Weeks 3 and 4

Cover via Amazon

WEEK 3

During week 3, I attempted to isolate a topic that I could apply using game theory and I continued to build my knowledge of game theory itself. Admittedly, finding a topic that is both interesting and not previously covered by someone else proved to be quite challenging, therefore, I focused most of my time trying to understand what game theory is. To accomplish that goal, I purchased two texts (that I will discuss in a later post) that Professor Wheaton recommended to me in class. The first, Prisoner’s Dilemma by William Poundstone, is an introductory work designed to give students a general understanding of game theory by discussing its origins and its use in social sciences, mainly international relations (specifically foreign policy following the advent of the atomic bomb); I read one-third of the book thus far. The second text is The Predictioneer’s Game by Bruce Bueno de Mesquita; I did not begin reading this book until about a week later. But, from thumbing through the pages of each book at the store, I realized that they would be more useful in helping me to understand game theory than they would be in helping me find a topic to apply it to.

In addition, I collected information related to Bueno de Mesquita’s work using game theory because of his status as the world’s leading game theorist. Thus far, I read his work pertaining to Iran’s nuclear program, the Copenhagen climate summit, and several papers dealing with domestic politics and political economy. Unfortunately, as is to be expected when reading scholarly articles, much of his work assumes the reader already has an extensive background in game theory, which, of course I didn't. Thus, I decided to change course; that is, I adopted a "bottom-up" strategy of learning the basics of game theory and gradually increasing the complexity of the works I would read.

WEEK 4

I continued reading William Poundstone’s book “Prisoner’s Dilemma.” Most of what I read dealt with the Soviet development of the atomic bomb and the reaction across the American political spectrum. There was much talk about conducting a preventive war before the Soviets could develop an atomic capability that could adequately serve as a deterrent. Even though the Soviets possessed the bomb by 1949, some U.S. policymakers thought it was possible to launch a preventive war that would cripple the Soviets’ ability to respond, and thereby help create a world government of sorts. This history of nuclear weapons served as a good example of real-world situation where one could apply game theory. But, more importantly for the study of game theory, Poundstone detailed the Ohio State Studies on game theory commissioned by the U.S. Air Force in the late 1950s and early 1960s. From these studies, although I believed this to be true anyway, I learned that humans psychologically feel greater satisfaction in knowing they “beat” their adversaries even if cooperating with them would have led to a higher payoff for both players. In fact, in one experiment, only two out of twenty-two pairs of players consistently cooperated with one another to increase their mutual payoffs. In addition to further reading, I attempted to create a model of the U.S. political system using financial reform legislation as the application topic.

I also began reading The Predictioneer's Game during week 4. If you've read Freakonomics by Dubner and Levitt, this book is the game theory version of it, meaning it tries to make game theory accessible to the masses. Bueno de Mesquita (BDM) opens the book by talking about how to purchase a car. He uses this example to sum up game theory's main argument: "that people do what they believe is their best interest." Here's how the example goes: most people buy cars in one of two ways. Most people go to a dealership, test drive a car and probably negotiate a price. This can be an annoying process because who likes to argue over money? The other way some people buy cars is that they research the car they want to buy and get a few quotes from a group of dealers and pick the best one. BDM says this is better, but not by much. But, back to the first way people buy cars, going to the dealership. BDM argues that by simply going to the dealer, the buyer is sending a "costly signal." That is, the fact that you went to the dealer signals that you want to buy a car because otherwise it was a waste of time and energy to go there. Thus, the dealer has the advantage because he possesses information about you, but not vice versa, so you probably do not end up receiving a good deal. He goes on to list other things buyers often do that puts them at a disadvantage, but I'd be rewriting the chapter if I listed it here. Anyway, here's how BDM suggests one should buy a car. Obviously, we all want to get the best deal possible in any purchasing situation, but how does one gain the advantage? Control the agenda in a negotiation; in this case, that means forcing the seller to put his best price knowing that the buyer won't accept right now no matter how good it is. First, determine exactly what you want in a car. It does not matter what the buyer wants (performance over safety, luxury interior, etc.). Then, locate every dealer within a fixed radius from the buyer's home that has the particular vehicle in stock (this can probably be done online). Call every dealer that has the car and tell them you plan to buy a car today (unlikely for most people, but it is in his example) and that the dealer who offers the lowest out-the-door price gets the sale because a check for that amount will be written and the buyer won't have another check with him. Make sure to tell each dealer that you plan to quote the lowest price to the next dealer and so on. By doing this, the dealer knows what price he needs to beat if he wants you to buy from his establishment. If the dealer tries to haggle with you, it's to his own detriment because you can move on to the next dealer. BDM argues that you can never get this advantage by physically going to the dealer because they already know you're interested in a car and probably need to buy one as soon as possible. Furthermore, if the dealer says you cannot purchase a car on the phone, the buyer simply replies that he cannot purchase a car from THAT dealership over the phone and then moves on to the next dealer. The dealer might even try to guilt the buyer by saying that the next dealer will only drop the price as little as $50 and that the buyer should just purchase the car from him right now. Another easy response according to BDM, "fine, then I'll the buy the car for $50 less at the other dealership, but if you quote that price now, I'll buy the car from you" (that's my paraphrasing of BDM's actual line). A desperate dealer will even go so far as to insult your intelligence by trying to assure you that they have the "best prices in town" rather than quote you a price on the phone. If the conversation continues, though, the dealer will run out of sales gimmicks and will be forced to quote his absolute lowest price.

That's how to buy a car according to Bruce Bueno de Mesquita. It seems like a good idea, but I'm willing to bet that he has the financial resources to buy a car with a check. But, when I can afford to buy a new car I am definitely going to try his method with a twist. That is, I'll say exactly the same things he does, except I'll only write a check for a down payment and I'll get financing through a bank, not the dealer's financing department. When that day comes, I'll be sure to write a post about my experience.

Related articles by Zemanta

• Bruce Bueno de Mesquita Uses Games To See the Future (science.slashdot.org)

The Predictioneer's Game and Prisoner's Dilemma (the book)

This post is dedicated to reviewing my two main sources of information for my study of game theory: Prisoner's Dilemma by William Poundstone and The Predictioneer's Game by Bruce Bueno de Mesquita (BDM).

PRISONER'S DILEMMA

Let me begin by saying that if you're even slightly interested in learning about game theory, you need to begin by reading this book. Game theory is not a subject that one can just delve into without any prior knowledge because it is quite mathematically complex. I learned this lesson the difficult way; when I first started studying game theory, I used the Internet just like almost of us would do. Unfortunately, most of the information online falls under two extremes: either it was too basic for someone to reach a novice level of understanding or it was so complex that it already assumed you know a significant amount of game theory beforehand.

Prisoner's Dilemma is great for beginners because it isn't just another mathematical book about game theory. Sure, some math is involved, it has to be to illustrate the concepts. But at least the examples are all user-friendly. Also, it serves as an excellent biography of John von Neumann and as a brief history of nuclear weapons and the Cold War. In fact, most of the applications that Poundstone uses come from the Cold War. For a book that is discussing one of the most complex theories in mathematics, Prisoner's Dilemma is surprisingly easy to read and, dare I say, a page-turner!

In addition to what you'd expect a work of this caliber to be, Prisoner's Dilemma also boosted my confidence that I could understand what game theory was, even if it was at just an introductory level. When I first started this process, I really underestimated the complexity of game theory and I experienced serious doubts about whether I could handle the subject. But when Professor Wheaton recommended it to me in class, and I started reading it, I was able to refocus my goal. I'm pretty ambitious and I thought I could teach myself the mathematical intricacies of game theory. When I (quickly) realized that that wasn't realistic, Prisoner's Dilemma allowed me to recognize that most people probably didn't know much about game theory besides that it existed and maybe what a zero-sum game or the prisoner's dilemma was. I can say with absolute certainty, that without this book, none of what you're reading on this blog would've been possible for me write about. Prisoner's Dilemma discusses most of the main concepts of game theory in a way that makes the reader want to increase his or her knowledge to the point where he or she can understand complex proofs, at least in my opinion. Bottom line: if you want to learn about game theory, you MUST to read this book.

THE PREDICTIONEER'S GAME

Bruce Bueno de Mesquita is one of the world's leading game theorist, if not THE leading game theorist today. Although he's written several texts, this one is aimed at the average person who probably has not had extensive exposure to game theory. I like to compare it Freakonomics, but it's not quite as good. Unlike Prisoner's Dilemma, BDM's book is more about the application of game theory to real-world situations rather than an introduction to the theory itself and the use of historical examples to illustrate the theory. In addition, he acts like a salesman on behalf of game theory. That is, he argues that game theory can be used not only to forecast the future, but if used properly, to actually shape future events. In fact, I developed the model for my personal application using BDM's recommendations. Unfortunately, his constant reference to his model never leads to him revealing what that model is, therefore, without his algorithms it would be nearly impossible for a game theory novice like myself to recreate it.

Although the book is quite an interesting read, and accessible to average reader, BDM's ego shines brightly. He never misses a chance to congratulate himself on his successful predictions as is clearly evident with is discussion of the Israeli-Palestinian conflict (he predicted the 1993 accord in 1991). Moreover, even though he devotes an entire chapter to his failure to predict the outcome of the 1994 health care debate, he blames the fact that he did not have the most accurate information. He even claims he would have been right if Illinois Rep. Dan Rostenkowski was never indicted on federal corruption charges! I'm not sure how he can say that since that's not what happened. That's one of the biggest criticisms of game theory, by the way; the notion that if the expected outcome never comes to fruition, the flaw occurred in how the model was used, not that the model itself is flawed (although I'll give BDM credit for admitting he needed to change his model to account for unpredictable events).

Up until now, I've been pretty harsh of my critique of The Predictioneer's Game, but in reality, for all the issues I had with it, the book did come in pretty handy. Like I said earlier, without BDM's recommendations, I would not have known where to begin building my model (see Week 5's post for the recommendations). In addition, even though I was not able to replicate his model, because I did not have access to his algorithm, by using his recommendations I did not need a complex equation to build it. And that is the main lesson I learned from reading this book: that in order to apply game theory, you do not necessarily need a complex algorithm to arrive at the rational solution. Of course, having those complex algorithms would allow an analyst to express more confidence in a forecast, but it's better than nothing. Although The Predictioneer's Game is not quite the necessity Prisoner's Dilemma is, I would recommend it to anyone who has an interest in game theory. It is an easy and interesting read and helps lessen the intimidation factor of game theory.