Game Theory in Greek Debt Crisis
Game Theory applies when two parties have incomplete information about each other’s intension while the outcomes for each of them depend on the actions of both.
About a year ago, the Greek government was facing serious debt, which led to a threat for it to exit the Eurozone if Eurozone did not offer a bailout aid. Although nobody was sure about the result of the Eurozone negotiation, it was believed that the so-called Grexit would have catastrophic influence on global economics. The linked article gives an analysis of the situation based on Game Theory, considering the Greek government and other Eurozone partners as two participants in the game.
In this particular scene, Greek government has only two possible actions. It can either provide the Eurozone with a plan to recover from debt, or give up the plan and simply chose to default. On the other hand, Eurozone faces two choices given the choice of the Greek government. If the Greek government chooses to give its plan, Eurozone can accept it, allowing the Greek government to receive bailout aid at a loss of its own holdings on Greek debt and keep the monetary union integrated. This solution will benefit both parties, while giving Greek government more utility. The article denotes the outcome utility as (1, 0.75). Eurozone can also decline the plan, while will lead to Grexit, denoted as (0, 1) as this event only harms Greek, or the collapse of the Eurozone, denoted (0, 0) because everybody is harmed. The latter two outcomes take on a half-half bet, and are unpredictable. Thus, it can be expected that once Eurozone turns down Greek’s plan, it will face the welfare outcome (0, 0.5). According to this analysis, Greek government will choose to give the plan because 1>0, and the Eurozone will accept this plan because 0.75>0.5. In this case, Game Theory provides a win-win choice. This strategy further illustrates the concept of Game Theory discussed in class, as it predicts two parties’ decision when their action is based on the other party’s action. The actual decisions of both parties also validate the prediction of the Theory.
Link: http://www.bbc.com/news/magazine-33254857