A fundamental problem is *over-usage*. Usually, nobody wants over-usage to occur. However, on an individual level companies want to maximise their profit while they neglect the *social cost*. The problem is also known as the *Tragedy of the commons* which is based on the *free-rider dilemma*.

A *game* is defined by three components: players, actions, and payoffs. Solutions concepts are usually in the form of a Nash equilibrium.

“Unless the number of individuals (micro) in a group is quite small, or unless there is coercion or some other special device to make individuals act in their common interest,

rational, self-interested individuals will not act to achieve their common or group interest.” – Mancur Olson(1965)

Players are a discrete set or continuum population of individuals.

Actions are a compact and bound set, to fulfil Nash’s proof, but some variant are possible to get a fixed point result.

Payoffs are most often a set of the real space.

Let be a game with players. Each has a strategy set where is the set of all possible strategy profiles.

Let be a strategy action for and be a strategy profile for all players except . When each chooses strategy resulting in then obtains profit .

A strategy profile is a Nash Equilibrium if no unilateral deviation in strategy by any single player is profitable for that player, that is, and .

**Prisoner’s Dilemma**

In the prisoner’s dilemma each of the two players has two action, either to *cooperate* (C)or to *defect*(D). The payoffs are defined as CC=(3,3), CD=(1,4), DC(4,1), and DD(2,2). If player start of with CC, any one player can gain an advantage by defecting. Once defected the other player has no choice but to defect as well to optimize his payoff. The Nash Equilibrium of DD is reached where neither player could optimize his payoff by switching strategy on his own. However, if both were to switch at once, they could get a better result. Since no trust between players exist this outcome is not possible without breaking the rationality assumption.

**Public Goods Game**

The N-person generalisation of the Prisoner’s dilemma. The players are a finite population of individuals. Each is endowed with a budget , common to all players. The action consists of each player choose some amount to invest in a shared investment account. The collected investments are . The payoff is . For the optimal decision (i.e. the Nash Equilibrium) is not to invest which results in a payoff of *zero* . Even though there would be a positive outcome if everybody invests, free-riding would allow some to make more gains. A *rational* individual would therefore not invest.

Side note:

The lecture on game theory in QPAM is covering the same topic and is therefore not covered in detail.

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