What is game theory?

Game theory is a subfield of economics that models how economic agents interact with each other, and how they make their decisions.

A game is basically a complex interaction structure that eventually leads to certain outcomes; for example, for a person, winning or losing a game of chess. Or, for a company, successfully entering a new market, or going bankrupt.

An economic agent typically has preferences between outcomes. For example, a player prefers to win at chess rather than to lose. A company prefers to be profitable than to go bankrupt.

A rational agent normally can sort outcomes in ascending (or descending order) or their preference. An agent should not have any "cyclic" preference; if they do, this is not considered rational. For example, an agent would prefers biking over walking, and who prefers riding a bus over biking, and who prefers walking over riding a bus, would not be considered rational.

It is very common to model the order in which agents rank their outcomes with monetary amounts (e.g., 1$ for outcome A, 2$ for outcome B) called payoffs. Another name for it is "utility", and it is commonly heard that an economic agent "maximizes their utility".

So, the goal of the game, for every agent, is to reach the highest possible payoff for themselves.

What about the rules of the game, which explain under which condition this or that outcome is reached depending on the agents' decisions? This is described by the structure of the game. In mainstream game theory, there are two main kinds of structures, which are the normal form (also called strategic game) and the extensive form (also called dynamic game). In the next section, we give an introduction to these two kinds of structures.