Game Theory

Game Theory (GT)

Acronyms Business

What is Game Theory?

Abbreviated as GT according to AbbreviationFinder, game theory is the study of decision making that an individual makes when the outcome of this choice depends on what other individuals decide, as in a strategy game.

This theory was developed from studies on economics and mathematics, through strategic situations in which a player needs to make the best choices, however, there is an interdependent relationship with other players.

Interdependence in strategic situations occurs when there is competition and, the action of each player, will change the outcome of the other players and the entire game. This study, then, became related to the behavior of people, companies and the government.

Examples of Game Theory

If a company decides to lower the price of a commodity, it may increase its sales revenue. However, other competitors can do the same and the revenue from sales is even lower than before.

The theory suggests that two competitors are unlikely to cooperate, as they want to get the most out of their resources.

Example with the Prisoner’s Dilemma

The most common example for game theory is called the “Prisoner’s Dilemma”, where two captured criminals are arrested separately and face a 10-year high sentence. During the interrogation they are offered two possibilities:

  1. Confess the crime: reduction of the sentence to 3 years if the other prisoner also confesses. If the partner does not confess, this prisoner is entitled to freedom;
  2. Do not confess the crime: if there is no confession by both parties, the investigators cannot arrest them for the biggest crime they have committed and the penalty will be only 1 year.

For this dilemma, each of the prisoners may betray or remain silent, but neither knows what the other’s action will be and this would result in different penalties for each one. The combination of possibilities is presented below:

In the case of one witness and the other not, the latter will benefit alone by obtaining freedom, while the other will spend a full 10 years in prison.

If neither prisoner reveals the truth, investigators cannot arrest them for the biggest crime they have committed. Also, if the two reveal the truth, both will have their sentences reduced. In these two cases, they cooperate with each other and neither harms the other.

The fact that a prisoner does not know what the action of the other will be, demonstrates that each one has the possibility of harming himself or benefiting from what they choose. In this case, the best choice will be confession.

It was from examples like this that game theory came to be scientifically analyzed by economists and mathematicians. One of the most famous was John Nash.

John Nash game theory

Game theory studies have become even more developed with the studies of mathematician John Forbes Nash, on the choice of individuals in situations involving competition.

From examples such as the prisoner’s dilemma, John Nash developed the theory with his concept better known as Nash Equilibrium. The balancing strategy, he said, is to make the decision that is best for each prisoner.

This balance happens if the two prisoners reveal the crime and cooperate, as the benefit is guaranteed for both. The prisoner who does not testify is at risk of being in prison longer if the other reveals the crime committed.

With these examples, game theory began to be extended to several areas other than economics and mathematics, but also to political and business strategies.

Game theory in administration

The development of game theory was essential for decision-making in public administration and, mainly, in business administrations, due to the importance of knowing competitors in a market.

The companies and businesses they conduct are considered “competitive games”, in which companies are the players who carry out the most possibly beneficial strategies.

Some companies are able to grow and dominate the market they participate in. In this case it has the so-called Dominant Strategy, in which the movement of other companies does not influence its results.

Most of the market is made up of competing companies and, as a result, getting to know other opponents has become the fundamental strategy of companies.

There are also other models of strategies more developed for companies with their competitors. One of them is known as “The Five Forces of Porter”, in which the strengths that a company needs to have in the market that is inserted before its competitors are presented.

Game Theory