The Undercover Economist

Externalities are costs that operate outside of a transaction, and they are not necessarily paid by the two parties engaging in the transaction. A good example of this is the fact that a person buying gas for their car forces bystanders to compromise their health by emitting fumes into the environment, even though the bystander did not participate in the decision to release those fumes. Externality charges connected to purchases can make consumers think more carefully about the consequences of their purchasing choices and make decisions that are more beneficial to the larger world.

Game theory is a field of economics that studies types of transactions and strategies in which a player’s decisions are influenced by the decisions and actions of another participant. Among other things, economists study dating, war, auctions, and poker as examples of places where game theory can lead to a successful outcome. However, game theorists view games as “mathematical objects” and often assume the existence of a hyperrational player quickly making perfect decisions. In real life, people do not behave rationally while participating in games, and this has to be taken into account in order to successfully implement game theory in a real-world scenario like an auction.