Why Game Theory is Not About Competition

economics is an academic pursuit holds human nature in pretty high regard if Noack theory is based around the idea that people always make rational economic decisions and act in rational way to better their self-interest we always buy the most competitive option we always know what the best price is we work in fields that deliver us the most fiscal prosperity and we approach every decision through a fundamental analysis of best possible outcomes for ourselves and even the most surface level objection to this idealistic view of economic participants reveal that they are actually really dumb sorry to say it but it's true this episode of economics explained was made possible by our fans on patreon if you'd like to gain early access to these videos before they're uploaded to YouTube as well as participate in exclusive live Q&A sessions please consider supporting our channel on patreon comm slash economics explained in this video I want to look at the way economists think we make decisions how we model this decision-making process and then look at how these assumptions impact the projected economy in contrast to the economy that we have in reality I would imagine most people watching this channel in some capacity have heard about game theory it is the plot piece for movies like Beautiful Mind it's even taught in a lot of high schools around the world as a discipline of economics now this theory is very useful for economics and John Nash the fellow who proposed this theory won the Nobel Peace Prize for economics but it is not a theory that applies exclusively to economics the whole idea of game theory is that it applies to anything where a decision must be made between two parties although if you want to credit the economic community for developing this idea then that's ok too going beyond this there are two separate types of game theory for two different types of interaction competitive game theory which analyzes how you should make decisions to win out over a competitor and cooperative game theory which is how you make decisions in relation to your friends now cooperative game theory is actually the more overlooked of the two but it is definitely the most important for modern but it's also slightly more difficult to understand so we will save that one for a little bit later for now let's look at competitive game theory and of course we have to explore the prisoner's dilemma if you have heard of game theory you have no doubt heard of prisoner's dilemma and sorry if this is the fifteenth YouTube video you have seen discussing this theory I promise we're gonna look at something a little bit different as it relates to this specific theory though but for now the theory goes that to alleged criminals are arrested for a crime and put into two separate interrogation rooms they are each given a choice at the present time they are facing 1 year in prison but they can stitch out their partner and avoid going to prison all together if they do that their partner will get 10 years in prison but if they both snitch on each other they will each get five years in prison of course the best option for the overall benefit of the group is to stay silent and respect the criminal code no snitching but game theorists don't see it like that they look at it from the lens of what decision will give you the most possible benefit which means spending the least amount of time in prison if your partner stays silent and use snitch you get no years in prison if your partner stays silent and you don't snitch you get one year in prison in this case either way you are better off snitching the same is true if your partner snitches if you stay silent you are going to prison for 10 years but if you also snitch you're only going away for five again no matter what your partner chooses you are better off snitching and so the decision is made you will snitch the same is true for your would-be accomplice and surprise surprise you each end up spending five years in prison when you could have gotten away with just spending one this is a really typical and probably overused example of how competitive entities can benefit from colluding in this example the entities were kept from colluding by concrete walls of their individual interrogation rooms but in the real world businesses are kept from colluding by anti-competitive trust laws but this is where it all falls apart a lot of economists will use this theory and call it competitive game theory and that's done but the truth is far from it this is just one example of a possible beneficial outcome take the same example and apply a more realistic set of numbers to it at the moment mr. prisoner we have no evidence for your case so if you don't snitch we probably can't put you in prison but maybe we can put your partner away if you don't snitch well I guess you're also free to go this is a much more likely scenario and in this case it's not really in your best interest to snitch because you have no incentive to and neither does your accomplice the logical Quadron of each of your decisions is called the Nash equilibrium after John Nash who first published this theory and if you are ever looking at a competitive game theory is important to remember that the Nash equilibrium is a variable there is no guarantee that it will dictate to a snitch or not to snitch to raise or lower prices it all depends on the scenario that you are presented with it all depends on the prices and it all depends on the years in prison and how this all relates to business is normally in terms of pricing the example is normally what competitive business should do with their prices on products if they both leave them high they will each make more profit if they both lower them they'll each make less profit but if only one of them lowers prices the business that did will make much much more money than the business with higher prices seems reasonable enough but here's the thing this whole theory revolves around companies selling identical products to will inform consumers he markets with perfectly proactive consumer protection the assumption is that these businesses can't collude because that is anti-competitive and illegal in most modern economies but what about too much the other way companies can get in just as much trouble for pricing their products too competitively Microsoft was in court for nearly a decade after it gave Internet Explorer away for free argument was that this was an attempt to put other internet browsing companies out of business so they would own the market entirely which is just as anti-competitive as cooperating on the price so this model kind of falls apart the other thing is this when was the last time you purchased anything and I mean anything where you sat down and assess the price of all of the offerings in the market to truly find the cheapest most competitive good I know for me at least it was probably never the truth is as long as a price is reasonable for most things I will just buy whatever has the best features is most convenient not yeah potentially what evident as the most prestige which kind of breaks these game theory models or just makes them far too complex to really be called models anymore for this reason discussions over prisoners dilemmas and competitive pricing matrixes are unlikely to make it into a boardroom of pretty much any corporation but what about if you are not competing with a second partner what about if you're actually working with them one place game theory is actually alive and well is in how to properly cooperate with other entities which is a big departure from competitive game theory which is basically just an idealistic instruction manual for bankrupting your competition cooperative game theory has become such a relevant part of our economy primarily due to things like economic unions and trade deals you see things like the North American Free Trade Agreement the trans-pacific partnership the European Union and even entities like OPEC take a lot of negotiation to form they involve world leaders from many countries that are all ultimately trying to increase the prosperity of their own country by operating collaboratively with their trade partners the big takeaway from this is the breakdown of inputs to benefits if a country imports more into a system it should benefit more offer let's take the North American Free Trade Agreement this is or well was the trade agreement between the United States Canada and Mexico now the economies of Mexico and Canada are nothing to be sniffed at but there is no getting around the fact that the United States is by far and away the largest participant in this kind of deal it will contribute the most and it will expect the most in return this is done by ultimately calculating how much an economy can contribute without a trade deal how much it can contribute with a trade deal and then splitting the difference I will leave a link in the video description for people that want to explore the actual mathematics behind calculating the net benefit of things like oil cartels or trade deals but just be warned it can get a bit intense the thing to really understand about this though is that it is actually used in the real world and we can see the result of it Donald Trump has received a lot of criticism for his stance on things like free trade agreements most modern economists agree that free trade between well developed economies is normally beneficial for all participants and for the most part this is true but Donald Trump has objected to a lot of trade deals and even found himself in trade wars sounds terrible but purely from the lens of cooperative game theory it might actually make it's just because cooperative game theory has the word cooperative in it does not mean that the participants are not looking out for themselves and cooperative game theory is all about making sure what you put in is what you get out and nobody gets out more than they put in because the United States as an economy is so large and so valuable as a trade partner Donald Trump is favoring bilateral trade agreements meaning trade agreements between just the USA and one other country over the more common multilateral trade agreements the rational reason for this is that in a bilateral trade agreement the USA will be contributing far more and will be able to demand far more as a result now whether or not mr. Trump is aware of his actions as they relate to advanced game theory and anyone's guess in fairness similar techniques are actually talked about in the art of the deal so maybe but regardless of speculation about the true motives of international trade negotiations it is important to understand cooperative game theory even if it is only just drop your friends stiffing you on the check for dinner game theory is a fascinating study especially in the capacity that it relates to the economics we see in the world around us today is it something that you were likely to ever have the opportunity to engage directly with in your professional career well yes in the sense that I suppose every decision you make supposedly follows the fundamentals of game theory but beyond that it is unlikely that you're going to be drawing up prisoner's dilemma in your next board meeting unfortunately that doesn't mean though that it is not important to understand and even if it's not action to some rigorous academic pursuit the basic idea of understanding everybody is out for themselves is probably helpful albeit a little terrifying if you want to buck the trend of prisoner's dilemma and rational decision-making give me money on patreon like these people did otherwise a like' and subscribe' goes a long way as well beyond that join our Q&A stream over and our discord server or hosted on our second channel it's always a good time and interesting economic discussions are always appreciated thanks guys bye

Channel: Economics Explained

Views: 266,223

Keywords: why game theory is not about competition, no such thing as a win win, game theory, the economics of game theory, game theory explained, game theory economics, game theory economics explained, the economics of game theory explained, economics explained game theory, game theory in economics, what is game theory, what is game theory in economics, game thoery, prisoner's dilemma game theory, prisoners dilemma economics explained, economics explained

Id: oJ8JU1O4I48

Length: 12min 15sec (735 seconds)

Published: Thu Jun 18 2020