Forgetting the “theory” part of the game theory, what comes into your mind when you hear the word “game”?
Fun, recreation, enjoyment, amusement or entertainment might be clicking your mind, I guess. Chess, Tetris, Scrabble, Checkers, Solitaire etc. you name it, there are so many of them around.
What about playing games in economics… sounds weird?
Games seem to be somewhat not serious activities. But not in the case of economics. The economic decision making games are “played” through economic reasoning, along the assistance of strict mathematical tools and defined rules. A crucial fact to know is that usually all games involve:
Game theory involves certain techniques and tools for assessing strategic behavior. Chess players deploy “gambits” i.e. planned series of moves to gain advantage as well as defending own pieces. The primary motive behind exhibiting strategic behavior is to guess and weigh the expected “move” of competitors while taking into consideration the bilateral interdependence regarding business decisions.
Your strategic behavior involves how you make decisions when you recognize that your actions affect, and are affected by, the actions of your competitors or your stakeholders.
Let’s get things to a more easy level.
While thinking, you might usually talk to yourself like:
If my competitor will do ‘this” I will do ‘that’ in reaction, then I will win over. This is an example of a gambit, a part of a game. You may also call it a strategy, but in a more quantitative way. Write it down through following the mathematical rules set by the theory experts, analyze it using basic calculations and the result will ‘suggest’ you what would be the best possible option while selecting a decision alternatives among few or many.
In simple words, a manager constructs a list of responsive “what-to-do measures”, in order to tackle what the competitor does. The list may contain a single or multiple solutions. Most of these responsive strategies are constructed in a proactive manners for quick reaction towards a rival’s action.
For example if your rival increase advertising efforts to promote his/her business by a 100%, you will either increase your advertising efforts to 100% or you will react by offering to your customers a certain price reduction to retain them. This is known as a structured approach towards a structured problem. Mathematical tools enable us to develop solutions to structured problems.
The idea is to use the element of surprise to keep your opponent from taking advantage of your strategy. By choosing actions randomly, neither player can take advantage of the other.
In simple words, the game theory is a set of concepts which can help you in making better managerial decisions in a quantitative way. The theory has a quite wide scope; covering the sciences of sociology, agriculture, environment, education, industrial organization, law, politics, biology etc. However, we will focus upon managerial economics, for the sake of relevance and conciseness.
At the foremost, we should keep in mind that the game theory is a quantitative approach, an arsenal, containing mathematical techniques and tools which may arm us in this fast paced competitive business world against our rivals. It may also aid us to make optimal decisions when the decisions of our stakeholders (i.e. employees, suppliers, distributors) can affect our business objectives.