The Theory of Games: A Fascinating Facet of Economics

There is a common misconception that an economist is an extension of an accountant and all they do is crunch numbers and deal with dry financials. Though, economics does have a financial part to it, it's so much more than that. It draws from various other disciplines and is rather engaging. I have tried to present one of my favourite economic topics in a different light so as to relate with the people who are not in the stream. Please do read and let me know your comments :)

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Who doesn’t love to play games? It is quite a novel way of spending time with friends and family. A lot of laughter and a little competitive spirit is always an amazing way to bond. For most people, there is something inexplicably compelling about the nature of competition. Why is that and how does this competitive spirit factor into the modern world?

Some scholars argue that competitiveness is a biological trait that co-evolved with the basic need for human survival. Survival of the fittest has been a constant through all stages of human evolution. Whether it was about fending off of wildlife as a caveman, fighting for your kingdom and conquering others as a ruler, or today’s cutthroat competition, humans have always fought tooth and nail to win.

Wherever there is competition, there is also a winner. The feeling of winning is exquisite and one often finds oneself challenging others to a competition just to experience that rush. You might not be an aggressive person. You might be a peace maker. But when it comes to a competition, even if it is against your family on a light-hearted evening, you play to win.

When you play to win, sometimes you might bend the rules a little to suit you. Other times you might break them altogether. This is what we all commonly call as cheating. It is a somewhat common practice in all kinds of games and sports. Though professional athletes are penalised if they violate any rule, nothing much can be done when someone cheats in a friendly game, except calling it quits. In fact, because data suggested that 50% of all Monopoly players cheat, Hasbro Inc. decided to create a Monopoly Cheater’s Edition with new rules. Generally, nobody likes a cheater and nobody likes to be cheated. But in the real world, not all things are fair and square. Once, you have set your objective, you have to reach your target by hook or by crook.

Apart from the world of sports, what relevance does this have in real life? The various market structures that we see today wouldn’t exist without the basic characteristic of competition. These types of market models are known as Imperfect Competition and can be broadly classified as Monopolistic and Oligopolistic. Firms exist to compete against each other, to capture more of the market share and to increase their profits.

In their book “The Theory of Games and Economic Behaviour”, John Von Neumann and Oskar Morgenstern introduce the concept of Game Theory and how it is a new approach to many problems involving conflicting behaviour. This was also used to explain how Oligopolistic markets worked.

A very intriguing model of the Game Theory concept is the Prisoner’s Dilemma model, which was proposed by Albert W Tucker. This model was formulated based on how prisoners react when asked to confess to a crime and was applied to various markets, especially to explain why cartels often refuse to cooperate. (Cartels are a type of Oligopolistic market)

The following is a simple explanation of Prisoner’s Dilemma. Let us assume that there are two prisoners, A and B. Suppose the prosecution doesn’t have enough evidence against them, the only way ahead is to extract a confession from them. Taking them both in separate rooms, the officer gives them the following proposal:

“If you confess to the crime and your partner does not, we will let you go but increase his prison sentence to 20 years. If you don’t confess but your partner does, we will let him go but increase your sentence to20 years. If you both confess, you both will serve sentences of 5 years each.”

It is also known to the prisoners that if they both do not confess, they both will serve only 1 year each.

Here is the most interesting part. To the perfectly rational mind, remaining silent is the best option as both prisoners, A and B, will be released within a year. But to the complex human brain, two things obstruct it from choosing this. One, the appeal of no jail time. Two, the doubt that lingers in their mind about the other’s choice. “What if he confesses?’

In most cases, this prompts both prisoners to confess which means they both will end up serving 5 years in prison and possibly losing a worthy accomplice. This is what cartels do too. They try to take advantage of the fact that the other party is trying to cooperate and steal profits. This goes to show that the ability to read another person and the ability to strategize are the two more important tools one could possess in today’s rather cruel world.

Prisoner’s Dilemma may not apply to your everyday board game or video game but it does make you wonder. What would you do if you were in a similar situation? Trust your friend to trust you or would you betray his/her trust? The clock is ticking…