Foundations of Game Theoretic Understanding of Socio-Economic Phenomena; A Network of Excellence in Economic Theory Prepared by Myrna Wooders, Department of Economics, University of Warwick Gibbet Hill Road, Coventry, CV4 7AL, UK [email protected] Applicable Instrument: Network of Excellence Sub-Thematic Priority most relevant to the topic: 1.1.7 Citizens and Governance in a Knowledge-based society Other relevant Sub-Thematic Priorities: 1.1.7.i Knowledge-based society and social cohesion 1.1.7.ii Citizenship, democracy and new forms of governance Summary: This EoI is for a network in game theory and economic theory, including evolutionary approaches. While the proposal relates to applications of theory, the main motivation and thrust is in a network of excellence in pure theory. Like research in theoretical physics or on the human genome, fundamental game theory and economic theory is not primarily motivated by immediate applications or by current policy issues. Instead, it is motivated by scientific intellectual curiosity. Because this curiosity arises from a quest towards a deeper understanding of the world around us, it is anticipated, however, that there will be applications of great significance – recall that the multi-billion dollar outcomes of auctions of spectrum in the US were guided by game theory. In addition, fundamental scientific theory, because of its search for understanding that will have broad consequences and transcend national boundaries, is appropriately funded by at the European Union level. The network aims to embrace the leading researchers in economic theory and game theory and strengthen Europe’s position as a leader in economic research.. Motivation; Need and Relevance. Along with standard techniques and concepts of economic theory and econometrics, arguably game theory now provides the most important set of concepts and techniques in the tool kit of the social scientist. 1 Besides in auctions of public property such as spectrum, these tools appear in such diverse settings as the analysis of voting behavior, the risk-taking behavior of participants in “Who wants to be a millionaire”, and European Union issues of tax competition and coordination between countries within the EU. Using the concepts of game theory, economic theory and also, to a more limited extent, evolutionary theory, research is currently in progress on all these topics plus a number of others, including competition policy and regulation, trade policy, educational policy, banking and finance. Citizen participation in influencing governmental policies and `big business’ – multi-national corporations, outside the jurisdiction of any particular nation – through protest movements and other forms of voluntary organizations is also being analyzed using both game theory and techniques and insights from economic theory. The importance of game theory and economic theory is witnessed by a long list of Nobel Laureates, including George Akerlof, Kenneth Arrow, Gerard Debreu, John Harsanyi, John Nash, Reinhard Selten, Amartya Sen, Michael Spence. Joseph Stiglitz and William Vickrey. Applications are important, but no application of the tools of economics and game theory, except perhaps with a bit of luck or the insights of an experienced and intuitive practitioner, can be better than the theory on which it is based. Evidence-based policy requires hypotheses to test and theories to interpret and understand the evidence. The contributions of the Nobel Laureates and those of many other researchers are fundamental. The tools already developed have had diverse applications, but still a number of questions remain. To treat the new 1 Another fundamental part of economics is empirical research and its econometric foundations. These are distinct from the activities of our proposed research but we wish to note their importance. questions that arise in modern, knowledge-based, multi-jurisdictional and multilevel societies, it is imperative that the fundamentals of game theory and economic theory are continually challenged and advanced. This EoI proposes a network uniting a number of game theorists and economic theorists in a collaborative endeavor to advance these areas of research and provide the tools and techniques needed for the analysis of modern society. This research will contribute primarily to the theme proposed by the EU, “Citizens and Governance in a Knowledge-Based Society”. It will also contribute to the theme “Sustainable Development, Global Change and Ecosystems”, since some of the issues involved concern strategic and multi-level decision- making. The research may also contribute indirectly to other themes since, whenever interactive decision-making is a factor, game theory may be relevant.2 While some of the research proposed by this network contributes to these themes directly, the primary contribution of game theory is to provide concepts, tools and techniques to be used in applications. A second ambition of the network is to establish Europe as the internationally recognized leader in game theory and the foundations of economic theory. For a position of leadership in economic science, strong expertise in theory is essential. This is especially true for basic research since it transcends geographical boundaries and is not limited to a particular time period. The proposed network already includes some of the world leaders in game theory and economic theory; the training and collaboration of the network members will build on this. In addition, the network aims to include researchers earlier in their careers who have exhibited excellence in research but are still relatively junior. If funded, the network will seek to embrace all of Europe’s leading scientists in economic and game theory. A Partial List of Research Themes (A) Cooperation with complete information. Two of the main issues in this theme are the ‘Nash Programme,’ that is, how bargaining and negotiation may lead to a cooperative outcome, and the related problem of variable threats. One objective is to extend existing models of multi-person bargaining games to include variable threats and to thus deepen our understanding of the effects of variable threats on bargaining outcomes; in a world of changing alliances on multiple issues, such understanding is vital. Coalition and network formation is central to any bargaining situation. Since these are relatively new and important areas of research, we wish also to understand these topics on their own. Applications include decentralized markets and trade, labor markets, local provision of public goods, communication networks, and kinship structures, among many others. Prior models in the literature involving networks with many participants have sought conditions under which perfect competition will be attained. Even with many sellers of a product, however, if a product is subject to ‘network externalities,’ then any ‘competitive’ outcome may be very unstable, with the dynamics leading perhaps to monopoly; such a result would constitute a major breakthrough and underpin a better understanding of stability considerations. (B) Cooperation with incomplete information. In (A) above it is assumed that all players have complete information—and thus, the same information. While the complete information case is important to our understanding of strategic behavior, it is more realistic to assume that players have private information on the fundamentals of the collective decision problem at hand. When individuals, nations, or unions of nations, do not know the objectives of others and yet a cooperative outcome is desired, how might this be achieved? Obviously, players with asymmetric information cannot coordinate efficiently without communication. At the same time, strategic behavior will often lead to misrepresentation of information. Hence, when information is asymmetric, players can benefit from communication and can effectively coordinate only through incentive compatible mechanisms (ICM), i.e., communication games designed in such a way that misrepresenting information is unprofitable. In practical terms, we need to understand how to set up organizations and systems so that economic actors, seeking to further their own self-interests, will promote the social good. The ‘social good’ could be the profits of the firm, the creativity and output of the network, the installation of desirable social policies, and so on. The theoretical issues involved are deep and have long captured the interest of some of the most eminent economic theorists. Since the implementers of a mechanism may not have precise information about the details of the situation, one objective of the network is to design mechanisms that are robust to deviations in the underlying situations. 2 For example, ‘Food Quality and Safety’ is, in practice, affected by a number of decision-makers who each have their own personal goals – for example, profits or re-election or promotion in academia or family well-being. 2 (C) Equilibrium concepts: The most fundamental problems of strategic interaction and coordination are about equilibrium itself: on what equilibrium do players coordinate, and how? In a Nash equilibrium, individuals take as given and fixed the behavior of other individuals and no individual perceives any possible gain from changing his behavior. But it is intuitive (and may correspond to the reader’s own experiences) that individuals do indeed consider how others might respond. Subtle and deep conceptual issues are involved. To illustrate the sort of issues involved,