As discussed last week, (read part — I here) game theory deals with mathematical models to understand the behaviour of decision making agents who are aware that their decisions affect one another. These agents may be individuals, groups, or firms. Every game has players (the decision makers), actions (what the players can do) and payoffs (what motivates them and their rewards). One big assumption taken while analysing a game is that all players are rational. A player is said to be rational if he seeks to play in a manner which maximizes his own payoff.
The actions of the players is also called a ‘strategy’. A strategy is one of the given possible actions of a player. The payoff is denoted by a number, also called utility. It reflects the motivation and the desirability of an outcome for a player. It is usually denoted by ‘u’ or ‘p’.
One way to represent a game is the strategic form, also called normal form. It is presented in a table, or a matrix, with a cell for each strategy combination. The game is defined by exhibiting on each side of the matrix the different players (players 1 and 2) and each strategy (strategies A and B). The matrix is then filled by the sets of payoffs they will each receive for a given strategy. if player 1 chooses strategy A and player 2 chooses strategy B, the set of payoffs given by the outcome would be p1A,p2B. which means that player 1 has a utility of p1A and player 2 has a utility of p2B.
The matrix helps you understand how much each player wins or loses with every result. This helps you understand what each player is most likely to do to optimise their payoff, and how this reflects on the system as a whole.
#Microeconomics, #GameTheory & #Finance
