Game theory looks at how strategic decisions are formed and how they are implemented. It is the study of conflict and cooperation. Economists use it to understand oligopolies, which is a market with few producers whose actions impact price and their competitors. It is described as the act of looking ahead, to predict what other competitors will do, and reasoning backward, to determine what you should do in relation to the actions of others¹. The major contributors to the development of economic game theory include John Nash, Selten, and Harsanyi².
This topic includes the study of externality issues and economics of information. As a decision-maker, game theory uses mathematical methodoogy to efficiently structure and analyze problems. For example, firms use game theory to make decisions about pricing and production levels. Game theory is also applied in economics in areas such as bargaining, merger pricing, voting systems, and many other fields. Economic theory has three other branches, along with game theory, which include decision theory, general equiliubrium theory, and mechanism design theory.
Nash Equilibrium is a concept in game theory that describes a situation where all participants are trying to determine the best strategy given the strategies of the other participants². In a Nash equilibrium, none of the participating players have any incentive to deviate from their chosen strategy. In general, game theory is based on the pay-offs that come from the different decisions and strategies.
1. Chwe, Michael. (May 16, 2013). Economics, Game Theory and Jane Austen. Retrieved from http://www.pbs.org/newshour/businessdesk/2013/05/economics-game-theory-and-jane.html
2. Introduction to Game Theory. Retrieved from http://www.courses.temple.edu/economics/Econ_92/Game_Lectures/1st-Look/introduction_to_game_theory.htm