The MBA Curriculum : Game Theory

Fast Company in its latest issue covers Game Theory or the lack of Game Theory in Business.

What is Game Theory?

Avinash Dixit and Barry Nalebuff, authors of Thinking Strategically: The Competitive Edge in Business, Politics, and Everyday Life, [suggested to me by my previous boss, Rajesh Jain, as the best book for new readers on Game Theory] provide the definition which is the most easy to understand. I can say this because for writing this post I searched through a number of definitions including Wikipedia but was not successful in finding a simple definition.

Game theory is the science of strategy. It attempts to determine mathematically and logically the actions that "players" should take to secure the best outcomes for themselves in a wide array of "games." The games it studies range from chess to child rearing and from tennis to takeovers. But the games all share the common feature of interdependence. That is, the outcome for each participant depends upon the choices (strategies) of all.

I have yet to understand Game Theory, but whatever I have seen of it I am convinced that it is one of the compulsory 'mental models' in your tool kit.

Avinash Dixit and Barry Nalebuff on the essence of Game Theory:

Games are fundamentally different from decisions made in a neutral environment. To illustrate the point, think of the difference between the decisions of a lumberjack and those of a general. When the lumberjack decides how to chop wood, he does not expect the wood to fight back; his environment is neutral. But when the general tries to cut down the enemy's army, he must anticipate and overcome resistance to his plans. Like the general, a game player must recognize his interaction with other intelligent and purposive people. His own choice must allow for both conflict and for possibilities for cooperation.

The essence of a game is the interdependence of player strategies. There are two distinct types of strategic interdependence: sequential and simultaneous. In the former the players move in sequence, each aware of the others' previous actions. In the latter the players act at the same time, each ignorant of the others' actions.

Fast Company says that "Game theory is the fun-sounding branch of economics introduced in the 1940s by Hungarian genius John von Neumann and developed in the 1950s by Princeton's John Nash, subject of the 2001 Oscar-winning film A Beautiful Mind." A lot of people in world were introduced to the idea of Game Theory after the release of the book and movie, A Beautiful Mind, further showing the importance of the medium like popular fiction and entertaining, oscar winning movies.

Over to Fast Company :

Over the years, the status of game theory -- which describes the interactions of self-interested parties such as poker players and deal makers -- soared, and its insights were applied to fields as far-reaching as evolution, auctions, even counterterrorism. Playing along, we here at the CDU decided to find out just how much court time game theory gets in the big game of business. After all, it has been taught to almost every one of the some 2.5 million MBAs and economists in the United States alone. Surely, we thought, it would be a slam dunk to turn up dozens of examples of game theory applied in the real world.

Adopting our usual rigorous methodology, we set the following parameters. To count, an example must:

1. be an actual business situation where somebody used the insights of game theory;
2. have occurred within the past five years; and
3. involve real, live, actual companies -- not governments, nonprofit organizations, or Russell Crowe.

First, we scoured the literature. We selected a relevant portfolio of 40 publications and submitted our queries. We tried again. And again. And we found . . . nothing. There were plenty of mentions of government spectrum auctions, and A Beautiful Mind came up hundreds of times. Not quite what we had in mind.

Perhaps, we thought, the media just doesn't get it. Undaunted, we assembled a panel of 30 respected game theorists around the world, and we sent them a survey asking, "Can you think of any examples of real, live companies that have consciously applied game-theoretical concepts to a real business problem?"

The response was . . . a deafening chorus of head scratching.

"The short answer is, I don't know," said David Levine of UCLA. "Let me think about this," replied MIT's Muhamet Yildiz.

Others on our expert panel, while not offering up any actual, you know, examples, were willing to speculate on why they couldn't. Traditional game theory "prescribes a lot of advice that does not actually seem to work," admitted Paul Bartha of the University of British Columbia. Why not? Maybe because "the sorts of situations that would allow the application of formal methods are so simple that people can understand them without much help," suggested the University of Minnesota's Andy McLennan.

Does that mean game theory is just, um, common sense? "Game theory gives you a nice systematic way to think about strategy, but it's not magic," agreed Hal Varian, an economist at the University of California at Berkeley and coauthor of the bestselling Information Rules (Harvard Business School Press, 1999). Or, as MIT's David McAdams put it, "Game theory is really a frame of mind and, once you have it, you see it everywhere."

Everywhere, perhaps, and nowhere.

In the end, none of our experts had a concrete example. But many offered the same advice: "Ask Preston McAfee" -- an economist at the California Institute of Technology and perhaps the country's foremost working game theorist (he designed that government spectrum auction). He was more encouraging: "There are lots of examples," he emailed, agreeing to an interview.

We reached the professor in his office at Caltech. "So," we asked, "what are all these examples of game theory applied to real life?" There was a silence on the line. "Well," he said, "a lot of companies hired game theorists to prepare for those spectrum auctions." Okay -- but what about nongovernment auction situations? "I don't know of any companies that employ pure game theorists -- but maybe they're keeping it quiet."

Very, very quiet.

This is indeed shocking that there was no example in the business world where Game Theory was used except government auctions in the last five years. It does show a paucity of the use of this branch of Mathematics.

Atanu Dey once told me this about the Prisoner's Dilemma, arguably, one of the most famous "game" in Game theory. I had trouble in understand and relating the prisoner's dilemma (not much improved still) and Atanu suggested that "fundamental concepts take sometime to understand. You need to train yourself to see them in various places. And once that becomes a habit you can see them everywhere, well almost."

I am not sure if the MBA Curriculum's currently use Game Theory or not, one thing is sure I am going to update my mental model with it.

Further Reading :

• The book, Thinking Strategically: The Competitive Edge in Business, Politics, and Everyday Life by Avinash Dixit and Barry Nalebuff.


• A good Intro article by the same authors in Econ Library.


• Good set of links from the Math Forum.


• GameTheory.net - A resource for educators and students.