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TECH TALK: Useful Concepts: Game Theory

July 16th, 2003 · 2 Comments

I always thought of game theory as very mathematical-oriented, and having little impact on the way one made decisions in business. It took a recommendation by Chetan Parikh of a book by James Miller Game Theory At Work to change this view. The book has an extraordinary collection of everyday situations and how ideas from game theory can be used to understand and then solve the problem.

Here is how the book starts: Your life consists of games, situations in which you compete for a high score. Game theory studies how smart, ruthless people should act and interact in strategic settings. This book will teach you to solve games. In some games, you will negotiate for a raise; in others, you will strive to ensure that an employee works as hard as possible. Sometimes you will know everything, while in other games, you will have to guess at what others know that you dont. Occasionally, competitors will work together to survive, while in other situations, co-operation will be impossible since the winner will take it all.In the world of game theory, there exists no mercy or compassion, only self-interest.

James Miller highlights some of the lessons from the book, many of which seem counter-intuitive (all the more reason to read the book!):

  • Never hire someone too eager to work for you.
  • Have less trust in smokers.
  • Many people in business exhibit honesty not because they are moral but because they are greedy.
  • Eliminating choices can increase your payoff.
  • Burning money can increase your wealth.
  • Exposing yourself to potential humiliation can increase your negotiating strength when seeking a raise.
  • If your suppliers are charging you high prices, you could benefit from creating a prisoners dilemma.

    In fact, a scenario which one faces often in life is prisoners dilemma. To understand this, one needs to first understand Nashs Equilibrium. According to John Nash (on whom the movie A Beautiful Mind was made), as outlined by Miller: A Nash equilibrium is an outcome where no player regrets his move given his opponents strategy. It is a powerful game theory tool because it shows when an outcome is stable; it shows outcomes where no player wants to change his strategy. The prisoners dilemma is a special category of Nash equilibria where all players ruthlessly ride their own self-interest to collective ruin.

    Writes Miller:

    A prisoners dilemma game manifests whenever everyone individually would be better off being selfish, but collectively all would benefit from being nice. In a one-period prisoners dilemma, you should always be mean to your rival, for meanness maximizes your score. Indeed, businesses must recognize when they are in such a game so they dont waste time trying to find a win, win outcome, for none exist in one-shot prisoners dilemma games. In repeated games with no last period, however, you should strive to co-operate to achieve a better outcome. To obtain this outcome, you most need your rival to believe in your capacity to detect and punish cheating.

    This should be all the rationale needed to read the book and understand Game Theory!

    Tomorrow: Markets

    TECH TALK Useful Concepts+T

  • Tags: Tech Talk

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