How Nash Equilibrium Changed Economics

Game Theory

John Forbes Nash, a mathematical genius,  died together with his wife Alicia in a car accident last week, while taking a taxi back home from an award ceremony. Nash was 86 years old and lived a long life of both success and hardship, as can be read in this well-written obituary by The Economist. It may also be interesting this read this blog post from The Bearing Wave two years ago.

Screenshot 2015-05-31 09.59.37Nash was one of the most influential economists of the 20th Century, and is hailed with firmly anchoring game theory at the heart of economics and he won the Nobel Prize in Economics to the Memory of Alfred Nobel in 1994. As Nash was handed the price, Professor Karl-Göran Mäler said in the presentation speech:

A simple economic example of strategic interaction is where two firms are competing with identical products on the same market. If one firm increases its production, this will make the market price fall and therefore reduce profits for the other firm. The other firm will obviously try to counteract this, for example by increasing its production and so maintaining its market share but at the cost of further reduction in market price. The first company must therefore anticipate this countermove and possible further countermoves when it makes its decision to increase production. Can we predict how the parties will choose their strategies in situations like this?

To this question, Nash had mathematically found the solution. It came to be called Nash Equilibrium, and it has become a fundamental concept in the theory of strategy, and the most widely used method of predicting the outcome of a strategic interaction, such as competition between companies, political conflict and competitive interaction between individuals.

In the video below from Financial Times, Ferdinando Giugliano explains why Nash work is so important and how the Nash equilibrium theory works in a simplified, intuitive example.The real world applications are, of course, far more complex.

How Nash Equilibrium Changed Economics

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