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Game Theory and Applications in the Presence of Cognitive Limitations

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Game theory in the presence of cognitive limitations

An EU-funded project investigated game theory and its application in the presence of cognitive limitation, in the context of classic economics.

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Game theory is an interdisciplinary theory that studies mathematical models of conflict and cooperation and attempts to predict the behaviour of agents or game participants. To make successful predictions in the area of economics on the strategies of other economic agents, agents depend on private information and the state of the economy. However such information is rarely accessible. The analogy-based expectation equilibrium (Jehiel, 2005) assumes that players consider the outcomes from past play in different games or states of the economy in order to form their expectations. GTAPCL (Game theory and applications in the presence of cognitive limitations) challenges the correctness of these expectations (cognitive rationality). It proposed a methodology based on the idea that the more experience of their opponents the players accumulate, the better they understand others’ strategies and can make more correct predictions. The project also revisited the theory of reputation, which assumes that players follow a stereotypical line of reasoning. It demonstrates how this behaviour, and beliefs, can be manipulated and taken advantage of by fully rational observers. Another important application of the approach takes into consideration the bidding behaviour during auctions. In a Nash equilibrium, agents can predict how bidders will process data based on their past behaviours and shape their expectations. As a result, bidders can be manipulated. This calls for possible regulation. From a more positive perspective, there are absolute auctions or auctions with secret reserve prices. Absolute auctions can be justified because they attract more participants. However, when the latter are fully rational, posting a reserve price below the seller’s valuation can never be justified. It is also hard to justify the use of secret reserve process, even if these can be informally viewed as providing a way not to frighten too many participants, when a high reserve price is posted. These auctions can be explained though in environments in which buyers do not have a full understanding of how participation is affected by the choice of reserve price and how the reserve price is distributed when secret. The analysis maintains that these buyers are not completely irrational in their way of forming expectations. These buyers consider in their analysis that participation and reserve price data are natural auction formats in competitive environments. This analysis could enable a system to manage the protection of buyers in auction houses.


Game theory, cognitive limitation, economics, auctions

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