This is “Nash Equilibrium”, section 31.18 from the book Theory and Applications of Economics (v. 1.0). For details on it (including licensing), click here.
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A Nash equilibrium is used to predict the outcome of a game. By a game, we mean the interaction of a few individuals, called players. Each player chooses an action and receives a payoff that depends on the actions chosen by everyone in the game.
A Nash equilibrium is an action for each player that satisfies two conditions:
Thus a Nash equilibrium has two dimensions. Players make decisions that are in their own self-interests, and players make accurate predictions about the actions of others.
Consider the games in Table 31.6 "Prisoners’ Dilemma", Table 31.7 "Dictator Game", Table 31.8 "Ultimatum Game", and Table 31.9 "Coordination Game". The numbers in the tables give the payoff to each player from the actions that can be taken, with the payoff of the row player listed first.
Table 31.6 Prisoners’ Dilemma
Left | Right | |
---|---|---|
Up | 5, 5 | 0, 10 |
Down | 10, 0 | 2, 2 |
Table 31.7 Dictator Game
Number of dollars (x) | 100 − x, x |
Table 31.8 Ultimatum Game
Accept | Reject | |
---|---|---|
Number of dollars (x) | 100 − x, x | 0, 0 |
Table 31.9 Coordination Game
Left | Right | |
---|---|---|
Up | 5, 5 | 0, 1 |
Down | 1, 0 | 4, 4 |
We describe a game with three players (1, 2, 3), but the idea generalizes straightforwardly to situations with any number of players. Each player chooses a strategy (s_{1}, s_{2}, s_{3}). Suppose σ_{1}(s_{1}, s_{2}, s_{3}) is the payoff to player 1 if (s_{1}, s_{2}, s_{3}) is the list of strategies chosen by the players (and similarly for players 2 and 3). We put an asterisk (*) to denote the best strategy chosen by a player. Then a list of strategies (s*_{1}, s*_{2}, s*_{3}) is a Nash equilibrium if the following statements are true:
σ_{1}(s*_{1}, s*_{2}, s*_{3}) ≥ σ_{1}(s_{1}, s*_{2}, s*_{3}) σ_{2}(s*_{1}, s*_{2}, s*_{3}) ≥ σ_{2}(s*_{1}, s_{2}, s*_{3}) σ_{3}(s*_{1}, s*_{2}, s*_{3}) ≥ σ_{3}(s*_{1}, s*_{2}, s_{3})In words, the first condition says that, given that players 2 and 3 are choosing their best strategies (s*_{2}, s*_{3}), then player 1 can do no better than to choose strategy s*_{1}. If a similar condition holds for every player, then we have a Nash equilibrium.