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5. Game Theory

Game Theory studies strategic interactions where the outcome for each participant depends on the actions of all. It provides a framework for analyzing situations where individuals or firms make decisions considering the possible choices of others.

Key Concepts:

  • Players: Decision-makers in a game.
  • Strategies: Plans of action available to players.
  • Payoffs: Outcomes or rewards resulting from strategy choices.
  • Equilibrium: A situation where no player can improve their payoff by changing their strategy, assuming others keep theirs unchanged.

Real-Life Example:​

In a competitive market, firms decide on pricing strategies considering the potential reactions of their competitors. Game theory helps understand these strategic decisions and outcomes, such as in pricing wars or collusion scenarios.