Question

What is game theory and how can it be used to analyze strategic business decisions?

Answer 1

Game theory is a framework which helps us respond based on the decisions and strategies of others. It defines various payoffs, strategies and theories for the same.

In business world, it is seen that the decisions taken by the top management affects not only the profitability, survival of the company, rather it impacts its employees, partners, subsidiaries etc . Hence to be a part of such complex mechanism, game theory is essential. Given what the rival firms are intended to do or based on their current actions, it is necessary to respond and act accordingly so as to maximise the profits of firm and survive in the market.

One such example is advertising . If one of rivals of a particular product chooses to advertise, the other one needs to be mindful on how this strategy of the rival would affect its market share, profits and payoffs. If he chooses to advertise, there would be certain costs and then both of them would get small shares of profits , given they both have incurred expenditure.

Game theory would also help analyse the threats or risks one would take in being the leader in a market or the benefit that would be possible, given the first mover advantage.

Situations like auctions also require game theory. Since the bids are unknown, the strategy to win a given sealed bid would require to analyse what the rivals would think.

All these factors would require the understanding of game theory which would help maximise utility, reduce business risks and achieve the goals of the organisation. Hence it is essential for busines settings.