A game table, or payoff matrix, displays the potential outcomes of a game. Each cell represents a possible allocation, which details the specific payoff each player would receive for a given combination of strategies. In economic games, these payoffs often represent income or profits. For example, the game table for Anil and Bala shows four distinct allocations, each specifying the income for both farmers based on their crop choices.

Hypothetical Outcomes (Payoffs) in a Game Table

An allocation A is said to Pareto-dominate allocation B if it is evaluated as better under the Pareto criterion. This condition is met if, in allocation A, at least one person is strictly better off and nobody is worse off compared to their situation in allocation B.

Pareto Dominance

When comparing economic allocations, to say someone is 'better off' means they subjectively prefer the new situation. This preference is not necessarily linked to a monetary gain.

'Better Off' Refers to Subjective Preference in Economics

An allocation describes the outcome of an economic interaction by specifying the distribution of goods or other valuable items among all participants. Within game theory, an allocation is the particular distribution of payoffs among the players that results from their combined actions. For example, in a market competition between two firms, an allocation would detail the profits earned by each firm.

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In game theory, a player's payoff is the benefit they gain from a particular outcome of the game. This benefit is determined by the combined actions of all participating players.

Payoff (in Game Theory)

Economic results, such as what goods and services are created, the methods of their production, and how income is distributed, are determined by the cumulative effect of countless interactions among various economic participants. A specific outcome detailing the distribution of value to all participants is formally called an allocation.

Economic Outcomes as a Result of Actor Interactions

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Microeconomics

A standard format for visualizing a game's outcomes is the payoff matrix, which is a rectangular grid of numbers. This matrix designates one participant as the 'row player' and the other as the 'column player.' The cells of the matrix show the resulting payoffs for each combination of strategies. By convention, the first number listed in each cell represents the payoff for the row player, while the second number is the payoff for the column player.

Representing a Game with a Payoff Matrix

Allocation (in Economics)

While some economic models of strategic interactions assume players know the exact payoffs for every outcome, many real-world situations involve uncertain payoffs. This uncertainty frequently arises when players do not know the personal preferences of their opponents. The ultimatum game serves as a key example of a strategic interaction where payoffs are uncertain, as the Proposer cannot be sure if their specific, randomly-matched Responder will accept or reject a given offer.

Uncertainty of Payoffs in Strategic Interactions

An economic model is a simplified representation of the economy that helps us understand the big picture. Since it is impossible to describe every detail of the millions of interactions that shape the economy, models are used to focus on the essential features relevant to a specific question while ignoring unimportant details. Economic models frequently employ mathematical equations, graphs, words, and pictures.

Economic Model

The analysis of any economic interaction, such as shopping, wage negotiations, or resource management, involves two distinct tasks. The first is to describe the outcome, which is a factual exercise. The second is to evaluate the outcome by judging it against alternatives, a process that relies on values.

Factual vs. Value-Based Analysis of Economic Outcomes

An individual's endowment is the collection of things they possess or characteristics they embody that enable them to receive income. These can be categorized as things someone owns, has, or is. Examples of endowments include physical wealth (like land or machinery), financial wealth (such as stocks and savings), intellectual property (e.g., patents), human capital (knowledge and skills), legal entitlements (citizenship and work rights), and personal attributes (like race or gender) that can influence income.

Economic Endowment

Gains from exchange, also known as gains from trade, are the benefits that participants in a voluntary transaction receive compared to what their outcome would have been without the transaction. These gains, which motivate voluntary trade between buyers and sellers, are measured by the economic surpluses generated for the involved parties. The prospect of these gains is the primary motivation for engaging in such interactions.

Gains from Exchange and Trade Definition

The 'rules of the game' refer to the established guidelines and constraints that structure how economic agents interact. These rules are crucial as they determine how the output of these interactions, such as goods and services, is ultimately allocated among the participants.

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