The triumph of capitalism and the free market society was altogether unsurprising for neoclassical economists. The reason for this is because the individualistic and independent element of the free market best complements their views on human nature. On the whole, individuals are rational in always viewing situations with self-interest. As a result, humans are continuously looking for ways to maximize their profits or satisfaction in their daily life, while minimizing their losses. This competitive and maximum utility characteristic in people makes a market that stresses the importance of advantage and individualism the most effective way in channeling their nature while insuring the opportunity of satisfying this human need. However, in addition to individuals and institutions attempting to maximize their self-interest in absolute terms, neoclassical economists view a large part of the equation is maximizing individual self-interest in relative terms too. Neoclassical economics sought to make economics a more grounded study by incorporating elements of mathematics, biology, politics, and social science to make it more relatable to the common worker engaged in the market. When looking at relative advantage in the market, neoclassical economists borrow a concept that is widely used in many fields of research: Game theory.
Game Theory in Neoclassical Economics
At its simplest, the Game theory offers mathematically-rooted predictions of individual’s behaviors in particular situations, as well as the potential outcomes of these decisions. However, game theory in neoclassical economics acknowledges that although the market stresses independence, success and failure is dependent on the decisions of competitors, partners etc. Paradoxically, game theory assumes that individuals need to create a balance between pursuing maximum self-interest with maximum collective benefits. Economists often study two forms of Game Theory that are relevant to the capitalistic market: Cooperative games theory and uncooperative game theory. The former looks at organizations or rules of businesses that consent to commitments towards one another. In other words, cooperative game theory is the “game” on a macro-level; the capitalistic system as a whole that is held together by a set of rules and binding agreements that provides the market with a degree of coherence and stability. After all, it is in an individual’s best interest to provide themselves with a foundation so they understand how to maximize their utility.
Non-cooperative games theory, meanwhile, looks at the meeting of individual and independent decisions that nonetheless influence another’s outcomes. In neoclassical economics, non-cooperative game theory is a greater source of research and intrigue because it both nurtures and undermines the system if played improperly. Many concepts have been introduced that investigate the relationship individual’s decisions have on one another in business. An extreme form of game theory includes the Zero-sum game. In this case study, the gains of one’s person’s decision are directly related to the loss of a competitor. If the utility of my gains are +3 points, the loss of my competitors as a direct result of my decision would be -3 provided they do not act. Game theory here works in such a way that competing interests are always antithetical to one another, and that there is only room for one ideal outcome. However, game theory in neoclassical economics does not work like that. Maximum utility is a often a result of self-interested partnerships so decisions are not usually made in spite of a competitor, but done together to enhance the entire industry. Game theory, in this way, promotes conservatism in behavior: for example, neither Coca Cola nor Pepsi would dare make a unilateral and costly business venture that had a high probability of failure, because damage to the reputation of the soda industry may hurt both companies, rather than one company individually.
Game theory in neoclassical economics is popularly viewed with the Nash equilibrium, named after American mathematician and economist John Nash. In the Nash equilibrium of game theory, the possible decisions of two or more individuals are known to one another and the equilibrium strategy reveals that nothing can be gained by changing strategy whether individuals are competing or working together. If cartels are formed to increase business, for example, the greatest payoff may involve the accumulation of resources although not necessarily the changing of business models between the two competing businesses. Changing the business model unilaterally by one partner may negatively affect the whole business, a branch of the business, or jeopardize the entire partnership. Either way, the negatives outweigh the positives with many outcomes. Thus, the strategy of maximum payoffs means that the Nash equilibrium has been reached. The reason the Nash equilibrium has remained a popular form of Game theory is because it is applicable to both Non-cooperative and cooperative game theory.
