I am deeply grateful to **Adam Hayes** for providing an excellent response to this question.

Here is a brief excerpt from his article for Investopedia in which he explains the basics of game theory.

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Game theory is a theoretical framework for conceiving social situations among competing players. In some respects, game theory is the science of strategy, or at least the optimal decision-making of independent and competing actors in a strategic setting.

The key pioneers of game theory were mathematician John von Neumann and economist Oskar Morgenstern in the 1940s.

Mathematician John Nash is regarded by many as providing the first significant extension of the von Neumann and Morgenstern work.

### Key Takeaways

- Game theory is a theoretical framework to conceive social situations among competing players and produce optimal decision-making of independent and competing actors in a strategic setting.
- Using game theory, real-world scenarios for such situations as pricing competition and product releases (and many more) can be laid out and their outcomes predicted.
- Scenarios include the prisoner’s dilemma and the dictator game among many others.

It is assumed players within the game are rational and will strive to maximize their payoffs in the game.

## The Basics of Game Theory

The focus of game theory is the game, which serves as a model of an interactive situation among rational players. The key to game theory is that one player’s payoff is contingent on the strategy implemented by the other player. The game identifies the players’ identities, preferences, and available strategies and how these strategies affect the outcome. Depending on the model, various other requirements or assumptions may be necessary.

Game theory has a wide range of applications, including psychology, evolutionary biology, war, politics, economics, and business. Despite its many advances, game theory is still a young and developing science.

According to game theory, the actions and choices of all the participants affect the outcome of each.

### Game Theory Definitions

Any time we have a situation with two or more players that involve known payouts or quantifiable consequences, we can use game theory to help determine the most likely outcomes. Let’s start out by defining a few terms commonly used in the study of game theory:

**Game**: Any set of circumstances that has a result dependent on the actions of two or more decision-makers (players)**Players**: A strategic decision-maker within the context of the game**Strategy**: A complete plan of action a player will take given the set of circumstances that might arise within the game**Payoff**:*T*he payout a player receives from arriving at a particular outcome (The payout can be in any quantifiable form, from dollars to utility.)**Information set**: The information available at a given point in the game (The term*information set*is most usually applied when the game has a sequential component.)**Equilibrium**: The point in a game where both players have made their decisions and an outcome is reached

### The Nash Equilibrium

Nash Equilibrium is an outcome reached that, once achieved, means no player can increase payoff by changing decisions unilaterally. It can also be thought of as “no regrets,” in the sense that once a decision is made, the player will have no regrets concerning decisions considering the consequences.

The Nash Equilibrium is reached over time, in most cases. However, once the Nash Equilibrium is reached, it will not be deviated from. After we learn how to find the Nash Equilibrium, take a look at how a unilateral move would affect the situation. Does it make any sense? It shouldn’t, and that’s why the Nash Equilibrium is described as “no regrets.” Generally, there can be more than one equilibrium in a game.

However, this usually occurs in games with more complex elements than two choices by two players. In simultaneous games that are repeated over time, one of these multiple equilibria is reached after some trial and error. This scenario of different choices overtime before reaching equilibrium is the most often played out in the business world when two firms are determining prices for highly interchangeable products, such as airfare or soft drinks.

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Here is a direct **link** to the complete article.

**Adam Hayes** is an Economic Sociologist, Assistant Professor of Sociology and Anthropology at the Hebrew University of Jerusalem. He resides in Tel Aviv, Israel.