Understanding Game Theory

Using Reason to Predict Future Behavior

When is the right time to "pounce"?

© iStockphoto/EEI_Tony

What if you could make good predictions about how competitors will respond to your actions?

What if you could take this into account BEFORE taking action to make sure that that action is in your best interest?

And better still, what if you could do this with a "scientific" method, rather than just with guess-work?

Understanding how people are likely to react to your choices is important in many areas of business.

For example, imagine that you're competing in a market with a small number of other companies. If you can anticipate their moves, then you can either remove some of their options, or beat them when they make their moves.

Game Theory gives you the tools you need to think about this.

What is Game Theory?

Game theory is a reasoned attempt to predict behavior. It applies in situations where an individual's success in making choices depends on the choices of others. Simple models include a group of players, a definition of the actions that those players can choose, and the "payoffs" (how much each player will win or lose) for each combination of actions.

John von Neumann and Oskar Morgenstern defined the foundations of game theory in 1944 with their classic book, "Theory of Games and Economic Behavior."

Simultaneous and Sequential Games

Situations described by game theory fall into two main categories:

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