The economics behind human behaviour

TIFO about John Nash

Who was John Nash?

John Nash was an Economist from Princeton University. He revolutionized economics with his essay on game theory, written in his paper - "Equilibrium points in N-person games." This paper was written by him while he was still studying in university and the rule that he proposed was soon named Nash Equilibrium.

What is Nash Equilibrium?

Nash Equilibrium is a state in which two or more competitors cannot change their strategies to achieve a better outcome. Usually, the Nash Equilibrium will not be in alignment with the S.O.S (Socially Optimal Solution). One example of this is in the Prisoner Problem. Imagine that you are one of two criminals who have been caught for a petty crime. The police suspect that you two have committed a larger crime, but they have no proof. However, they put each of you in a room, and tell you...

If you both remain silent, each of you will receive one year in jail for your petty crime. If one of you remains silent and the other one confesses to the larger crime, the one who confesses will go free, whereas the one who remained silent will receive 3 years in jail. If both of you confess to the larger crime, each of you will receive 2 years in jail. 

From a Socially optimal perspective, both of you should remain silent, since remaining silent will give you a cumulative 2 years in jail, whereas confessing will give you a cumulative 3 or 4 years, depending on who confesses.

However, from an individual perspective, confessing is always the better choice. If the other criminal remains silent and you confess, you go free immediately. If the other criminal confesses, you have to confess since you will have to spend 3 years in jail if you don't. Therefore, the equilibrium point is that both of you will have to confess, even though that causes you to spend the most cumulative years in jail. 

Why is this useful in real life?

In a lot of businesses around the world, Nash Equilibrium is critical. It helps traders, businessmen and people in many such fields predict how a company might behave based on the response its competitor might have to its action. In the field of Stock Trading, a trader might use a company's actions to make a quick decision as to whether the actions will help the price of the shares of the company or hurt it. By using this, he can decide whether he wants to buy the shares or sell them so that he can make a profit.

What about you? What's your favourite TIFO moment? Tell me down in the comments below.