Game theory in business planning

Mobile Site The Art of Game Theory One of the most challenging objectives for any organization is to make the transition from formal strategic planning to informal strategic thinking. Strategic thinking is one of the most powerful forces for creating value. In order to make this transition, we can look at business decisions in terms of playing a game.

Game theory in business planning

While used in a number of disciplines, game theory is most notably used as a tool within the study of economics. The economic application of game theory can be a valuable tool to aide in the fundamental analysis of industries, sectors and any strategic interaction between two or more firms.

game theory in business planning

Game Theory Definitions Any time we have a situation with two or more players that involves known payouts or quantifiable consequences, we can use game theory to help determine the most likely outcomes. Any set of circumstances that has a result dependent on the actions of two of 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 dollars to utility.

How Game Theory Works

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. The point in a game where both players have made their decisions and an outcome is reached.

There is also an assumption of maximization. It is assumed that players within the game are rational and will strive to maximize their payoffs in the game. This will exclude any "what if" questions that may arise.

The number of players in a game can theoretically be infinite, but most games will be put into the context of two players. One of the simplest games is a sequential game involving two players. The numbers in the parentheses at the bottom of the tree are the payoffs at each respective point. The game is also sequential, so Player 1 makes the first decision left or right and Player 2 makes its decision after Player 1 up or down.

Figure 1 Backwards induction, like all game theory, uses the assumptions of rationality and maximization, meaning that Player 2 will maximize his payoff in any given situation. At either information set we have two choices, four in all.

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By eliminating the choices that Player 2 will not choose, we can narrow down our tree. The result is an equilibrium found by backwards induction of Player 1 choosing "right" and Player 2 choosing "up". Below is the solution to the game with the equilibrium path bolded.

Figure 3 For example, one could easily set up a game similar to the one above using companies as the players. This game could include product release scenarios.

If Company 1 wanted to release a product, what might Company 2 do in response? Will Company 2 release a similar competing product? By forecasting sales of this new product in different scenarios, we can set up a game to predict how events might unfold. Below is an example of how one might model such a game.

For related reading, see: Figure 4 The Bottom Line By using simple methods of game theory, we can solve for what would be a confusing array of outcomes in a real-world situation.

Using game theory as a tool for financial analysis can be very helpful in sorting out potentially messy real-world situations, from mergers to product releases. Trading Center Want to learn how to invest? Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.Game Theory for Business: A Primer in Strategic Gaming outlines a straightforward, practical approach for using game book demonstrates how Strategic Gaming has, can, and should be applied to help savvy strategists and negotiators shape and play the game of business more effectively.

But game theory actually has some very real applications in everyday life, which you are probably already doing without an enormous white board and advanced calculus.

Game theory Share this page Game theory is a technique for analysing how people, firms and governments should behave in strategic situations i.e., in which they must interact with each other, and in deciding what to do must take into account what others are likely to . Adam Brandenburgeris J.P.

Valles Professor of Business Economics and Strategy, Stern School of Business, New York University.. Barry J.

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Nalebuffis Milton Steinbach Professor of Management at Yale School of authors' research, teaching, and consulting focus on game theory and business strategy.

Sep 24,  · Strategic thinking using game theory in a business or leadership sense starts with an ability to understand the basic principles behind “human nature and behaviour”, and then know how to utilize this knowledge in a manner that influences positive win-win outcomes.

The Baseline Theory, And Game Theory Words | 5 Pages. Memorial Prize award in The baseline theory, and game theory are applicable in business contexts as it did for Glasberg et al () research case study.

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