Ch 2 Game Theory A mathematical tool to study strategic decision making o Developed by John Von Neumann Oskar Morgenstern 1944 o Helps us understand how players will respond to various situations Decision Theory The study of how actors make choices absent interactions with other actors Distinct from Game Theory o Exogenous Externally determined o Endogenous Determined by the interaction of two players Public policy is nearly all endogenous Rational Choice A perspective that assumes individual choice is purposeful o All individuals must be allowed a choice over alternative action o Individuals must recognize the costs and benefits of their choice o Individual must be able to express a preference over the consequences attached to each action o Individual must rank these preferences then choose the preferred action Utility Function A mathematical relation that assigns a number to each element in a set of options in terms of individual ordered preferences o Number reflects value Optional Preferences Preference orderings that assign values to outcomes that convey only relative order o Reveal order but not magnitude of preference o Ex This before this but not this 3x this Cardinal Preferences Do reveal the magnitude of relative preferences Strict Preference Individual prefers A to B Weak Preference Suggests an individual prefers A at least as good as B Indifferent Preference Suggests that an individual prefers A equally to B Comparable Preferences Individual s preferences over their options are complete Have a stance on all issues A B C B A C Transitive Preferences The individual holds strict preferences over a set of alternatives such that A B B C then A C Personal Utility Maximization Process by which a rational individual seeks to obtain the greatest amount of utility or personal satisfaction by choosing their most preferred and available option Strategy Profile Complete set of best responses for each player given the action of all other players Nash Equilibrium A set of strategies such that no player can unilaterally improve their position given the other player s action o Reveals both players best response given the other s action Dominant Strategy When a player has a single strategic response regardless of what another player does o Ex A B o Ex A B o Ex A B Commitment Problem Where one or both parties cannot credibly commit to a strategy despite its high utility How do you avoid suboptimal outcomes in pursue of one s own interests o Repeated Interaction Learn about what to expect from others Discount Factor The degree which people discount future benefits relative to current ones o Ranges from 0 to 1 o Do not value future 0 Low discount factor Person prefers to be compensated in the near term o Value future same as present 1 High discount factor Person is patient Present Value How much your future stream of benefits worth to you today Grim Trigger Strategy If player A defects then player B will defect for the rest of the interaction Tit for tat Player begins cooperating and then echoes the other player s last move Internalized Norms Beliefs or values that derive from a variety of sources including family religion or non religious based morals o Represents a form of psychological cost that the player feels they would suffer for engaging in defection Third Party Enforcement The introduction of a third party to the game o Ex The government the police private company o Third party has ability to offer punishment for defecting o Problems from third party contracting Likely that a third party will often have a conflict of interest with a scenario involving two or more parties and have an incentive to sway enforcement in a biased direction Monitoring and enforcing is costly Monitoring and enforcing is imperfect It is impossible all those who break the law will get caught Contagion A subset of selfish individuals Interest group pluralism Assumed that if individuals had shared preferences on some political or policy issue they could simply form interest groups that could advocate for the specific policies that they preferred o Barriers Free riders
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