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. 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 >>
  4. 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 >>
  5. Does the tradeoff model or the pecking order play a greater role in capital budgeting?

    Understand the difference between the trade-off theory and the pecking order theory, and learn what these theories tell companies ... Read Answer >>
  6. How has the popularity of online gaming affected the internet sector?

    Discover how the increasingly popularity of online gaming has directly affected and fundamentally transformed the Internet ... Read Answer >>
Related Articles
  1. Insights

    Prisoner's Dilemma

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

    How To Game The Video Game Industry

    Investopedia explores the business, current developments, future trends of video games industry and how the overall industry makes money.
  3. Tech

    How The Video Game Industry Is Changing

    Video game creation has become increasingly complex, and the cost of creating a game to run on one of the major consoles has risen with this greater complexity.
  4. Tech

    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. 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 ...
  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. Tech

    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.
  8. 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.
  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.
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. Biased Expectations Theory

    A theory that the future value of interest rates is equal to ...
  5. Demand Theory

    A theory relating to the relationship between consumer demand ...
  6. Accelerator Theory

    An economic theory that suggests that as demand or income increases ...
Hot Definitions
  1. Salvage Value

    The estimated value that an asset will realize upon its sale at the end of its useful life. The value is used in accounting ...
  2. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  3. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
  4. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  5. Fixed Asset

    A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be ...
  6. Absolute Advantage

    The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost ...
Trading Center