A:

Game theory was once hailed as a revolutionary interdisciplinary phenomenon bringing together psychology, mathematics, philosophy and an extensive mix of other academic areas. Eight Noble Prizes have been awarded to those who have progressed the discipline; but beyond the academic level, is game theory actually applicable in today's world?

Yes!

The classical example of game theory in the business world arises when analyzing an economic environment characterized by an oligopoly. Competitive firms are faced with a decision matrix similar to that of a Prisoner's Dilemma. Each firm has the option to accept the basic pricing structure agreed upon by the other companies or to introduce a lower price schedule. Despite that it is in the common interest to cooperate with the competitors, following a logical thought process causes the firms to default. As a result everyone is worse off. Although this is a fairly basic scenario, decision analysis has influenced the general business environment and is a prime factor in the use of compliance contracts.

Game theory has branched out to encompass many other business disciplines. From optimal marketing campaign strategies, to waging war decisions, ideal auction tactics and voting styles, game theory provides a hypothetical framework with material implications. For example, pharmaceutical companies consistently face decisions regarding whether to market a product immediately and gain a competitive edge over rival firms, or prolong the testing period of the drug; if a bankrupt company is being liquidated and its assets auctioned off, what is the ideal approach for the auction; what is the best way to structure proxy voting schedules? Since these decisions involve numerous parties, game theory provides the base for rational decision making.

Another important concept, zero-sum games, also stemmed from the original ideas presented in game theory and the Nash Equilibrium. Essentially, any quantifiable gains by one party are equal to the losses of another party. Swaps, forwards, options and other financial instruments are often described as "zero-sum" instruments, taking their roots from a concept that now seems distant. (For an in depth explanation about game theory, check out Game Theory: Beyond the Basics.)

This question was answered by Arthur Pinkasovitch.

RELATED FAQS
  1. What's the difference between agency theory and stakeholder theory?

    Learn how agency theory and stakeholder theory are used in business to understand common business communication problems ... Read Answer >>
  2. How is game theory related to the Nash equilibrium?

    Learn how Nash's equilibrium is an important concept in game theory, and understand how it applies to the common prisoner's ... Read Answer >>
  3. What is the chaos theory?

    The chaos theory is a complicated and disputed mathematical theory that seeks to explain the effect of seemingly insignificant ... Read Answer >>
  4. What are the differences between weak, strong and semi-strong versions of the Efficient ...

    Discover how the efficient market theory is broken down into three versions, the hallmarks of each and the anomalies that ... Read Answer >>
  5. Is a good's production cost related to its value?

    Learn about the history and debate regarding the metrics used to determine the value of a good and which theories place emphasis ... Read Answer >>
  6. What is capital structure theory?

    Discover capital structure theory as it relates to financial management and the methods in which companies attempt to raise ... Read Answer >>
Related Articles
  1. Insights

    Prisoner's Dilemma

    Learn more about this classic game theory scenario.
  2. Insights

    The Basics Of Game Theory

    Break down and examine the potential consequences of economic/financial scenarios.
  3. Investing

    7 Controversial Investing Theories

    We take a closer look at the theories that attempt to explain and influence the market.
  4. Investing

    You Love Video Games, But Do You Know How The Industry Works?

    Traditionally, the video game industry was limited to consoles, such as Microsoft’s (MSFT) Xbox and Sony’s (SNE) PlayStation, but it now includes PC games, mobile games and, in the near future, ...
  5. Insights

    Are Big Budget Video Games Dead?

    More people seem to be gaming on tablets and smartphones over consoles, which means this could be the end of big budget console games.
  6. Investing

    What is a Zero-Sum Game?

    A zero-sum game is a situation in which one person’s gain equals another’s loss, resulting in a net benefit of zero.
  7. Trading

    The Nash Equilibrium

    Nash Equilibrium is a key concept of game theory, which helps explain how people and groups approach complex decisions. Named after renowned mathematician John Nash, the idea of Nash Equilibrium ...
  8. Insights

    Advanced Game Theory Strategies For Decision-Making

    The importance of game theory to modern analysis and decision-making can be gauged by the fact that since 1970, as many as 12 leading economists and scientists have been awarded the Nobel Prize ...
  9. Insights

    The 6 Most Famous Failed Video Game Makers (KING, ZNGA)

    The video-game industry pulls in $100 billion in revenue annually. Failed companies offer a cautionary tale.
  10. Insights

    Can Games Make You A Better Investor?

    As investing is a great example of an activity that draws on a wide range of mental and emotional skills, it is worth exploring how to improve this skill set.
RELATED TERMS
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s ...
  2. Decision Theory

    An interdisciplinary approach to determine how decisions are ...
  3. Game Theory

    A model of optimality taking into consideration not only benefits ...
  4. Gaming Industry ETF

    A sector exchange-traded fund that invests solely in gaming companies, ...
  5. Biased Expectations Theory

    A theory that the future value of interest rates is equal to ...
  6. Nash Equilibrium

    A concept of game theory where the optimal outcome of a game ...
Hot Definitions
  1. Quadruple Witching

    The expiration date of various stock index futures, stock index options, stock options and single stock futures. All stock ...
  2. Co-pay

    A type of insurance policy where the insured pays a specified amount of out-of-pocket expenses for health-care services such ...
  3. Protectionism

    Government actions and policies that restrict or restrain international trade, often done with the intent of protecting local ...
  4. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  5. Demonetization

    Demonetization is the act of stripping a currency unit of its status as legal tender and is necessary whenever there is a ...
  6. Investment

    An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic ...
Trading Center