What does playing chess, asking for a discount, robbing a bank, and studying economics have in common? For all of the actions above, one has to apply and administer strategic thinking in the most effective way. Game theory is a direct reflection of this because it utilized strategic thinking to make choices; most commonly applied in the business world. It is a method of thinking where individuals have to make a decision after analyzing different perspectives; one has to think about what they are going to do and what might be the consequences of their decisions. By anticipating their possible actions and reactions, the company or person attempts to make the most beneficial decision; usually, attempting to maximize their minimum loss if things go south. Over the years, Game Theory has evolved and settled its place as a powerful tool that predicts the results of different interactions between competitors. The importance of these interactions is highlighted in the economic sector because of the positive decisions it provides businesses while taking into consideration other factors.
Game Theory relies directly on logic; therefore, the better rationality applied, the more accurate the results might be. Even though logic is the main component in this kind of theory, it also relies on a very important assumption, the assumption of maximization. This idea consists of the thought that every company or “player” involved wants to maximize their own results; relying on other people's self-interest. Because of this, this kind of strategy is ideal in an open market; where competitors are all interested in the growth and profit margins of their own companies.
One of the most common applications of game theory is in the pricing decisions of companies. For the most part, companies have one of two choices: to compete or to cooperate. By choosing to cooperate, both companies would be selling the same product while keeping their prices high, and this way they both have high prices and high profits. But by choosing to compete, companies might lose more than they plan to gain. This is because when a player lowers their prices, they get more customers and increase their gain while simultaneously hurting its competitors. But then if the other company sees this, they may decide to also lower their price; balancing their sold items but decreasing their profit margins. Because these decisions are crucial, companies, many decide to use Game Theory to come up with the best action plan.
An example to demonstrate this can be as simple as coming back to one of the first topics described in the article; robbing a bank. When trying to choose between running away from the police and surrendering, one has to consider the logistics behind it and what would be the outcome of different scenarios. One can either stay and surrender -but not have a chance to escape- or attempt to run away and face worse consequences. When applying Game Theory we have to look at the possible results of the decision at hand. If one were to choose to run away, we have to recognize that the police’s target is to capture the person committing the crime; meaning there might be other back up cops in all the exits to function as their own safety net. And now after thinking about how that decision may affect the turnout, we can conclude that the safest choice with the better result is to stay and surrender. As stated before, we should rely on logic and the players to have a conclusion that will have the most beneficial results; showing how Game Theory works.
As shown, Game Theory is applied in many ways that bring abundant benefits. The benefits include how it is meant to reduce business risks. In business models, the tools of Game Theory allow individuals to obtain information on price, market shares, competitors, technologies, and other aspects. With this information, one can generate decisions that will have the least repercussions. Overall, this theory is one that may not be known to common people but is widely known in the business world because of its stellar results in the internal decision-making process.
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