Game Theory

Simply put, game theory is the science of strategic thinking. A branch of applied mathematics and economics, game theory is used to analyze interactive situations with two or more “players” whose choices are interdependent. What one does affects what another will want to do, and vice versa, and the combination of their choices determines their respective “payoffs.”

The mathematical theory of games was first developed by John von Neumann and Oskar Morgenstern in the 1940s, but its applicability was limited to parlor games. John Nash, the subject of the 2001 Oscar-winning movie A Beautiful Mind transformed game theory into a more general tool that enabled the analysis of win-win and lose-lose scenarios, as well as win-lose situations. Nash enabled game theory to address a central question: should we compete or cooperate?

Game theory remains at the cutting edge of economic theory, with game theorists winning the Nobel Prize in Economics in 1994, 1996, 2005 and 2007. For his path-breaking dissertation that revolutionized economics and many other disciplines, Nash won the Nobel in 1994, along with game theorists John Harsanyi and Reinhard Selten. William Vickrey won the Nobel in 1996 for his pioneering work in incentives, asymmetric information, and auction theory, all crucial to the advance of effective strategy in a world of influence – like chess, football, military strategy and business. Thomas Schelling and Robert Aumann won the 2005 Nobel for their game-theoretic work in conflict and cooperation, including contributions on credible commitments and repeated games. In the committee’s words, such contributions have made game theory “the dominant approach” to the analysis of conflict and cooperation. And most recently, Leonid Hurwicz, Eric Maskin and Roger Myerson won the 2007 Nobel prize for their work in mechanism design theory, a branch of game theory that extends the application of game theory to how different types of rules, or institutions, align individual incentives with overall social goals. Their work on allocation mechanisms has had a significant impact on the design of auctions, social welfare systems and many organizations.

For all these advances, practical business applications have emerged only recently. Early applications were too simplistic, too time-consuming, or too reliant on complex mathematics and black-box calculations. That is no longer the case. Strategic Gaming is straightforward, fast, intuitive, and powerful, and as such is the leading practical application of game theory.

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