The 2005 Nobel Memorial Prize in Economics was recently awarded to Israeli economist Robert Aumann and American economist Thomas Schelling. Their primary work, which was most deserving of this singular recognition, occurred several decades ago and focused on something called “Game Theory.” Although this subject may sound like strategies to win at Madden 2006, Final Fantasy, Grand Theft Auto, or some other video distraction (and it indeed can be used for that purpose), it is actually one of the most fruitful avenues to understanding and positively shaping our world.
The “Classical” economics of Adam Smith and his followers generally teaches that because economic agents (consumers, producers, workers, investors, etc.) naturally pursue their own self-interest, things work out in an optimal way for society as a whole. While this view explains the underlying logic of markets quite well, it gives us mere mortals far too much credit for being rational automatons and essentially has each of us making decisions in a vacuum. Game theory is an effort to give these basic ideas more “real world” meaning, albeit in a highly mathematical and esoteric way.
This whole genre of economic thinking was originally laid out in a seminal book by Jon Von Neumann and Oskar Morgenstern (The Theory of Games and Economic Behavior) in the 1940s. Other scholars built upon this work, the most famous of which was John Nash of A Beautiful Mind fame, who spelled out conditions in which competitive games would lead to a stable outcome (equilibrium).
The basic notion here is simply that many aspects of human behavior, economic or otherwise, and even natural phenomena can be thought of in terms of games. As a practical matter, we typically make decisions based not only on how we would like things to be, but on how others will react. Since we don’t know exactly what the other folks will do, this process gives us a lot of choices and uncertain outcomes. We do the best we can, and game theory helps us define strategies and predict outcomes.
Aumann and Schelling came at their work from different perspectives. Aumann tended to concentrate primarily on the mathematics of the situation, while Schelling focused more on the ways in which the theory could be applied. Both did a variety of things, but each distinguished himself in a particular arena. Aumann analyzed games that are repeated over and over, such as the daily struggle of kids and parents to get their way in the family setting. Schelling worked on games which involved both cooperation and competition. As one example, both labor and management want to see a company do well, but they have different views about how the spoils should be divided. Thus, at times they work together and other times they are at cross purposes. This type of tension frequently occurs for all of us. The work by Aumann and Schelling also played an important role in the most important games of their generation—the Cold War and the nuclear arms race.
If you stop and think about it, much of what we do every day involves making decisions in light of potential responses. The same can be said of states, nations, companies, and a host of other institutions. In essence, we are all involved in playing multiple and often overlapping games. This process is applicable to everything from economics to social interaction to family dynamics to trade negotiations to war and peace. A greater understanding of the underlying logic of these matters can help to improve outcomes in all areas of life. We will never be able to fully comprehend and predict human behavior; we are, after all, “human.” Nonetheless, the quest to explain and foresee underlying patterns in a systematic manner is nothing less than the quest to enhance all aspects of our lives. Aumann and Schelling did much to advance this field of study, and are most deserving of the Nobel Prize.