Scenario” covered in the coursework because a dominant strategy exists. A dominant strategy is a strategy where it is the best response, regardless of the opponent’s decision. The Nash Equilibrium described in both the article and the coursework take the idea of best strategy a step further and state that Nash Equilibrium is when a pair of strategies are the best response to each other. On the other hand, the Hawk-Dove Scenario and Coordination Scenario have “multiple equilibria” because there is no dominant strategy available for the players. Often times, such multiple equilibria scenarios are not Pareto-Optimal since a player can be made better off without anyone else being made worse off. The article makes no reference to Pareto Optimality or its role in the auction designed to benefit the state through the insights of Nash Equilibrium.