Game-theory garbage [updated]

Much of so-called microeconomics at major universities these days involves being examined in something called “Game Theory,” which [as Wikipedia succinctly explains] “attempts to mathematically capture behaviour in strategic situations, in which an individual's success in making choices depends on the choices of others."

Unfortunately for its enthusiasts, nobody in business actually uses the strategies explained by game theory—sorry all you folk with MBAs who’ve had to learn that stuff--and the actions of actual purposeful economic agents (i.e., entrepreneurs, who are really game changers) are barely if at all taken into account. (Game changers, by definition, being difficult to predict when writing these games’ rules.)

Also, as with the classic prisoner’s dilemma, the “strategising” will often ignore one very important question: as in this one, i.e., are the prisoners guilty? (Which, by the way, is a more fundamental point than it might appear.) And, of course, there’s nothing stopping real actors actually talking to each other either. And as far as playing the “game,” it turns out when tested even actual prisoner’s don’t conform to the theory of the prisoner’s dilemma.  And, with the recent discovery of a winning strategy for the allegedly unwinnable Dilemma, instead of abandoning their theory the “theorists” instead simply decided that winning isn’t everything.

Ah well. Just another bunch of time-wasting stuff economics students have to study for when they could be studying economics.

Teachers of this garbage argue that since economics is a “science of choice,” so therefore “all human choices are economic choices: whether one is choosing between guns or butter, or between this potential lover and that one.”* So they both insist on the garbage being taught instead of teaching economics, and they insist on this garbage then being used to advance economics into fields in which it has no right to be.

Because calling economics a “science of choice” simply allows them to blur the distinction between what is part of the science of economics, and what is properly part of other fields of study. And since modern mainstream economics can’t even get the most basic questions about its own science right – just witness the fumbling and folderol when asked about the causes of the financial crisis the economics profession helped so signally to cause—I would suggest it most urgently stick to its own knitting (or even learn about the fundamentals of how to knit properly) before choosing to comment on the crochet patterns of other professions.

Economist Jim Rose however argues that game theory tells us many things we don’t already know, and he links to a whole long list of them—from jumping cats to taking soccer penalty kicks -- many of them no doubt eminently useful in their own fields (especially if you’re a cat prone to lumping), closer examination of which reveals however that none of them involve anything about actual economics.

So rather than spending time on this garbage, students wanting to really learn about their actual subject would be better spent learning economics instead of this latest fashionable bolt-on. They might for example read about how prices are formed based on individuals’ differing values (which, if so-called “microeconomics” were to mean anything would surely begin here). In this vein for example they would be reading such books as Eugen Von Böhm-Bawerk’s masterful Basic Principles of Economic Value, a full grasp of which will give any student more micro muscle than any number of exams based on prisoners’ alleged and irrelevant dilemmas.

Bohm-Bawerk’s small book was a landmark of the theory of price formation.

Böhm-Bawerk considered the supply-and-demand formulation as all well and good, but he discovered that prices are determined more directly by something else.

They are determined almost directly by each individual’s differing valuations.

Böhm-Bawerk developed a theory of price formation that was based exclusively on the subjective [i..e, individual] valuations of buyers and sellers.  In Böhm-Bawerk’s theory, prices are determined within the limits set by the “the marginal pairs” of buyers and sellers.  

What is a “marginal pair”?

In any given market for a good, there will always be four people whose valuations put them in a special position. Böhm-Bawerk called these four people the "marginal pairs." It is these marginal pairs that directly determine prices.

Essentially, these “marginal pairs” are the folk who either just miss out in the market by valuing the purchase slightly too little, and those for whom the purchase price was only just worth less to them than the thing being purchased.

These pairs set the lower and upper limits respectively of the final price—that price being set in the end by the exchange of goods for money: the goods going to those who value the goods more than the agreed final price; the money to those who at that price value the money more than the goods; the range of that price being set by the market’s “marginal pairs.” (More here about “the mystery of the marginal pairs” about which too few of today’s economists even know.)

This, explained Mises years later, can be considered the essence of “the pricing process.” And in giving the upper and lower limits of the purchase price, that is all that economics can ever do. Even knowing the range of market participants valuations, all that can be deduced from them is the range of final prices that might eventuate. The range may be deduced from economic theory, and after that all is higgling – and economics must remain silent. Within that range, explained Bohm-Bawerk, there

is room for any amount of "higgling." According as in the conduct of the transaction the buyer or the seller shows the greater dexterity, cunning, obstinacy, power of persuasion, or such-like, will the price be forced either to its lower or to its upper limit.

And here then there may be room for game theory, to explain the process of higgling within the range of final prices that may be deduced from economic theory.  It may have some small use in that context. But that is only a very small room within a very vast field of price theory, about which today’s students are unfortunately taught far too little. And to confuse the small room for the field would surely be the height of strategic foolishness.