Game Theory
Summarized by Sam Mishra, MBA (MIT Sloan)
A firm's business decision is often affected by the moves made by its competitors. In other words, if the firm believes that its competitors are rational and act to maximize their own profits, the firm has to take this into account while making its own profit-maximizing decisions. In many ways, strategic decision making is all about anticipating the competitors' moves in the marketplace, and executing accordingly.The main theories / strategies within Game Theory are the following:
Nash Equilibrium
These strategies are an outgrowth of pioneering work by the famous mathematician John Nash (the subject of the popular movie "A Beautiful Mind") in the 1950s. This is a set of strategies such that each firm is doing the best it can given the action of its competitors. This interaction is illustrated by the classic Prisoner's Dilemma problem in Game Theory, where prisoner X does the best it can in anticipation of what prisoner Y will do and vice versa. Please read up on Prisoner's Dilemma to learn more.Dominant Strategy
This is a strategy that is optimal for a firm regardless of what its competitors do. To learn more, please visit our illustration of Dominant Strategy.Maximin Strategy
This is a strategy that maximizes the minimum gains that can be earned by the firm. We use the Meat and Potatoes example to illustrate this strategy; please check it out here.Tit-for-Tat Strategy
This is a strategy where the firm attempts to reach a cooperative outcome through sending appropriate signals, and punishes the competitor if the competitor fails to cooperate.
Also see Relational Contracts.
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