Deciphering The Game Theory

Decision-making is a vital process we all face. Right from what we want to eat for breakfast to which corporate deal to make, decisions are everywhere. They are so important that sometimes a single decision can make or wreck your life.

This is exactly what the Game theory focuses on – decision making. Game theory is a theoretical framework for imagining social situations among competing actors and producing optimal decision-making of independent and competing actors in a strategic setting.

Game we all experience

Imagine you are playing a game of ludo with a person. How will you decide what you will do next? If you get a six on the dice, will you bring out a new piece from your side in the field or will you continue to play with your existing pieces in the field?

Any rational person will first see the field, see where all the pieces are, quickly analyse where the opponent’s pieces are. Then he will see if he moves the piece already in the field, how close or far will they be from the opponent’s pieces. Will the opponent be able to reach the piece and kill it? And what will happen to the game if he brings a new piece in the field? After this quick analysis, a person decides if he wants to bring a new piece or continue with the existing piece in the game.

The same process will be repeated by the opponent as well. This is what game theory is basically. You got a game, you have two players (in a simplified game), and you have to make a decision to choose between two options to continue the game.

Every decision you make depends on the action of your opponent & vice-versa and affects the end result of the game.

Game in Business

In business world, a classic example of game theory is pricing strategies. However, Game theory is also used extensively in various collective bargaining activities. For example, negotiations between worker unions and management to improve salaries, purchasing negotiations with suppliers, compensation/incentive agreements between management and suppliers or business partners use this theory.

Businesses further use game theory to make product-based decisions like whether to put a new product into the market, to enter or depart a new market, whether or not the first-mover advantage exists, as well as competitors’ potential movements relating to new products and defence strategies.

But businesses are not the only place where games are played.

Game in law

Another interesting game can be found in the field of law, where two lawyers are going against each other and one’s argument depends on the others argument and vice-versa.

In law, the case is the game, the two parties and their lawyers are the players and the arguments are their strategies or decisions. The game ends when either the plaintiff wins, the defendant wins, or when they compromise and settle the case.

Yet, it’s not just the courtrooms where game theory is used.

When Regulators play the game…

Regulatory bodies across the world use the game theory in their actions and decisions.

For example, insider trading is illegal, but earlier the legal investigations were costly and there were low penalties due to which, traders would engage in such activities. However, regulators increased the number of prosecution proceedings together with increased penalties, both in terms of monetary demands and prison-term. Here, the traders had to decide whether they will participate in insider trading and to counter them, the regulators increased the penalties and risk factors of the game (insider trading).

Another example of regulators playing a game can be seen when they threaten to use the ‘regulatory bomb’. This is the power regulators use only as a last resort or under extreme circumstances, like RBI’s power to shut/ suspend all the banks and financial institutions.

Here is a perfect example of ‘regulatory bomb’:

Since 1978, Yale Law School has required recruiters to sign a promise of non-discrimination against students based on their gender. Most recruiters had no trouble doing so, but the military had a problem because the military explicitly prohibited gays and homosexuals from being recruited. As a result, the United States military was unable to engage in the recruitment process for many years.

However, following the terrorist attacks in September 2011, Congress (the legislative branch) granted the Department of Defence the authority to withhold all federal funds from the institution if the university refused to allow the military to recruit.

This meant that if Yale Law School’s practises did not alter, it would lose $300 million in government support each year.

When the Department of defence realised Yale would not back down, it issued an ultimatum to the law school, essentially requesting that the law school allow the military to recruit or lose all federal money. Yale attempted, but failed, to argue its way out of this. In 2007, Yale Law School eventually succumbed and permitted the military to recruit from its law school, ending their years of game.

Thus, it is important to understand that the regulators know their game really well and we should not take it lightly. And the easiest way to face the regulators is to be ethical – follow the rules and be on the right side. Otherwise, the regulators will play their game with you and you would not like the end.  

To conclude, I would like to end this blog by asking you, my dear readers, where do you notice the game theory in your regular routine? And if you wanted to experience game theory, what game are you most likely to play – is it a corporate game of price setting and deals or will it be a legal game of courtroom and regulator taking decisions. Also, how do you think the game will turn out?

MIT – WPU Scholl of Economics, BSc ( Honours – Economics)