Game Theory †Descriptive, Normative or Prescriptive Essay

Going through life we often are surprised by the different ways how people think, make decisions and interact. We believe that most of us are rational human beans (to some extent) and, therefore, our decisions should be grounded in analysis of the situation, our experience and intuition. Therefore, the human mind can be seen as an incredibly complicated machine that runs series of theoretical simulations of possible situations (often subconsciously) to find the most optimal course of action, taking into consideration the possible strategies of others. When the decisions are important to us and the reasoning process is conscious, we engage in strategic thinking. It has always been tempting to develop a theory that would actually explain and predict the human interaction based on strategic thinking, therefore making the strategic decision making more effective to both parties and without risk to going into â€Å"worst case scenario†. Therefore ideally game theory should cover the questions how the decisions should be made in order to maximize the gains, what reasoning does it imply, how to make the best choice of strategy and what will the pay-offs be for both parties. What questions does game theory actually answer – this is how the topic of this essay might be rephrased. In this essay the discussion will be focused on the question whether game theory is a descriptive, normative or prescriptive theory. First, a brief explanation of different types of theories should be given as well as the definition of game theory and the development in this academic field of study as well as the practical applications. Then the standpoint of the author will be defined and supporting as well as contradicting arguments based on various academic articles will be presented and discussed. The last part of the essay will sum up the discussed ideas and draw the final conclusions and remarks. To start with the necessary in-depth understanding of the essay topic, the distinction between normative, descriptive and prescriptive theories should be clarified. As it is known, normative theory deals with how things should be – what ought to be in context of the specific field of study. Descriptive theories are concerned with explaining the way things happen (people behave) in real ife, moreover the prescriptive theories aim to suggest how things should happen (or how people should react) and this could be just on theoretical level or also connected with the real life (therefore not only giving prescriptions on how to act but also the predictions on the future situations). Joseph B. Kadane and Patrick D. Larkey in their paper „The Confusion of Is and Ought in Game Theoretic Contexts† from 1983 reflects on the essay topic and distinguishes between different types of normative and positive theories: Among positive theories, we distinguish three types. Descriptive theories are concerned with empirical phenomena, but stop with a description. Explanatory theories go further by addressing â€Å"why questions. † Finally, predictive theories discuss what behavior will be. We also distinguish between two types of normative theory, both concerned with what behavior should be. Speculative statements are nonoperational usually consisting of a goal or criterion (e. g. , maximize utility or profit) with no precise instructions on how one might accomplish the goal or apply the criterion. Prescriptions are operational in that they give both a goal (or criterion) and feasible procedures (an algorithm) for accomplishing it. From this quotation it can be clearly seen what theory distinctions in game theory context are made. The essay author will adopt this view and within normative theories take into consideration both speculative and prescriptive types of theories, within descriptive theories include both descriptive and explanatory types and within prescriptive theories look at predictive and prescriptive (for real life situations) types. After clarifying the different types of theories in connection with game theory, the short description of game theory and development of modern game theory will be given. In the Oxford English dictionary the definition of game theory is as follows the branch of mathematics concerned with the analysis of strategies for dealing with competitive situations where the outcome of a participant’s choice of action depends critically on the actions of other participants. Game theory has been applied to contexts in war, business, and biology. From the definition we see the important factors are the mathematical analysis, different strategic options with different outcomes (pay-offs) and the interdependence of the players. Therefore it indeed looks like the so desired theory described in the introduction of the essay, however, what does it actually deliver, that is the main focus of this essay. Modern game theory has been developing now for more than 50 years since the book Theory of Games and Economic Behavior by John von Neumann and Oskar Morgenstern was published in 1944. However, it must be noted that some important efforts in explaining the strategic choices – strategic decision making has been done also before, for example by Zermelo. Konong, Kalmar and Borel. Game theory has evolved considerably since the publication of von Neuman and Morgenstern’s book and what is interesting the theory has developed far beyond its initial mathematical boundaries. This is due in a large part to contributions in the 1950s from John Nash (1950, 1951). However, it was in the 1970s that game theory as a way of analysing strategic situations began to be applied in all sorts of diverse areas including economics, politics, international relations, business and biology (Chermichael, 2005). By having established the understanding about the subject of the essay, the arguments can now be presented. The author believes that the game theory at the stage of evolution it is now in is a descriptive and prescriptive theory concerning strategic decision making, however with some limitations. Argument 1: Strategic decision making implies / do not imply rational thinking The first contra argument discussed will be about the assumption of game theory that the players are rational. It can be argued that this indeed does not reflect real life as people often make irrational choices and therefore game theory is not describing the real world nor giving prescriptions on how to act in real situations but is indeed a normative theory. What needs to be emphasized here is that the essay author argues that game theory is a prescriptive theory when dealing with strategic decision making. Strategic decision making involves long term commitments from an organization and therefore it will be carefully analyzed and discussed before the final decision, in order to be sure that the chosen course of action will deliver the highest possible results. Following this thought it can be concluded that the players will act rationally, as they are aware of the huge impact of the decision and have certain decision making skills (which can be assumed as they are high in the organizational hierarchy that they are the ones making strategic decisions). Argument 2: Game theory does / does not describe predict the real world situations Strong critique regarding the interpretation of game theory is expressed by Rubinstein (1991): There exists a widespread myth in game theory, that it is possible to achieve a miraculous prediction regarding the outcome of interaction among human beings using only data on the order of events, combined with a description of the players’ preferences over the feasible outcomes of the situation. [.. ]The mystical and vague word â€Å"rationality† is used to fuel our hopes of achieving this goal. I fail to see any possibility of this being accomplished. Overall, game theory accomplishes only two tasks: It builds models based on intuition and uses deductive arguments based on mathematical knowledge. As we see from this quotation, Rubinstein is critical regarding the game theory having any descriptive or prescriptive characteristics. However, he states that what is missing for it to be a descriptive (and following that prescriptive theory), is the data describing the process of reasoning adopted by the players when they analyze a game. Since this article more than 10 both scientific and empirical articles have been written directly dealing with the problems mentioned in this article therefore the interpretation has evolved as well as the game theory itself. Moreover, game theory has been used throughout the years by companies and has been proven to be a useful tool for strategists. Camerer in his article â€Å"Does strategy research need game theory? (1991) comes to a conclusion that a common criticism that game-theoretic models assume too much rationality is often wrong because first, some games require little rationality to compute equilibria; and second, players may reach an equilibrium by communicating, adapting or evolving to it rather than by calculating it. Indeed, the author agrees that the interpretation of the games needs careful attention, however, the theory can be used as a descriptive theory for strategic decisions and by studying it strategists can come to a better decisions therefore evolving in a prescriptive theory. Another extra point enhancing the previously stated is the evolution of game theory now including cooperation, asymmetric information and other factors which are present in real life situations. Hutton (1996) describes game theory as an intellectual framework for examining what various parties to a decision should do given their possession of inadequate information and different objectives. Here we see that in later works game theory is seen as a more sophisticated theory dealing with various situations not only basic theoretic models. The paper of Kadane and Larkey from 1983 states two suggestions in order to clear the â€Å"is and ought† confusion. First, a Bayesian perspective should be adopted, second, more attention should be given to the model validation. The Bayesian view of games clarifies the proper, respective roles of prescriptive and predictive theory. Taking the Bayesian norm as prescriptively compelling for my play leads me to want the best description I can find of my partner/opponent’s play. Thus both prescription and description have important roles to play in the Bayesian view of games. Therefore, we see that through Bayesian approach the descriptive and prescriptive characteristics of game theory are enhanced. From authors research for relevant literature concerning the question what type of theory is game theory, it can be seen that most papers concerning these questions are around 1980`s and the beginning of 1990`s. Later papers on game theory, however, are more concerned of empirical applications of game theory as well as in depth analysis of the theory. The empirical work in such fields as auctions, M&A, price strategy, marketing strategy etc. as been applying successfully the principles of game theory, therefore strengthening the statement that Game theory is indeed now a descriptive and prescriptive type of theory. Argument 3: Game theorist work has been internationally recognized as applicable to real life and practically useful to make better strategies and strategic decisions Another strong argument supporting the statement of the author is the work of rec ent Nobel Prize winners in economics, in 2007 and in 2012 the winners are game theorists Leonid Hurwicz, Eric Maskin, Roger Myerson and Lloyd Shapley, Alvin Roth respectively. (Nobel Prizes in economics also was awarded to game theorists in 1994, 1995 and 2005). Leonid Hurwicz, Eric Maskin and Roger Myerson won the 2007 Nobel Prize for their work in mechanism design theory, a branch of game theory that extends the application of game theory to how different types of rules, or institutions, align individual incentives with overall social goals. Their work on allocation mechanisms has had a significant impact on the design of uctions, social welfare systems and many organizations. As the theory can be applied successfully to real fields of business and real organizations, it can be concluded that game theory must be a prescriptive and therefore also descriptive theory. Moreover, the Nobel Prize in 2012 to Shapley and Lloyd was awarded for the theory of stable allocations and the practice of market design – the creation of the link from theory to practice. BBC article (15. 10. 012) regarding the winners of 2012 Nobel Prize in economics by Stephanie Flanders, the BBC Economics Editor, states The work of Lloyd Shapley and Alvin Roth reminds us that economics can be both deeply mathematical and abstract, and deeply practical – not to say hugely useful to public and private organizations all over the world. [.. ] In the past 50 years, game theorists – and micro-economics in general – have genuinely made the world a better place. Either they have helped to solve practical real-world problems or, where there is no solution, they have helped us to understand the issues more clearly. So once again we see that game theory when applied correctly can help to solve real life problems and therefore is a prescriptive and descriptive theory. Working on the essay the author read through many articles on game theory including the classic papers of Nash (1950,1951) where the theory is explained in detail but applications explained are indeed rather simple and not that applicable to complex real world situations, however, very useful for simple situations. Looking at the research papers written in late 1990`s and 2000`s, the empirical applications can be seen more clear and grounded in real life. The critique on game theory expressed by researchers in early 1990`s have been taken into consideration therefore helping the game theory to evolve ad become descriptive and prescriptive theory that can be applied to many fields. Moreover, practitioners are indeed using game theory, for example highly successful consultancy company McKinsey is using game theory to help managers make better decisions and foresee the different possible risks of different courses of action (Hagen Lindstadt and Jurgen Muller, 2009). The author believes that the game theory has evolved from being more a normative theory to normative prescriptive theory, then by applying these rules to real world descriptive theory has been developed, and now in hand of a masterful strategist game theory is indeed a predictive and prescriptive theory helping to make better strategic decisions.