Beginner's Guide to Game Theory | Learn Game Theory

So I can nearly guarantee that game theory is something, a science really, that as an individual, as a player in the game of your life, as a leader, as someone in business or your work, as someone in school, that you haven't properly considered and really integrated the concepts of into your life. And at least in my own life, I can say that game theory as a frame of mind, as a way of approaching challenges, of improving myself, of improving work, and so on, really is just fundamental to that and is extremely valuable across all of those domains. So in this video, this will not be an analytical deep dive into game theory. This will not have math or anything of that sort. This is really a practical approach to game theory. Also, this video is sponsored by Odoo, the all-in-one business software company. And you can stay to the end to learn more about that. And now back to the video. And I think the view, the perspective on game theory that will most benefit you, again, as an individual, but also in your business, in your relationships across really every domain of your life, in which approaching it with strategy and approaching it with rational thought is better than the alternative, which is just thinking emotionally, acting on impulse, not thinking through decisions, and so on. And that's the point I want to start off with, which is that game theory is not practical at all. As in, you've probably heard of the prisoner's dilemma. You may not have heard past or much of game theory beyond that. Game theory is really the art of decision-making and the art of strategy, of it in a very mathematical and very scientific manner. And once you get into the math of it, there are not many overlays into reality at the individual level. Right? I could give you a thousand examples of games where players make X amount of decisions. And sure, that's the rational decision. That's the rational outcome. But that doesn't impact how you should act as an individual. That doesn't impact the decisions you should be making or how you should be even approaching decision-making. But what's really interesting about game theory is that the number one degree held by billionaires isn't computer science. It's economics. Right? And that understanding how monetary systems work is really just valuable in approaching the game of money, really, and the game of wealth and work and output and so on. And in a similar sense, game theory is economics, except strip it of the money. And now you have decisions. You have individuals. And game theory really is central to economics in that sense, because it asks the question of, okay, you are in a game. You are in a market. Right? There are different players. There are different things you can do. There are payoffs. What decision should you make? Economics is the monetary branch of that, in a sense. But game theory strips that down to its core of, okay, well, I need to make a decision. What kind of decisions should I make? And then what kind of decisions are other people going to make? Right? That is the concept of kind of an equilibrium. I have not formally studied game theory. I'm not an expert in this. I have studied it to some extent at Stanford University, at Boston University, in the College of Marin. But again, this is not an analytical foray into game theory. You should not watch it if that's what you're going for. Instead, I just want to give you the most, well, the basics of game theory in a sense, as in different aspects of the economics of information, game theory, and so on, but more so what's actually going to impact you once you finish watching this video. And going back to what I said about game theory impacting me, it really is the frame through which I approach things. And that's because game theory inherently is a formulaic manner of approaching decisions and situations. And then ultimately how you go about coming to a course of action or deciding a strategy based on what you think other players are going to do, based on your assessment of outcomes, and so on. The first concept, right, at its core is just that situations are games. A game is not a game in the video game or a board game sense. A game is a situation in which you have actors, or what we're going to call players, and then you have decisions that have to be made and you have outcomes associated with those decisions. So we have a game, we have players, and then I'm going to call the decisions decision nodes. A node is just a point at which multiple decisions can be made, and then we have payoffs. So for example, let's consider we have a game, we have player one making a decision, so that's just, let's say, U. They can pick between A and B. And then we have player two at this decision node, right here, who can make a second decision and choose between C and D at either of these nodes. And then there's sort of payoffs associated with the ultimate outcomes here, right? So let's say player one gets a payoff of one here, one there, and I'm just writing numbers. Here we have four payoffs, right? So player one chooses A, and player two chooses D, you arrive at a payoff of zero and one here. Player one chooses B, and player two selects C, you get a payoff of two and one. There's a lot of concepts here I want to break down. The first is just the overall frame with which we're approaching this with, right? This could be a decision in real life. This could be a decision in which, say, you and a business partner have to either collaborate or you're working independently on projects, and you get certain payoffs depending on the course of actions, and depending on whether you work together and you're happy about it, you're forced to work together, or you choose to work independently, and how you go about that. So the first concept is that the people you're around when it comes to a decision you have to make are players, and you can expect certain things of people, right? There's this concept of rationality, which is that people are going to do what maximizes their own payoffs or their utility functions, essentially. Not all players are rational, and that's one kind of practical problem of game theory, and that people don't always do what is mathematically best for them. But everyone else will act in a certain way, and you have assumptions, right? You put probability distributions on what you think other players are going to do. Then we have decision notes, right? Decision notes just breaks down very complex decision processes, as in, okay, I want to start a business. How should I do it? Into just very specific decisions, as in, okay, I can make a decision here. I have different courses of action. I can do, say, I can start this type of business. I can start this type of business. I can start this type of business, right? A, B, C. And then there's also decisions that other people can make that then impact you as a player in a certain game. And then you have payoffs. Payoffs are what you assume the outcome will be. And this is, again, slightly different in an academic context, but for the case of this video, what you assume payoffs are going to be. Or for everyone involved, who gets what based on what they want, based on the decisions that were chosen. Okay, so let's assume that the, this is a new pen, A and C are chosen, right? So player one chooses A, and then player two chooses C. If that happens, if these decisions are made, then player one gets a payoff of one, and player two gets a payoff of zero. Now, payoffs are utility functions, right? Utility, in a sense, is the net result that someone gets from an ultimate outcome, right? A state of a world. So again, in the case of starting a business, if your business does well, you might get all things summed as in, okay, I make a million dollars, but I spend two years doing it. I spend less time with my family. If you, in a theoretical sense, combine all of that, let's say you get a payoff, a utility payoff of 40, right? And then if you don't start the business, you get more time with family, you make $50,000 a year at your job, and let's say you really enjoy your job, and you don't have to work that hard, and you don't want to work hard, maybe then your payoff is, your utility payoff is 45. In that case, you wouldn't want to start your business. So utility functions, in a sense, are the net result or the outcome in the state of world that is produced by a series of actions. So in that sense, any decision that you have to make, any process at its core can be broken down into the components of, there are actors, there are people who make decisions that are going to affect the decision or the result of these decisions. They're going to affect the game or bring about different outcomes in a sense. There are different decisions that can be made. So each player can make a certain set of decisions, and then there are certain payoffs associated with those decisions. Now, there's a lot more that goes into here as well, right? For example, this assumes almost perfect information. This assumes that you know what the other player's payoffs are. This assumes you know the structure of the game, and that's a lot of assumptions. Whereas if you take that into reality, you get this very messy situation where not everyone knows everything about the game, about the other players, about their own payoffs even. And so in that sense, some players may have more information than others. That's going to affect the game and so on. But at its core, what we can see already right here is a very structured way of thinking about decision-making and about strategy. And that's what I kind of want to emphasize off the bat here about how you go about decision-making. If you just break decision-making down into its components, right? If you break any difficult problem down into its components, you're going to be so much better off versus what nearly everyone does across the majority of decisions, which is not approach them with data. It's not approach them by thinking through them. But it's just, okay, I feel this way. I think this is the best. I recall this or so on. And then going about it and committing to an entire course of action because of that. So game theory is not perfect. It is not practical. But as a frame of mind, as, okay, I'm approaching a difficult decision. What should I do? It's very useful in that sense. What it does off the bat too in a emotional sense is it forces you to take a step back, right? As in, let's say you get into a difficult situation at school, right? And it comes down to someone thinks you cheated, or someone is pinning their cheating on you. Your friend won't like you if you go to the professor. Your professor will think you cheated and give you a bad grade if you rat on your friend. In that sense, that's a very difficult decision to make. Emotionally, you're going to think one thing. But if you break that down into its components, you get a much more structured view, right? So in that sense, you have you, let's say you're player one. You might have player two being your friend. And then you have player three who might be the professor, right? So you've broken down this problem into three players. And then you have a certain number of decisions, right? Let's call this D1 and D2. And let's say D1 is, okay, go to the professor. I tell them what really happened. D2 is I take the hit to my grade. And then we have payoffs associated with those actions, right? So we have P. And this P, let's say, gives you a negative payoff of 14. And this negative 12, because whatever happens, you're going to be in a bad situation. But then there's also player two is your friend. And in one case, if you do screw them over, let's say player two is going to get a payoff of negative 30, because they're going to get, you know, they're going to have to drop the class. In case two, they get a payoff of four, because they cheated and got a better grade. And then the professor is kind of indifferent. The professor doesn't really care. We've now broken a difficult decision, a difficult problem into three players, two decisions that you can make. And based on just what you think about the decision, the payoffs associated with them. Of course, in a mathematical sense, you're not going to know these numbers. But simply the process of let me step back, let me analyze this situation. Here's what I can do. Here's what other people can do. And here's how that affects me. That's an incredibly useful process beyond school when you step into business. When you step into, hey, I'm running a business. I can allocate resources here. I can allocate resources there. There's a whole lot of things I can do with certain partners, with people, with my effort and my time and that of employees. Whereas thinking of things in a strategic and inherently strategic sense will be any other way of just going about those decisions. Now, it turns out that this is exactly how banks, insurance companies, all those types of big organizations in large part go about viewing the world and making financial decisions because of it. For example, let's say we have asset one, which produces, let's say, a yield of one. Let's not go one and zero. Let's go three, two. And then we have asset two that produces two, three. And then we have two states of world. So we have state one, state two. So let's say, for example, that state one is a stock doing well or a company doing well. State two is a company not doing well. So let's say that's the earnings call. Asset one, if we buy them, if the company does well, will produce a monetary yield of three. If it doesn't do well, or if the company doesn't do well, so in state two, it'll produce a monetary yield of two. And then vice versa for asset two, that'll produce two instead of world one, three instead of world two. And then we have certain costs associated with these assets, right? So this may cost $1.50 to buy. This may cost $1.60 to buy. What banks do, what insurance companies will do is break down the world, and I shouldn't say banks, but investment firms will break down the world into certain assets, certain states of world and make decisions because of that. Insurance companies too, for example, right? There's a whole branch of kind of information economics, game theory relating to moral hazard, which is the idea that players in the game are going to respond differently in an insurance sense based on their own characteristics. For example, I'm more likely to buy health insurance if I'm going to die from cancer in two years because I smoke a pack a day. So considering that's how some of the biggest companies in the world, in a mathematical sense, analyze and make decisions that affect trillions of dollars, considering how that's what CEOs do, how that's what presidents do, and their analysts, right, to come to decisions, that really is something that if you take it into your own life will be just as valuable. Now, everything we've touched on thus far is you as a player. What that means is the game is a constant, right? So you have certain decisions that can be made, you have certain payoffs that you think will come of your actions or decisions or that of other players, but you cannot fundamentally change the game. Now, that's the thing about life. That's the beautiful thing about life. It's the beautiful thing about running your own business, right, about being in your own relationship with someone or whatever it may be in whatever context, and that is you can change the game. You can affect the game. Now, game theory is just one side of the coin. Game theory is where you're studying decision-making. You're studying strategy given games as constants. Now, mechanism design, and here I'll write that down, is the other side of the coin, and that is taking behavior as a constant, taking rationality as a constant, and then designing games to get certain outcomes. So an example there would be, you know, let's say we're a company and we know that our customers want to make money and don't want to put effort into making money, right? That's kind of like the scales there. You could ask the question, how do we design a rewards or incentive program that maximizes the amount of customers that are going to use it? In that sense, behavior is a constant. The pool of potential customers, let's say, is a constant. It's just a question of how do we design the game itself? How do we design the decisions that can be made? How can we set the payoffs and so on? So the beautiful thing about that is that if you apply mechanism design to your life, if you become the game maker, then you can, in an academic sense, on paper, you can design your life to get a certain outcome. Given that, for example, you know that, let's say you want to be healthy, you want to spend time with your family, you want to travel, and you want to make good money doing things you enjoy, whether that's a billion dollars or 100,000 a year, whatever it may be. You now know the payoffs. You know what you want. You know what you don't want. Not in a literal sense, but you have some ordinal ranking there, in a sense. Well, now, how can you design your life to bring about those outcomes? And that's what every business guru is telling you to do, in one sense or another. They're telling you to do a wake-up, a morning routine. They're telling you to do X, Y, and Z in your business to use these SOPs or whatever it may be. Those are all fundamentally structures that affect the game that is your life to theoretically change the outcome. As in, they should, if they work, will change the outcome of the game. One useful thought there, as well, is that if we think of decisions as... If we think of ourselves, decision-making-wise, as constants, that makes designing a game a lot easier. For example, it's very hard to go against your natural will. So let's say we want to wake up. Let's say we want to put four hours of extra work in a day. There's a few things we could do there. One of which is, okay, I want to work more. I'm going to force myself to do it through pure force of will. I'm just going to find time, and I'm going to get it done. If you do something like that, you're not going against you as a player. You're doing something that will bring you pain, bring you suffering, that you haven't structurally altered things to do, you're probably going to fail. Same thing with New Year's resolutions and people who go to the gym, right? They say they're going to go to the gym. They just say, okay, I'm going to do it. I bought my membership. And then they don't structurally change anything to bring about the outcome that they want. And so they will fail. Now, if you assume that you are lazy, that you will default to your system, to the game, to the decisions that are presented to you, to what will bring you less suffering, then it's just about designing the game. Then it's just about, okay, how can I change things so that I, as a player, will make the best decision available to me, and that best decision will bring about the best outcome or the outcome that I want. An example there is, let's say, going back to work. If you go to an apartment in a new city, let's say you move cities, you call your family once a week, you don't see them in person anymore. You don't really have any friends. You're just in this apartment, right? And you have your computer. You have good Wi-Fi. You don't have much else. What are you gonna end up doing? You're gonna end up putting 10 hours, 12 hours a day into work. And over time, that will probably change how you view things. That will probably change what brings you purpose and joy in your life. Because now the game becomes, okay, I'm in this apartment. There's really nothing else going on. All I have is my computer, and I have progress to make on whatever I'm trying to work on. Let's say you wanna write a book because you need to write 100,000 words. As opposed to just forcing yourself to write 100,000 words, you've done that. You've structurally changed the game. You've put yourself in a new place. You've removed a lot of the other decisions that you could have made. For example, going out today with friends or just, let's say, you used to live in a nice house, right? Let's say I could go and I could watch a movie on the couch. Now you live in a one-bedroom. You can't do that. You have no friends. You can't go out. All you can do is, say, write your book. But over time, writing the book then becomes enjoyable because your brain has nothing else to focus on. All you can do is continue to improve at writing the book and researching and so on. Now what's gonna happen there is you will ultimately write the book. You will write it much faster. You will write a better book than you would otherwise. That doesn't say that doesn't come without costs, right? You saw your friends less. You didn't do anything you would prior have considered as fun. But you did get the book done. So that's an example of I'm drastically changing the structure of the game to bring about an outcome that I want with that being writing the book. In a pragmatic sense, maybe that's not what you want. But all of this is just based on what you want. If you really want to spend time with your family, if you wanna go out all the time, if you wanna party, well, change the game to bring about that outcome. Structurally change your life, change the decisions you can make. And ultimately that will put you in such a better just frame of mind and also just ultimately better outcome versus the inverse, which is, okay, I'm gonna try this. I'm gonna try this. You're not really thinking about how you actually try things, how you approach trying things and so on. So once again, whether you view yourself as a player in the game when it comes to approaching difficult decisions or when it's you actually making the game with the game being your life, overall, the frame of mind that is presented by game theory and by mechanism design will really help you in that sense. And so I urge you to research those things on your own time. Again, I don't think the academic side of those things are valuable to you or will be valuable to you by any means beyond just intellectual interest. But in terms of the general concepts, so again, the value of information and rationality and payoffs and decision nodes and players and indifference and things of that sort, just approaching things with that frame of mind, stepping back, thinking through decisions. That is such a better frame of mind. That is such a better way to approach decisions and challenges versus the polar and unfortunately, the more common means of going about those things. Now, before we go any further, I do want to mention a company called Odoo. They are my partner for this video. They are a suite of business tools, a hub for business in a sense. And I polled you guys on YouTube, I guess in my audience, and about 60% of you said you wanted to start a product or a business. If you do that, Odoo is really the best place to do so. I will release a video in a few days. It may have already come out about a business I'm starting that I'm completely running through Odoo. They've everything from a CRM and sales tools to product and inventory, to accounting and compliance, and really just this whole range of business apps that once they, as they do come together on the platform, it'll seriously help you with synergies, efficiencies, just eliminating the headache of running 15 different apps for your one business. And then ultimately make things easier and cheaper and better for you. So whether you're already running a business, I highly suggest starting with Odoo, or you're looking to start one as well. They will help you do that. It's also free for one app. You can click a link in the description. You can go just play around with their at least one app for free. And then you can also pay a small fee for access to all of their apps. So again, I'll break down how exactly I use them in a future video with a business of mine. But other than that, that does wrap up the video. So thanks to Odoo. And then also thank you to you for watching this video. And I do hope that you walk away with at least some intellectual interest in game theory. And also just that, that really fundamental thought here, which is, okay, if I strategically analyze my life and the situations presented to me, I will be that much better off in terms of how I go about them. And then the outcomes that I arrive at.