What Economists Call Game Theory Psychologists More Accurately Call the Theory of Social Situations; the Branch Most Widely Used in Economics Is the Theory of Non-Cooperative Games

The heart of modern “rational” economic theory is the concept of a non-cooperative or “Nash” equilibrium of a game. If you saw the movie A Beautiful Mind this theory – created by Nobel Laureate John Nash – is briefly described, albeit inaccurately. But to put the oxen before the cart, let us first describe what a game is. A game in the parlance of a game theorist or economist does not generally refer to a parlor game such as checkers or bridge, nor indeed to Super-Mario III. Instead, what economists call game theory psychologists more accurately call the theory of social situations. There are two branches of game theory, but the one most widely used in economics is the theory of non-cooperative games – I shall describe that theory here.

The central topic of non-cooperative game theory is the question of how people interact. A game in the formal sense used by economists is merely a careful description of a social situation specifying the options available to the “players,” how choices among those options result in “outcomes,” and how the participants “feel” about those outcomes. The timing of decisions and the information available to players when undertaking those decisions must also be described.

The critical element in analyzing what happens in a game (or social situation) is the beliefs of the players: what do they think is likely to happen? How do they think other players are likely to play? From a formalistic perspective the beliefs of players are generally described by probability distributions – we assign a probability to an outcome – although in more advanced theories – such as epistemic game theory – beliefs are more sophisticated and mathematically complicated objects. Please observe that the notion that we are uncertain about the world we live in and about the people we interact with is at the very core of game theory.

Given beliefs about consequences and sentiments about those outcomes it is almost tautological to postulate that players choose the most favorable course of action given their beliefs. At one level this is what it means for players to be “rational” and should scarcely be controversial… yet many dense books have been written criticizing this notion of rationality.

--David K. Levine, ed., Is Behavioral Economics Doomed? The Ordinary versus the Extraordinary (Cambridge, UK: Open Book Publishers, 2012), 5-6.