Q&A: What Is Game Theory? (Plus Applications and Examples)

By Indeed Editorial Team

Published September 29, 2021

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

People often use the term "game theory" in both professional and educational scenarios. This theory has many simple and complex applications within several fields of study. Learning about what game theory is may help you apply it to real-world and theoretical decision-making experiences. In this article, we discuss the definition of game theory, describe the basic elements of it, provide a list of its common applications, share three major types and give examples of how to use it.

What is game theory?

Game theory is the study of decision-making in which multiple parties must make choices. People using this theory usually attempt to make the best possible decisions when presented with a specific set of conditions. The principles of game theory derive from elements of psychology, economics and math.

What are the basic elements of game theory?

Here are the four basic elements of this theory:

1. Imperfection

When using game theory, there often arise scenarios where there's no perfect decision to make. Nonetheless, people using this theory must make decisions using the information that's available to them. An example of this scenario is when two or more individuals have limited information about a situation and must make decisions based on what they know.

Related: 12 Decision-Making Strategies

2. Rationality

It's an assumption that the individuals using game theory are making rational decisions. Rationality is a human behavior that considers our ability to make consistent and deliberate decisions. When using this theory, you can typically assume that all parties involved are choosing their actions rationally, instead of emotionally or randomly.

3. Interaction

The conflict between rational decision-makers in game theory resolves through interaction and communication. Each player's choices and reactions affect how the other players act. This element ensures that there are a limited number of possible solutions to a conflict, depending on the rules of the interaction.

Related: 6 Tips for Making Effective Business Decisions

4. Self-interest

In game theory, the conflict between rational decision-makers also relies on self-interest. Players attempt to maximize their own utility or satisfaction based on what they have and what advantages they may gain or lose by interacting with others. This element allows each player to have the freedom of choice.

What are the applications of game theory?

Here are some common applications of this theory:

  • Mathematical modeling: You can use this theory to model mathematical situations in which decision-makers compete based on uncertainty, imperfection and rationality. This allows researchers to predict probable outcomes of conflicts using the knowledge they have.

  • Economic modeling: This theory also applies to economic situations, allowing for predictions about market behavior regarding consumer behavior. This application is the foundation for many introductory economics courses.

  • Neuroscience: Neuroscience has furthered the study and application of this theory. Neuroscientists have examined how its techniques can model neural networks inside living brains.

Related: How To Make a Hard Decision in the Workplace

What are the types of game theory?

There are many types of game theory, but here are three major ones:

1. Model-based game theory

Model-based game theory is most commonly used to study conflict that's based on imperfection and rationality. In this type, you can create a model of a situation using mathematics and observation. The model provides evidence for why certain outcomes occur in the conflict. Since these types of conflicts occur in real life more often than others, this kind of analysis has become an important tool for addressing economic situations, such as competitive market behavior.

2. Simulation game theory

Simulation game theory (SGT) is an extension of model-based game theory that creates a mathematical representation of a situation using computer simulation methods. In SGT, you can simulate the conflict between several players and potential outcomes. An example of this type of analysis is a poker game where many possible outcomes exist. SGT can also compare different scenarios and help predict how society may respond to certain situations.

Related: Decision-Making Models: Definitions and Examples

3. Cardinality-based game theory

Cardinality-based game theory (CBGT) is another extension of model-based game theory that's based on the number of players and interactions between opponents. Game theorists commonly use this type of analysis when there are few players or interactions. An example of this type of analysis is the resolution of political disputes.

What are examples of game theory?

Here are some basic examples of this theory:

Prisoner's dilemma

The prisoner's dilemma, originating in the 1950s with Merrill Flood and Melvin Dresher, is a situation in which two players, who are acting as prisoners, decide if they want to share information about a crime with each other or with the police. When the police interrogate the suspects, an officer either arrests one person or charges both with a crime the prisoners may or may not be guilty of committing.

In one scenario, if only one person confesses to a crime they didn't commit, the police officers may charge them and give them a lengthy prison sentence. If both prisoners confess, they may receive a reduced sentence because of their cooperation.

Related: How To Make a Decision Grid in 7 Steps

Stag hunt game

The stag hunt game, which started as a theory by Jean-Jacques Rousseau, is a scenario in which the players acting as hunters base their choices on rational decision-making and interaction. This situation involves two hunters who seek to capture a deer in common territory. If only one of the hunters traps a deer, they may require assistance in transporting it home. If they both trap a deer, they must decide whether to share the deer and return home with the meat or keep it all for themselves.

Ultimatum game

The ultimatum game, which came about in 1982 from Werner Guth and his colleagues, is a situation in which two players must decide how to split a sum of money between themselves. If they choose to take a certain percentage, they may receive a smaller amount of money than what the other player received. If the players can't agree on how to split the money, each receives nothing.

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