A zero-sum game is a situation where one party’s gain or loss is exactly balanced by the losses or gains of another party or parties. It is a concept that is often used in game theory, economics, and business to analyze the outcomes and strategies of different players in a competitive scenario. In a zero-sum game, the total benefit or cost of all the players is always zero, meaning that there is no net change in wealth or value. For every winner, there is a loser of equal magnitude.
Examples of Zero-Sum Games
Zero-sum games can be found in many contexts, both in real life and in theoretical models. Some examples of zero-sum games are:
Poker and gambling
In these games, the amount of money won by some players is equal to the amount of money lost by the others. The net change in the total money of all the players is zero.
Futures and options trading
In these financial instruments, the contracts represent agreements between two parties that are based on the price of an underlying asset. For every investor who makes a profit on a contract, there is another investor who suffers a loss of equal value. The net change in the total wealth of all the investors is zero.
Zero-Sum vs. Non Zero-Sum Games
Zero-sum games are the opposite of non zero-sum games, where the total benefit or cost of all the players is not zero, meaning that there is a net change in wealth or value. In non zero-sum games, the outcome can be beneficial or detrimental to all the players, or to some of them. Non zero-sum games are more common and realistic than zero-sum games, as they reflect the complexity and interdependence of real-world situations. Some examples of non zero-sum games are:
Trade and exchange
In these situations, two or more parties agree to exchange goods or services that they value differently. By doing so, they can both increase their utility or satisfaction, creating a positive sum game. For example, if Alice trades her apples for Bob’s bananas, and they both prefer the fruit they receive, they both gain from the trade.
Public goods and externalities: In these situations, the actions of one or more parties affect the welfare of others, without being reflected in the market price or cost. This can create positive or negative externalities, which are benefits or costs that are not internalized by the parties involved. For example, if a factory pollutes the air, it imposes a negative externality on the society, as it reduces the quality of life and health of the people. On the other hand, if a farmer plants trees, it creates a positive externality, as it improves the environment and the climate.
Implications of Zero-Sum Games
Zero-sum games have important implications for the behavior and decision-making of the players involved. They are competitive and adversarial, as the players have conflicting interests and goals. The players have to act strategically and rationally, taking into account the actions and reactions of the other players. The players may also try to deceive or manipulate the other players to gain an advantage.
Zero-sum games are often solved with the minimax theorem or the Nash equilibrium, which are concepts that determine the optimal strategy for each player, given the strategies of the other players. The minimax theorem states that a player should choose the strategy that minimizes the maximum possible loss, while the Nash equilibrium states that a player should choose the strategy that maximizes the expected payoff, assuming that the other players do the same.
Zero-sum games are not conducive to cooperation or collaboration, as the players have no incentive to work together or share information. The players may also face a dilemma or a paradox, where the individually rational choice leads to a collectively irrational outcome. For example, in the prisoner’s dilemma, the dominant strategy for each prisoner is to defect, but this results in a worse outcome for both prisoners than if they both cooperated.
Is Trading a Zero-Sum Game?
Yes, and no. In an environment where market participants are all fighting for fluctuations or price movements, this does create a zero-sum game scenario. In markets like the forex market or futures, most traders often just earn through capital gains which doesn’t lead to the creation of wealth.
However, things change when shares of companies are the assets being traded. While there will be traders who are looking to profit from price swings, there are also long term investors who aren’t looking to gain through quick trades. By pursuing gains through dividends or the overall growth of the company, the dynamics change from traders simply fighting for money between each other to the exchange of goods and services between market participants.
The overall lesson here being that fundamentals play a vital role in the stock market as it dictates whether a stock has the capacity to generate wealth. Something that will determine if the trading of shares will remain a zero-sum game.
