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The Impact of Game Theory on Economic Development

Several mathematical models have been deployed in economics to help in such practices as simulation and forecasting production, distribution, and even demand and supply. According to Kronberger (2019), game theory can be described as a catchword attractive even to individuals who believe that economics and economic theories are subjects befitting scientists in their abstract realms. While this argument may be true to some extent, it can be illustrated that game theory is quite abstract but still useful in developing economic models applicable across industries and sectors. For example, businesses can use it to determine whether to compete or collaborate in a particular market depending on the actions and reactions of the opponents. The famous Prisoner’s Dilemma can illustrate this scenario where choices are available to two prisoners based on what they choose to do. The focus of this essay will be to explore how game theory has impacted economic development. To achieve this objective, arguments will be illustrated using examples of areas of economics where game theory has played a critical role. Before this exploration, a brief understanding of game theory and the key constructs will be presented.

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Overview of Game Theory

Game theory is one of the many mathematical models used in the analysis of scenarios and strategies adopted by stakeholders in any particular problem. It can be described as an autonomous discipline common in such fields as applied mathematics and social sciences. Most considerably, game theory finds critical applications in engineering, politics, economics, computer science, international relations, and philosophy. In essence, game theory is used across all areas that require a mathematical study of conflict and strategy (Bhuiyan, 2016). The term game is critical in defining the theory. According to Bhuiyan (2016), a game can be defined as an abstract scenario comprising a strategic situation. Under normal circumstances, strategic interactions involve two or more players or decision-makers, each with two or more courses of actions or strategies, where outcomes are subject to the strategic choices of all players. In this definition, it is apparent that a minimum of two parties are required to make rational choices that seek to maximize their interests.

In the above description, it can be argued that game theory is a strategic tool used across all competitive situations. Its use is majorly to help find the best course of action based on the expected outcomes or payoffs. For example, two companies competing based on prices have the options to lower prices, raise the price, or keep the current prices. If the first decides to lower prices with the hope to lure customers, the second might follow suit and lower the prices even further. In this scenario, the competitive payoffs can deteriorate with each retaliation. Alternatively, the competing firms can agree to standardize prices and share the market between them. This is a scenario of competing or collaborating where the decisions are made to optimize the payoffs of the players. A key idea to emphasize is that the outcomes are subject to both own choices and those of the opponents (Schecter & Gintis, 2016). In such areas as economics, governments can make decisions on regulation or deregulation based on what industries and sectors behave and the outcomes of these behaviors.

Throughout its application, game theory has evolved considerably as the scope and purpose widens. The idea of evolutionary game theory has been discussed by many scholars who emphasize that large numbers of players are involved, all of whom can freely access the information needed to make rational decisions (Xie & Wu, 2019). However, the basic idea remains that conflicts and strategies are the defining features of game theory modeling. The idea of the game theory emerged from some key publications, some of which date back to the early 1700s. However, it is the 1944 publication by John Neuman and Oskar Morgenstern titled “Theory of games and Economic Behavior” that introduced a mathematical and economic model now called the game theory (Bhuiyan, 2016). Applications have diversified since then as multiple disciplines found uses for the model. Government regimes, politicians, economists, engineers, and practitioners from other disciplines have all used the model. As will be discussed in the section below, many of the applications have had a direct implication on the growth and development of world economies.

Impact of Game Theory on Economic Development

Assessing the impacts of game theory on economic development may require a critical analysis of where game theory is applied and what economic outcomes can be derived from these applications. As a mathematical model and a tool for strategic decision-making, it can be argued that game theory has led to the development of industries and sectors starting from individual firms and their consumer bases. The decisions made by businesses have an impact on the economy, which means a successful application of game theory can manifest itself in successful companies, international expansion, emerging industries, and improving economic indicators. With little literature available on this subject, inferences are the key basis for most arguments presented here.

The first step in exploring the impacts of game theory on economic development is to examine the economic applications. Such an attempt has been made by Newton (2018), who highlights such areas as finance, macroeconomics, market selection, and industrial organization. In macroeconomics, businesses have been using game theory to make production decisions, especially the input levels. In market selection, behavioral game theory examines the markets and their characteristics. The outcome of this application is that a company can decide on the best market or determine the behavior of consumers in response to the firm’s business offerings. Finance can necessitate the application of Nash equilibrium and other game theory tools used to model costs and to achieve stochastic stability. In these cases, the optimal decisions are made based on the forecasts made from the information available and the expected reactions of all stakeholders. A successful business can display such properties as growing revenues, expansion across multiple dimensions, and profitability levels.

In industrial organizations, the focus of the game theory has largely been on pricing and competition. These two aspects are critical since they affect not only consumer behavior but also that of other firms across the entire industry and their supply chains. Therefore, the key players in the game model are the consumers and the sellers. In this case, the buyers select the best offerings in terms of price, quality, and technology while the companies work with multi-price Nash equilibria to meet both the demand of the consumers and leverage against the actions of competitors (Newton, 2018). Firms that can gain a competitive edge will deploy all the necessary strategies and expect the best possible payoffs, which include more market share and reduced competition. From an economic perspective, competition has always been beneficial since it drives innovation and development. Many emerging businesses have focused on becoming better than incumbents, while the current ones attempt to adapt to remain competitive. The developments taking place in such a scenario have positive implications for the overall economic development.

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The implications of game theory on the industrial organization can be illustrated by examining how individual industries and the businesses therein make critical decisions that impact the economy. Some of the emerging economic concepts include the circular and sharing economy, a paradigm that is characterized by reduced wastage, environmental sustainability, sharing resources, and collaborative commerce (Choi et al., 2020). The growing popularity of these concepts can be the result of the advantages gained over the traditional economic models. Their disruptive nature means that further developments in the economy can be expected. The role of game theory in the development of this economy has been explored by Choi et al. (2020) who finds that production is the key component targeted by this mathematical model. In this case, such aspects of production as resource utilization and social issues are modeled in game theory in the context of the sharing economy. Therefore, businesses deploying a sharing economy can predict what resources will be needed and how the end product will be received. In essence, the firms will be hoping to appeal to a certain clientele that subscribed to the core ideologies of the sharing economy.

The circular economy deploys similar game theory modeling to sharing economy. According to Choi et al. (2020), the key components modeled in a circular economy include sustainable operations, fair distribution of resources, and supply chain operations where both options of competition or collaboration are explored. Businesses will formulate policies depending on what the outcomes of the model dictate. For example, if the model predicts that resources are distributed more fairly through cooperation between the stakeholders or players in a supply chain, then supplier management policies can be developed to maximize related outcomes. Businesses in the same industry can also decide to compete or collaborate in the circular economy based on the optimal outcomes in sustainability and resource distribution. For example, a joint supplier management framework can be developed to allow producers to derive the best possible value from their suppliers and sourcing considerations. Considering the size and outputs of the circular and sharing economies, game theory can be credited for making many aspects of their development possible.

Another case example of the impacts of game theory in economic development can be illustrated using the oil and gas industry. Today, this is one of the largest global industries comprising multi-billion-dollar businesses. Mining oil and gas can be an expensive affair due to the heavy investments made. Considering many companies have to prospect and select the right exploration methods, it can be argued that the returns on investments are not the only consideration in the decision-making. Shale gas and hydraulic fracturing are the two main methodologies used in this industry and the outcomes have to be effectively modeled. The application of game theory in this context has been illustrated by Gao and You (2016), who find that besides maximizing the net present value, other considerations have to be made. In other words, the problem can be described as multi-objective with mixed-integer linear characteristics that cannot be resolved using other optimization models. Therefore, the development of this industry and its role in the development of global economies can be attributed to the game theory.

The gas industry of the modern-day operates at a time when global warming and sustainability are becoming critical to all stakeholders. Therefore, some of the many objectives include sustainability and greenhouse gas emissions (Gao & You, 2016). Additionally, shaling and hydraulic fracturing have environmental implications that have to be added to the list of objectives. A balance between all these aspects, including the return on investments, determine the possibility of oil exploration and the acceptable externalities. For instance, fracturing close to farmlands or residential places can be discouraged since the dangers can outweigh the economic benefits. Game theory is one of the few models that can support the existence of the oil and gas industry and the economic implications it has on individual countries.

Another industry with critical economic implications is agriculture, where its massive size and its role in sustaining nations have necessitated the deployment of game theory. Farmers across the work can face some scenarios similar to those in the gas and oil industry, especially greenhouse gas emissions, sustainability, and environmental consequences. According to Xie and Wu (2019), such countries as China have had to formulate farming policies based on the hawk-dove game theory to model both the ecological environment and the country’s food security. The rationale for this approach is that there exist, multiple stakeholders, including farmers, the government, consumers, and environmental protection groups. The policies made have to be aligned with the interests of all people. For instance, the government is concerned with food security, the farmers consider economic viability, consumers would be interested in the quality and prices of the food products, and the environmentalists advocate for reduced pollution. Therefore, Nash equilibrium is pursued where all these mutually exclusive objectives are at the optimal level.

The importance of the agricultural industry to the global economies cannot be ignored. The World Bank (2021) estimates that the industry has to feed an expected 9.5 billion people by 2050. In some developing countries, agriculture accounts for up to 25% of the gross domestic product (GDP). From an environmental perspective, agriculture is also responsible for an estimated 25% of greenhouse gas emissions. Therefore, the size of the industry is massive with the consumer base being practically all human beings on the planet. The agrarian revolution can illustrate how agriculture has led to the emergence of global economies, and the application of game theory has made it possible to further develop agriculture. The main argument is that all critical industries are the basis of economic development, which means that the role of game theory in these sectors translates directly to economic development.

With globalization, many economies become integrated and liberalized, which means that businesses have to conduct operations across national borders. The movement of people and products between international destinations is a multi-objective that requires game theory. A case scenario is the operation of ports and their strategic decisions. Like all major industries, the port operations comprise multiple stakeholders with some interests that can be mutually exclusive. According to Hidalgo-Gallego et al. (2016), the application of game theory is necessitated not only by the size and number of stakeholders but also by the complexity of the industry. The sophistication emanates from the massive number of intervening agents and components of strategic decision-making that have to be included in the modeling. Examples include terminals shipping lines, supply chains, and transport operators. Additionally, the primary objectives of the port management can cover such areas as cost, time, schedules, policies, regulations, port planning and governance, port selection, mergers and alliances, and spatial analysis of seas. With all these aspects, game theory becomes the most important model since others cannot cover everything exhaustively.

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Many studies have historically plauded the ability of the game theory to help in the management of all port economics. From an industrial organization perspective, Hidalgo-Gallego et al. (2016) argue that competition and cooperation across such dimensions as ownership, regulation, and port activities can be modeled. Even with government devolution and increasing privatization, port profits become a key component of the national welfare of all countries that have seaports. Strategic decisions often focus on the ownership and investments, as well as the nature of the market. across the world, seaports tend to operate either ad monopolies or oligopolies since only a few of them exist. Whether state-owned or private, ports have to consider strategic decisions, including cross-country competition in key regional hubs and the behavior of all customers served by them. Efficiencies in operations and costs can help boost growth and profitability, which reflects in the countries’ GDP. With game theory, port economics can become easier to model and understand and critical decisions can be made with ease.

From the examples discussed above, it can be seen that virtually all major industries in the economy are forced to deploy game theory due to their complexities. Modeling strategic decisions can be achieved using various tools but each of them has varied capabilities. Game theory has been described as the tool that makes it possible to include multiple stakeholders and objectives. However, focusing on industries alone may not offer a clear picture of what role game theory plays in economic development. Major areas of application can also, some of which span across multiple industries, can also be explored. For example, some scholars believe that project management is increasingly becoming dependent on game theory as a tool for strategic decisions (Piraveenan, 2019). In essence, project management is an area that tends to use a wide range of tools and concepts in decision-making. Examples include investment analysis can be accomplished using field analysis, cycle cost method, NPV, internal rate of return, and prospect theory. Game theory is only gaining prominence in project management due to the shortcomings of these methodologies and approaches.

It is important to acknowledge that project management is a practice that covers all industries. Information technology, agriculture, transport, construction, mining, and manufacturing all incorporate projects, some of which are extremely complex and multinational. According to Piraveenan (2019), a project can be defined as a time-bound exercise seeking to obtain a service, product, or result. In construction, projects yield infrastructure, while IT projects often involve software and hardware. Regardless of the project, game theory is particularly useful in scenarios comprising entities pursuing similar outcomes. As compared to other tools, game theory is the most feasible in project management since it offers a more rigorous mathematical framework. Additionally, the game theory makes it possible for managers to understand the interests and needs of all stakeholders, which helps complete projects successfully. From an economic perspective, all projects accomplished leave a positive mark on the economy. For instance, construction projects yield roads, buildings, and other major infrastructure that support the economic development of a country. A key point to note is that the relationship does not necessarily have to be direct.

Conclusion

Game theory is a mathematical model that has existed for decades and has helped shape modern economies. Economic development can be assessed from the perspective of the trends and paradigms across industries and sectors, beginning with the individual entities. Economic development is the result of advances in businesses and industries. Therefore, the impact of game theory can be examined in terms of the extent to which it has supported the growth of businesses. Firstly, the term game theory has been described as a mathematical framework for use in abstract scenarios comprising conflict and strategy. The economy comprises stakeholders whose interactions fall under either competition or cooperation. Therefore, this model has been critical in influencing key economic decisions.

Multiple examples of major global industries have been used to illustrate the role played by game theory. Gas and oil is one of the largest industries where critical decisions have to cover NPV, sustainability, and environmental protection. The same applies to agriculture, an industry whose consumer base is practically the entire world population. The emerging sharing and circular economy concepts have also relied on game theory to balance their key objectives, including shared resources, sustainability, and resource distribution. Lastly, project management covers all industries, and game theory is only gaining prominence. All these industries and economic applications explain how game theory has positively impacted economic development.

References

Bhuiyan, B. (2016). An overview of game theory and some applications. Philosophy and Progress, 59-60(1-2), 112-128.

Choi, T., Taleizadeh, A., & Yue, X. (2020). Game theory applications in production research in the sharing and circular economy era. International Journal of Production Research, 58(1), 118-127.

Gao, J., & You, F. (2016). Game theory approach to optimal design of shale gas supply chains with consideration of economics and life cycle greenhouse gas emissions. AIChE Journal, 63(7), 2671-2693. https://doi.org/10.1002/aic.15605

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Hidalgo-Gallego, S., Núñez-Sánchez, R., & Coto-Millán, P. (2016). Game theory and port economics: A survey of recent research. Journal of Economic Surveys, 31(3), 854-877.

Kronberger, T. (2019). The economic concept of Expanded Game Theory as justification for the Queen’s Evidence and for understanding the reasons of protectionism. 33rd IBIMA Conference. Granada.

Newton, J. (2018). Evolutionary game theory: A renaissance. Games, 9(2), 1-67.

Piraveenan, M. (2019). Applications of game theory in project management: A structured review and analysis. Mathematics, 7(9), 1-31.

Schecter, S., & Gintis, H. (2016). Game theory in action: An introduction to classical and evolutionary models. Princeton University Press.

The World Bank. (2021). Agriculture and food. The World Bank.

Xie, H., & Wu, Q. (2019). Analysis of fallow farming decision-making behavior of farmers based on hawk-dove game theory: The case of Guizhou Province. Sustainability, 11(14), 1-15.

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