Strategic Thinking
Author | Sarwat Jahan and Ahmed Saber Mahmud |
Strategic Thinking Finance & Development, December 2015, Vol. 52, No. 4
Sarwat Jahan and Ahmed Saber Mahmud
Game theory analyzes behavior when decisions must take into account the potential actions of opponents
Anyone who has had to make a strategic decision taking into account what others will do has used game theory. Think of a game of chess. The outcome of the game depends not only on one participant’s move, but also on the actions of the opponent. When choosing a course of action—in other words, a “strategy”—a player must take into account the opponent’s choices. But the opponent’s choices in turn are based on thinking about the course of action the player might take. Game theory studies this interdependent decision making and identifies the optimal strategy—that is, the best course of action—for each player in response to the actions of others and how this leads to an equilibrium outcome, in which no players have a reason to change their strategy.
Because situations involving interdependent decisions arise frequently, so does the potential application of game theory in strategic thinking. Businesses competing in a market, diplomats negotiating a treaty, gamblers betting in a card game, and even those contemplating proposing marriage can use game theory.
The science of strategyThe earliest example of a formal game-theoretic analysis was by Antoine Cournot in 1838, when he studied the business behavior of two firms (a duopoly in economic parlance) with identical costs producing the same products but vying for maximum profits in a limited market. The mathematician Émile Borel suggested a formal theory of games in 1921, which was furthered by Princeton mathematician John von Neumann later in the decade. But game theory became a field in its own right after the publication of Theory of Games and Economic Behavior by von Neumann and economist Oskar Morgenstern in 1944. They studied “zero-sum” games, in which the interests of two players are so strictly opposed that the games are pure conflict—with one person’s gain always resulting in the other’s loss. A good example is chess, which has a winner and a loser. But games do not have to be zero-sum. Players can engage in positive sum games—for example, jointly writing this article generated benefits for both authors/players and was a win-win game. Similarly, games can result in mutual harm (negative sum)—for example, the failure to prevent a war. John Nash treated the more general and realistic...
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