A paradigm example of game theory is the prisoner's dilemma: Albert and Bertrand are imprisoned separately. If you Talk and the other stays Silent your reward is high but if the other Talks too the punishment is severe.
| B Talks | B Silent | |
| A Talks | A: Beatings B: Beatings |
A: Free B: Dead |
| A Silent | A: Dead B: Free |
A: Free B: Free |
If Albert talks, he might be beaten or free, depending on what Bertrand will
decide to do, if Albert keeps silent, het might be dead or free, which is clearly
worse. He will talk.
If Bertrand talks, he might, just like Albert, be beaten or free, depending on
what Albert will decide to do, if Bertrand keeps silent, he, like Albert, might be dead
or free, which is clearly worse. He will talk.
Hence non-cooperation leads to the solution in the upper left yellow box, cooperation
leads to the lower right yelow box.
This simple example displays a very general logic inherent in a host of decisions to cooperate or not to cooperate. It is applied to many economic situations: will you share technical knowledge with others and both get rich or take a chance to get very rich yourself with the risk of staying poor? Will you negotiate a merger or protect your company from being bought? Many economic decisions depend on what you think competitors will do, what you think competitors think you will decide, and even more complex types of knowledge and expectations.
In game theory such kinds of decision problems are scrutinized by DME, leading to more complex situations and more complex solutions.
Further Study:
Damme, Eric van (1987) Stability and Perfection of Nash Equilibria,
Berlin [etc.] : Springer-Verlag, 1991 2nd, rev. and enl. ed.