Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Friday, October 28, 2005

How Useful Is Game Theory?

from Steven Levitt:

Unfortunately for game theory, the simple ideas that are so alluring were quickly mined. What followed was less interesting. Modern game theory has become extremely mathematical, notation heavy, and removed from everyday life. Many of my colleagues would not agree with me, but I think game theory has failed to deliver on its enormous initial promise. I’m not the only one who feels this way. I was recently speaking with a prominent game theorist. He told me that if he knew what he knew and he were just getting started in the profession today, no way would he be a game theorist.
from John Lott:

If economics isn't testible, you don't have a science. Having a certain richness is nice, but there are simply too many game theory models that end up making similar predictions. When you can't even differentiate monopoly behavior from perfect competition in predation what good is it? Indeed the goal frequently seems to be how many different models can be generated. I also agree that Game theory creates a bias towards thinking about everything in terms of monopoly. What is interesting in Game Theory disappears when you assume that firms are behaving competitively. For whatever it is worth, I wrote a book on all this entitled: "Are Predatory Commitments Credible?" Take a simple example in Predation to show how sensitive the results are. All the models basically look at the information held by the predatory firm. But what if the victim firm can sell short the stock of the predator? Given that the costs to the predator from actually engaging in predation are so large, indeed much greater than the losses imposed on the victim, victim firms that sell short the stock of the predatory might not only hope that the predator enters the industry but the victim firm might now want to stay in the industry just so that they can benefit from the predator's losses. Of course, the very possibility of short selling can make it unnecessary. The whole thing is a mess.
from William Polley (where there is a wonderful summary of the recent discussion by others not cited above):
Game theory, like any model building apparatus, is a way of keeping track of what's going on so that you don't contradict yourself. I certainly understand the frustration of Mandel and others over the non-falsifiability of models with multiple equilibria. (See also the story Roberts relates in his post.) However, I think a number of important real-world situations may be characterized by coordination failures and multiple equilibria. It is worth having a framework that can accommodate that, as long as you don't start seeing multiple equilibria behind every tree. It's not a theory of everything... at least not yet, and it may never be. It's one more tool in the toolbox, useful for identifying the effect of changes in the rules or institutions and making sure you don't violate your own assumptions.
I'm sure Polley is correct, but I really prefer the the overstatements of Levitt and Lott. For a brilliant and very readable introduction to game theory and the prisoners' dilemma, read this.
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