Think Tank: Strategic Decision Making Using the Game Theory

Posted in (Inside Rishabh)

The Think Tank team picked the ‘Game Theory’ for one of their September speed sessions

An introduction to the interesting theory below.

Games have always been the avenue or platform for mindful tactics and strategies to be put into action. With games like monopoly and chess, we have admired the skill & foresight of champions of the two. What becomes more exciting though is the application of a theory that is evolved from gaming to decision making not only in Las Vegas – the hub of gambling but also the business & corporate world.

The interpretation and formation of game theory has been picked by various brilliant personalities and while an economist calls it the ‘game theory’, the psychologists call it the theory of social situations.

A game parlor is what would flash in ones mind when one thinks about the application of game theory; however it lays its emphasis on how groups of people interact with each other with their end goal in mind.

The game theory, as simple it might sound, branches into several directions & applications making it that much more complex. There maybe large use of concepts from mathematics and diagrammatical representations demonstrating combinations of actions and reactions of players (decision makers, rivals etc). The game theory borrows concepts from various decision making tools such as the commonly used Fish bone analysis and decision matrix.

The prime application of the game theory is seen in anticipating the opponent’s (a business rival, a competitor) moves and is depicted in a diagrammatic (fishbone/ four cubicles) or mathematical format (eg. decision matrix). Further, it provides a Dash Board presentation of each possibility and the consequences of the proposed strategy or situation.

To simplify the magnanimous field, we can roughly divide the game theory into 2 broad areas. The non-cooperative (or strategic) games – used by rivals competing for profits for e.g. Companies competing to win business with an individual profit in mind. And the cooperative (or coalitional games) – used by NGOs for e.g. several NGOs teaming up to achieve a common goal

Example of the non-cooperative game theory in application

A simple example of the non co-operative game theory would be 2 companies bidding for a project. Company A does not know the bid placed by company B and vice versa. However the combination of bids placed has an impact on each ones profit making possibility. Hence each one has to anticipate the bid placed by the other with the aim of making maximum profits. The crux: in a non co-operative game theory, players make independent decisions

Example of the co-operative game theory in application

Consider the following set-up. There are three players, so N = 1, 2, 3. Think of player 1 as a seller, and players 2 and 3 as two potential buyers. Player 1 has a single unit to sell, at a cost of $4. Each buyer is interested in buying at most one unit. Player 2 has a willingness-to-pay of $9 for player 1’s product, while player 3 has a willingness-to-pay of $11 for player 1’s product. If players 1 and 2 come together and transact, their total gain is the difference between the buyer’s willingness-to-pay($9) and the seller’s cost($4), namely $5. Likewise, if players 1 and 3 come together, their total gain is again the difference between willingness-to-pay($11) and cost($4) , which is now $7. Players 2 and 3 cannot create any value by coming together; each is looking for the seller, not another buyer. Next, no player can create value on his or her own, since no transaction can then take place. The crux: in a cooperative game theory, players make interdependent decisions

Cited from: http://pages.stern.nyu.edu/~abranden/coop-01-04-07.pdf

Some other strong concepts/models to understand game theory are ‘Nash Equilibrium’ and ‘Prisoner’s Dilemma’

A snapshot of the Prisoner’s dilemma in a diagrammatic representation below

Game Theory

Further reading references & citations:

  1. http://faculty.lebow.drexel.edu/McCainR//top/eco/game/game.html
  2. http://en.wikipedia.org/wiki/Game_theory
  3. http://levine.sscnet.ucla.edu/general/whatis.htm

Researchers in this field have even won the Noble laureate, which only indicates the practical importance of it.

A theory that definitely probes & needs curiosity

Article author - S Vinekar

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