2. Strategic Interactions

Because economics is about social interactions and how these are governed by institutions, this chapter begins with exercises on game theory rather with isolated individuals and their preferences than (as is conventional in microeconomics). It defines institutions as the "rules of the game" that govern these interactions, emphasizing the concept of "mutual dependence recognized" among strategic actors. The chapter explores various game types, including the Hawk-Dove Game, Assurance Game, and Prisoners' Dilemma, to illustrate the diverse institutional structures governing interactions and the potential for Pareto-inefficient outcomes in non-cooperative settings.

Through a set of problems to be solved, the chapter examines concepts such as risk dominance, mixed strategies in monitoring scenarios, and the limitations and versatility of the Nash equilibrium concept. It also extends game theory to real-world phenomena like residential segregation, demonstrating how uncoordinated decisions can lead to Pareto inefficient social outcomes.