When you get to know of game theory, you get a sense of déjà vu: you always somehow assumed it existed. Last October, two of its main scholars were awarded the Nobel Prize in economic sciences. Professors Robert Aumann and Thomas Schelling each got half of the prize.

The sense of déjà vu is understandable since children are expert at games. As one gets older, games get more sophisticated and more frequent.

Prof. Schelling, for example, dealt at length on brinkmanship. Children are expert at brinkmanship and many of their strategies are copied by leaders of various nations especially when they are on a collision course with either the international community or another powerful nation. The North Koreans are probably the masters, seeing how they reacted in the nuclear proliferation dispute, and the Iranians are beating similar drums, though probably with a different motivation.

Prof. Schelling's cold war era book, The Strategy of Conflict, was very influential and, to this day, it is often used as an introduction to game theory.

It deals with what happens when there is a stand-off between two big opponents, how they resort to brinkmanship and credible threats and how they try to set the agenda and lock themselves into seemingly unmovable positions by making pre-commitments. The fusion of the three raises the stakes and adds to the tension, increasing both the pressure on the other party to back down and also the probability of eventual conflict. There's not that much difference between what happens on the micro level in a street fight and what happens on the macro level between nations.

This is nothing new. We all know how great generals scuppered their ships or burnt bridges, and how the great Caesar crossed the Rubicon and marched on Rome. It is a way of showing they meant business.

This is how Suetonius describes it:

"When the news came [to Ravenna, where Caesar was staying] that the interposition of the tribunes in his favour had been utterly rejected, and that they themselves had fled Rome, he immediately sent forward some cohorts, yet secretly, to prevent any suspicion of his plan...

"However, after sunset some mules from a nearby mill were put in his carriage, and he set forward on his journey as privately as possible... Coming up with his troops on the banks of the Rubicon, which was the frontier of his province, he halted for a while, and revolving in his mind the importance of the step he meditated, he turned to those about him, saying: 'Still we can retreat! But once we pass this little bridge, nothing is left but to fight it out with arms!'

"Even as he hesitated, this incident occurred. A man of strikingly noble mien and graceful aspect appeared close at hand, and played upon a pipe. To hear him not merely some shepherds, but soldiers too came flocking from their posts, and among them some trumpeters. He snatched a trumpet from one of them and ran to the river with it; then sounding the 'Advance!' With a piercing blast he crossed to the other side. At this Caesar cried out, 'Let us go where the omens of the Gods and the crimes of our enemies summon us! The die is now cast!'

"Accordingly he marched his army over the river; [then] he showed them the tribunes of the Plebs, who on being driven from Rome had come to meet him, and in the presence of that assembly, called on the troops to pledge him their fidelity; tears springing to his eyes [as he spoke] and his garments rent from his bosom."

It is actually quite remarkable how tensions escalate, sometimes rather rapidly. I remember at least two instances, as a child in a primary school at Rabat, in the 1960s, when the class was made to fervently pray that a nuclear war be averted. Prof. Schelling's subject was big back then and, unless today's leaders are careful, can easily get big again. There's a fine balance between standing up to a bully and throwing your weight around.

Opponents don't always fight, however. They often find a way of co-habiting. This aspect, how opponents work together, was part of both Prof. Schelling's and Prof. Aumann's work and broke new grounds in economics and business strategy.

It is unlikely that two big companies occupying the same turf end up fighting each other to death. They are more likely to enter into a sort of uneasy alliance in which they continue to try and take a series of advantages over each other but not so much as to rock the boat, at the same time keeping prices higher than they would be under real competition.

That's how societies end up burdened with duopolies and oligopolies. And why duopolies and oligopolies last longer than monopolies: one cannot cooperate with a monopoly and one can only fight it.

Prof. Aumann, working independently, took a mathematical approach to the problem of conflict and cooperation and how firms co-habit turf. He found that when individuals have to face each other over and over, in so-called "repeated games", there is much incentive to cooperate rather than compete outright. We Maltese, in our small society, are expert at this and there is little need to explain it further.

The flip side, of course, is that cooperation is more difficult if participants interact only rarely or only for a short time or when nobody knows what the others are doing and there is an element of conjecture and suspicion.

Game theory explains various other behaviours. To get to a destination fastest, for example, it is better for a car driver to abide by traffic regulations rather than rush around and get involved in a collision as others follow suit. Similarly, civilised people always form queues, sometimes even when it is inefficient to do so.

Prof. Aumann also deals with repeated games where the parties have different levels of information or even where all parties have incomplete information. If you have doubts as to whether someone is taking your side, then he or she is taking the other side! This work also explains why information is power and why nations engage in spying.

Another aspect of Prof. Aumann's work considered how behaviour changes depending on what each party thinks the rules of the game are. Furthermore, the level of knowledge about what the other party knows usually leads to different courses of actions by the participants.

In one movie I watched, the Americans accidentally fired a missile at the then USSR and the movie revolved around the tense anxiety which built up as to whether the USSR leaders were going to believe it was an accident and suspend their reaction until the US war plane destroyed the missile or whether they would react immediately, believing that the missile and the plane and the explanation was in fact a trick. It was thus a matter of evaluating the nature and the number of games being played.

Prof. Aumann's work on deficient and asymmetric knowledge also throws light on the role of mediators.

Mr Azzopardi is managing director of Azzopardi Investment Management Limited (www.azzopardi.com) which is licensed by the MFSA to provide investment services, including stockbroking. This article is only meant to provide information, which the writer believes to be accurate at the time of writing, and is not intended to give investment advice and its contents should not be construed as such.