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Game Theory, is a special branch
of mathematics which has been developed to study decision making in
complex circumstances. The
idea to see business as a game, in the sense that a move by one player
sparks of moves by others, runs through modern strategic thinking.
It historically dates back to the Talmud and Sun Tzu's writings.
However, its contemporary codification is credited to John von Neumann and Oskar Morgenstern who, in 1944, published Theory of Games and Economic
Behavior. In the early 1950s, John Nash generalized these results and
provided the basis of the modern field. A rapid rise in theoretical
developments led to the founding of the first academic journal devoted to
the field by Oskar Morgenstern in 1972. Few corporations nowadays think
about their strategy without adding some game theory models or game elements into their strategy
process.
Game theory can be defined as the
study of how people interact and make decisions. This broad definition
applies to most of the social sciences, but game theory applies
mathematical models to this interaction under the assumption that each
person's behavior impacts the well-being of all other participants in the
game. These models are often quite simplified abstractions of real-world
interactions. While many game theorists certainly enjoy playing games, a "game" is
an abstract representation of many serious situations
and has a serious purpose.
A major issue with game theory
is that is is necessary to make assumptions. Any model of the real
world must make simplifying assumptions because the real world is too
messy to analyze with any precision. There is a constant tradeoff between
realism and solvability. Even if one could write down a model that
accurately describes how people make decisions in general, no amount of
computers would be able to calculate it.
What assumptions are made normally? The
most common ones are:
- rationality (people take
whatever actions are likely to make them more happy - and they know what
makes them happy), and
- common knowledge (we know that
everyone else is trying to make himself or herself as happy as possible,
potentially at our expense).
These assumptions take many
mathematical forms, from very strong (and likely unrealistic) to much
weaker forms in the study of behavioral game theory.
Experimental economics examines the
validity of these assumptions by seeing how real people act in controlled
environments.
The most widely known example of
game theory is probably the prisoner's dilemma: A zero-sum game
cooperation game that got its name from the following hypothetical
situation: imagine two criminals arrested under the suspicion of having
committed a crime together. However, the police does not have sufficient
proof in order to have them convicted. The two prisoners are isolated from
each other, and the police visit each of them and offer a deal: the one
who offers evidence against the other one will be freed. If none of them
accepts the offer, they are in fact cooperating against the police, and
both of them will get only a small punishment because of lack of proof.
They both gain. However, if one of them betrays the other one, by
confessing to the police, the defector will gain more, since he is freed;
the one who remained silent, on the other hand, will receive the full
punishment, since he did not help the police, and there is sufficient
proof. If both betray, both will be punished, but less severely than if
they had refused to talk. The dilemma resides in the fact that each
prisoner has a choice between only two options, but cannot make a good
decision without knowing what the other one will do.
Compare also:
Business Simulation
| System Dynamics
| Benchmarking |
Brainstorming |
Six Thinking Hats |
Force Field Analysis |
Exponential Smoothing |
Scenario Planning |
Dialectical Inquiry
| Theory of
Constraints |
Operations Research
More strategy frameworks and
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