Game Theory -

• Game theory is a theoretical framework for conceiving social

situations among competing players. In some respects, game
theory is the science of strategy, or at least the optimal
decision-making of independent and competing actors in a
strategic setting.
• Game theory is used in various fields to lay out various
situations and predict their most likely outcomes. Businesses
may use it, for example, to set prices, decide whether to
acquire another firm, and determine how to handle a lawsuit.
Working -
• Game theory tries to understand the strategic actions of two or more
"players" in a given situation containing set rules and outcomes. Any
time we have a situation with two or more players that involve known
payouts or quantifiable consequences, we can use game theory to help
determine the most likely outcomes.
• The focus of game theory is the game, which serves as a model of an
interactive situation among rational players. The key to game theory is
that one player's payoff is contingent on the strategy implemented by
the other player.
Terms in Game Theory
• Game: Any set of circumstances that has a result dependent on the actions
of two or more decision-makers (players).
• Players: A strategic decision-maker within the context of the game.
• Strategy: A complete plan of action a player will take given the set of
circumstances that might arise within the game.
• Payoff: The payout a player receives from arriving at a particular outcome.
The payout can be in any quantifiable form, from money to utility.
• Information set: The information available at a given point in the game. The
term information set is most usually applied when the game has a sequential
component.
• Equilibrium: The point in a game where both players have made their
decisions and an outcome is reached.
• The key pioneers of game theory were mathematician John von
Neumann and economist Oskar Morgenstern in the 1940s.
Mathematician John Nash is regarded by many as providing the first
significant extension of the von Neumann and Morgenstern work.
The Nash Equilibrium
• Nash equilibrium is an outcome reached that, once achieved, means
no player can increase payoff by changing decisions unilaterally. It can
also be thought of as "no regrets," in the sense that once a decision is
made, the player will have no regrets concerning decisions
considering the consequences.
• The Nash equilibrium is reached over time, in most cases. However,
once the Nash equilibrium is reached, it will not be deviated from.
• The Nash equilibrium is an important concept
referring to a stable state in a game where no player
can gain an advantage by unilaterally changing a
strategy, assuming the other participants also do not
change their strategies. The Nash equilibrium provides
the solution concept in a non-cooperative (adversarial)
game. It is named after John Nash, who received the
Nobel Prize in 1994 for his work
• Example
• Imagine two competing companies: Company A and Company B.
Both companies want to determine whether they should launch a
new advertising campaign for their products.
• If both companies start advertising, each company will attract 100 new
customers. If only one company decides to advertise, it will attract 200
new customers, while the other company will not attract any new
customers. If both companies decide not to advertise, neither company
will engage new customers
• Company A should advertise its products because the strategy provides
a better payoff than the option of not advertising. The same situation
exists for Company B. Thus, the scenario when both companies
advertise their products is a Nash equilibrium.
Impact of Game Theory
• Economics
• Game theory brought about a revolution in economics by addressing
crucial problems in prior mathematical economic models. For
instance, neoclassical economics struggled to
understand entrepreneurial anticipation and could not handle the
imperfect competition.
• Game theory turned attention away from steady-state equilibrium
toward the market process.
• Economists often use game theory to understand oligopoly firm
behavior. It helps to predict likely outcomes when firms engage in
certain behaviors, such as price-fixing and collusion.
Business
• In business, game theory is beneficial for modeling competing
behaviors between economic agents. Businesses often have several
strategic choices that affect their ability to realize economic gain. For
example, businesses may face dilemmas such as whether to retire
existing products and develop new ones or employ new marketing
strategies.
• Project Management
• Project management involves social aspects of game theory as
different participants may have different influences. For example, a
project manager may be incentivized to successfully complete a
building development project. Meanwhile, the construction worker
may be incentivized to work slower for safety or delay the project to
incur more billable hours.
Consumer Product Pricing
• The strategy of Black Friday shopping is at the heart of game theory.
The concept holds that should companies reduce prices, more
consumers will buy more goods. The relationship between a consumer,
a good, and the financial exchange to transfer ownership plays a major
part in game theory as each consumer has a different set of
expectations.
• Other than sweeping sales in advance of the holiday season,
companies must utilize game theory when pricing products for launch
or in anticipation of competition from rival goods. A balance must be
found. Price a good too low and it won't reap profit, yet price a good
too high and it might scare customers toward a substitute.