Strategic Thinking for Global Governance
1. Introduction to Strategic Thinking and Game Theory
My Other
goal, player
- Examples:
- Firms setting prices consider competitors’ decisions.
- Governments design their foreign policy considering other countries (e.g.,
allies and rivals' strategies).
Case Study: United States policy on tariffs applied to Chinese imports
- Trump’s America First Policy: Less imports from China → More production from US
firms → More employment and better wages
- Strategy: Tariff on Chinese imports
- Elements to consider in this discussion: Imports lead to cost increases. → Higher
final prices → Less consumption and less employment
- China’s Retaliation Strategy: Fewer exports for some US companies
, - Other players: Vietnam
Game theory is a set of techniques that help in the analysis and understanding of strategic
interactions. In many cases, game theory can produce a prediction of the outcome of a
game.
- Game theory encompasses the study of many different types of strategic
interactions. Games can be classified according to whether they are:
- Simultaneous-move vs. sequential-move
- One-shot vs. repeated
- Non-cooperative vs. cooperative
- Full information vs. imperfect or asymmetric information
- Game Theory’s Behavioral Assumptions
1. RATIONALITY
- Players aim to maximize profits.
- Players only care about their own payoffs.
- Players are perfect calculators.
2. COMMON KNOWLEDGE
- Each player knows the environment and the rules of the game.
- Each player knows that the other players know the environment and
rules of the game.
- Each player knows that all other players are rational. Moreover, each
player knows that all others know that she/he is rational.
A Strategic Game
- A situation in which:
- A set of players (participants) is mutually aware of their interactions
- Each player has a set of decisions
- The outcome for each player depends not only on their decisions but also on
the rest of the players’ decisions.
- Basic Elements in a Game
- Players: Agents participating in the game and making decisions (Firm 1 and
Firm 2 in our example). “Nature” is a potential player.
- Given the actions available to them, players devise strategies. A
player’s strategy will determine the actions the player will take at any
stage of the game.
- The strategy concept is sometimes (wrongly) confused with that of a
move. A move is an action taken by a player at some point during the
play of a game. A strategy, on the other hand, is a fully contingent
plan that specifies which action will be taken in every possible
situation throughout the game.
, - The strategy must specify what action is chosen even in
situations that are possible but do not finally occur in a game.
This will be very important in sequential games.
- Example: A strategy in soccer would specify what to do if a
penalty kick is called, even if in the game no penalty is finally
conceded.
- Actions: The moves available to each player. A set of alternatives.
- Payoffs: The outcome players get as a result of their interactions (The
cost/benefit that each player gets from each possible outcome of the game).
- The payoff to a player depends not just on his chosen action but also
on the action chosen by the other player.
- The set of these payoffs can be represented with a payoff matrix. A
payoff matrix shows how the payoff or the outcome of each player
depends on the actions of both.
- In our example, the four sets of numbers (x, y) are the payoffs.
- Strategies: The options agents have.
- Example: Two firms simultaneously decide whether to produce 30 or 40 million units
each. So, there are two actions available to each firm: produce 30M or 40M units.
- The matrix contains four cells or boxes. Each cell shows the payoff to the two
firms that results from a pair of choices.
- The first number in each cell shows the specific payoff (or the profit) for Firm
1. The second number shows the payoff for Firm 2.
- If Firm 1 decides to produce 30M units and Firm 2 produces 40M units, the
payoff is (150,200): Firm 1 earns 150M€, and Firm 2 earns 200M€.
One of the main objectives of GT is to find solutions to games. This means that we must
make reasonable predictions with respect to the game’s outcome.
- It is important to see that Firm 1 will never choose “Produce 30.” Why? Because,
regardless of what Firm 2 chooses, “Produce 30” yields lower payoffs to Firm 1 than
“Produce 40.”
- The same happens with Firm 2. Therefore, we know that both firms should rationally
choose “Produce 40.”
- Thus, we have found a solution to the game. We can predict each firm’s choices and
final payoffs.
1. Introduction to Strategic Thinking and Game Theory
My Other
goal, player
- Examples:
- Firms setting prices consider competitors’ decisions.
- Governments design their foreign policy considering other countries (e.g.,
allies and rivals' strategies).
Case Study: United States policy on tariffs applied to Chinese imports
- Trump’s America First Policy: Less imports from China → More production from US
firms → More employment and better wages
- Strategy: Tariff on Chinese imports
- Elements to consider in this discussion: Imports lead to cost increases. → Higher
final prices → Less consumption and less employment
- China’s Retaliation Strategy: Fewer exports for some US companies
, - Other players: Vietnam
Game theory is a set of techniques that help in the analysis and understanding of strategic
interactions. In many cases, game theory can produce a prediction of the outcome of a
game.
- Game theory encompasses the study of many different types of strategic
interactions. Games can be classified according to whether they are:
- Simultaneous-move vs. sequential-move
- One-shot vs. repeated
- Non-cooperative vs. cooperative
- Full information vs. imperfect or asymmetric information
- Game Theory’s Behavioral Assumptions
1. RATIONALITY
- Players aim to maximize profits.
- Players only care about their own payoffs.
- Players are perfect calculators.
2. COMMON KNOWLEDGE
- Each player knows the environment and the rules of the game.
- Each player knows that the other players know the environment and
rules of the game.
- Each player knows that all other players are rational. Moreover, each
player knows that all others know that she/he is rational.
A Strategic Game
- A situation in which:
- A set of players (participants) is mutually aware of their interactions
- Each player has a set of decisions
- The outcome for each player depends not only on their decisions but also on
the rest of the players’ decisions.
- Basic Elements in a Game
- Players: Agents participating in the game and making decisions (Firm 1 and
Firm 2 in our example). “Nature” is a potential player.
- Given the actions available to them, players devise strategies. A
player’s strategy will determine the actions the player will take at any
stage of the game.
- The strategy concept is sometimes (wrongly) confused with that of a
move. A move is an action taken by a player at some point during the
play of a game. A strategy, on the other hand, is a fully contingent
plan that specifies which action will be taken in every possible
situation throughout the game.
, - The strategy must specify what action is chosen even in
situations that are possible but do not finally occur in a game.
This will be very important in sequential games.
- Example: A strategy in soccer would specify what to do if a
penalty kick is called, even if in the game no penalty is finally
conceded.
- Actions: The moves available to each player. A set of alternatives.
- Payoffs: The outcome players get as a result of their interactions (The
cost/benefit that each player gets from each possible outcome of the game).
- The payoff to a player depends not just on his chosen action but also
on the action chosen by the other player.
- The set of these payoffs can be represented with a payoff matrix. A
payoff matrix shows how the payoff or the outcome of each player
depends on the actions of both.
- In our example, the four sets of numbers (x, y) are the payoffs.
- Strategies: The options agents have.
- Example: Two firms simultaneously decide whether to produce 30 or 40 million units
each. So, there are two actions available to each firm: produce 30M or 40M units.
- The matrix contains four cells or boxes. Each cell shows the payoff to the two
firms that results from a pair of choices.
- The first number in each cell shows the specific payoff (or the profit) for Firm
1. The second number shows the payoff for Firm 2.
- If Firm 1 decides to produce 30M units and Firm 2 produces 40M units, the
payoff is (150,200): Firm 1 earns 150M€, and Firm 2 earns 200M€.
One of the main objectives of GT is to find solutions to games. This means that we must
make reasonable predictions with respect to the game’s outcome.
- It is important to see that Firm 1 will never choose “Produce 30.” Why? Because,
regardless of what Firm 2 chooses, “Produce 30” yields lower payoffs to Firm 1 than
“Produce 40.”
- The same happens with Firm 2. Therefore, we know that both firms should rationally
choose “Produce 40.”
- Thus, we have found a solution to the game. We can predict each firm’s choices and
final payoffs.
