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How Game Theory Applies To Economics

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Anyone who saw the award winning film “A Beautiful Mind” will probably have heard of “game theory”. This film was based on the true story of John Nash and his battle with schizophrenia. This inspirational figure managed to overcome his mental health problems to go on to win a noble prize. The prize was awarded for his contribution to economics in the form of John Nash game theory; in particular his idea of the Nash’s equilibrium.

What is Game Theory?

This could probably be best described as a mathematical based theory that can be used in economics and other social sciences. It involves looking at the strategies people use when making choices and attempts to capture all this in a mathematical way. It could be seen as a theory of how people behave in social situations and is believed to be applicable to everything from parlor games to the way governments will react. It is the possibility of game theory helping economists understand how economic human entities behave that makes it so interesting.

What is Nash’s Equilibrium?

Nash’s equilibrium deals with the suggestion that strategies that involve trying to make other players perform less well may not mean a better result for the player making the move. In order to understand Nash’s equilibrium it is necessary to imagine a game involving at least two players.  In this particular game it is assumed that each player understands their best strategy. If each of these players has found their equilibrium position then it will not benefit one player if they decide to unilaterally change their strategy. When all players have found their equilibrium position it is referred to as Nash’s equilibrium. So basically Nash’s equilibrium means that there is no benefit for one player to change their strategy when everyone else in the game has found their best position.

How is Game Theory used to help Economists?

Game theory and Nash’s equilibrium can be used to examine what occurs when decisions are made between groups in society; this could be between individuals, businesses, industries or even governments. It looks at how the decisions of one group will impact the decisions of another group when these decisions depend on each other. It demonstrates how cooperation between groups can lead to more beneficial results for all of the participants involved. Some of the ideas within the theory may seem quite obvious, but they have had a large impact on economic theory.

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