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Barry Nalebuff is the Milton Steinbach Professor of Management at the Yale School of Management.  Professor Nalebuff has written on a wide variety of subjects ranging from strategy to pricing,[…]

Barry Nalebuff explains the basis of Game Theory.

Question: What is Game Theory?

Barry Nalebuff: Game theory is a science of strategy. It’s anticipating how others will respond to what you are doing and realizing that you can actually change what they are doing.

In Physics, there’s the Third Law: For every action, there is a reaction equal and opposite. But in game theory, you could influence what the other person’s reaction is. It’s not programmed. You can change it.

Question: What is the history of game theory?

Barry Nalebuff: Since game theory is a science of strategy, and people have been thinking strategically forever, you can go back to the Peloponnesian War.

But I think, as a real science, in terms of being mathematized, being formalized, it goes back to Von Neumann and Morgenstern and really just about 55 years ago. It was during the war [i.e. WWII], in terms of thinking about how to locate enemy submarines and the cat and mouse game is where it began.

It started really with zero sum games, the notion that, I’ll find your sub, I’ll destroy you before you destroy me. So one person wins and one person losses.

Then John Nash, who later became famous with “A Beautiful Mind,” created the next important development, which is cooperative games; understanding that games don’t have to be just be zero sum. He gave us the concept of, what’s now called Nash equilibrium, basically a resting point for a game. A place where what I’m doing is best, given what I think you’re doing. And what you are doing is best, given what you believe that I’m doing.

And, one, it wasn’t clear that games all have such a resting point. And he showed that pretty much they do, though not always in something called the pure strategies, or a fixed strategy, like sometimes in football or in tennis I’ll [IB] your forehand or backhand or I have to bluff.

But when you allow that type of general strategies, then Nash showed that each game does have such a happy end point.

It is important to remember actually that solution to the game isn’t always a good solution. So just because people are happy with what they are doing, doesn’t mean it’s good for society.

Recorded on: Oct 2, 2008