WHAT IT IS:

Game theory is a tool used to analyze strategic behavior by taking into account how participants expect others
to behave. Game theory is used to find the optimal outcome from a set of choices by analyzing the costs and
benefits to each independent party as they compete with each other.

Under Game Throry There Are Two Approcaches

1.ZERO SUM GAME THEORY

2.NON ZERO SUM GAME THEORY

What is a 'Zero-Sum Game'

Zero-sum is a situation in game theory in which one person’s gain is equivalent to another’s loss, so the net
change in wealth or benefit is zero. A zero-sum game may have as few as two players, or millions of
participants.

Zero-sum games are found in game theory, but are less common than non-zero sum games. Poker and gambling
are popular examples of zero-sum games since the sum of the amounts won by some players equals the
combined losses of the others. Games like chess and tennis, where there is one winner and one loser, are also
zero-sum games.

In game theory, the game of matching pennies is often cited as an example of a zero-sum game. The game
involves two players, A and B, simultaneously placing a penny on the table. The payoff depends on whether the
pennies match or not. If both pennies are heads or tails, Player A wins and keeps Player B’s penny; if they do
not match, Player B wins and keeps Player A’s penny.

This is a zero-sum game because one player’s gain is the other’s loss. The payoffs for Players A and B are
shown in the table below, with the first numeral in cells (a) through (d) representing Player A’s payoff, and the
second numeral Player B’s playoff. As can be seen, the combined playoff for A and B in all four cells is zero.

NON ZERO SUM GAME :-

most transactions or trades are inherently non zero-sum games because when two parties agree to trade they do
so with the understanding that the goods or services they are receiving are more valuable than the goods or
services they are trading for it, after transaction costs. This is called positive-sum, and most transactions fall
under this category.

Application of non sum Game Theory in Business Model Development!

The application of game theory outside of a firm – An Example

The diagram below shows a simple matrix containing various sets of strategies. A set contains two approaches,
one from you (in black) and the other by your competitor (in blue). While other factors are assumed constant
and negligible, suppose both you and your only competitor decide to spend money on advertisement campaigns.
This results, in relatively modest payoffs of $400,000 for each (see the payoff pattern 4, 4).

Such set of decision strategy is known as Nash Equilibrium which implies neither entity can improve its profit,
by changing its own strategy alone involving an interdependence of actions. Jon Forbes Nash explained this
concept in 1950’s. Furthermore, it’s visible in the famous Prisoners’ Dilemma.

As another strategic possible measure, you and your competitor do not decide to advertise, get a payoff of
$600,000 (see the pattern 6, 6). Remember that in some situations, no advertisement policy may result in
reduced expenses, and that’s why more profit.

In the case, when, either you or your competitor alone decide to advertise, earn $500,000 payoff on it. If you
don’t promote, you have to bear a loss of -$500,000, assuming your competitor utilizes your decision
consequence as his/her opportunity (see the pattern -5, 5). In the very same way, if you advertise but your
competitor does not, he/she has to suffer a loss of -$500,000 (see the pattern 5, -5).

The application of game theory inside a firm – An Example

For a layman, the initial concept of the game theory might look like just as a strategic tool to boost competitive
abilities of a firm against its competitors only. Actually, it can also be successfully applied inside a firm, in the
perspective of considering various internal stakeholders of a firm as players. One playing against another!
Here is an exciting example of an application of game theory where two internal entities of a firm “playing” the
game against each other. Remember, the purpose of each player is to “win” against the other. The strategies
adoption to bring down the rival player is purely motivated because of a simple fact if one wins the other loses;
(nobody wants to lose).

Let’s get back to the example.

We have two players in this game. The player A, a manager and the player B, workers. The manager’s objective
is to increase workers efficiency. His gain lies in the better productivity of the workers. On the other hand,
workers “gain” is in reduced efficiency assuming a lower efficiency level benefits them.

The manager wants to make workers more efficient without monitoring them because it incurs cost as well as
it’s a necessary evil. However, the workers perceive monitoring threat as it compels them to work more along
knowing, it’s also a weakness of the manager due to its extra costs.

The probability of opting monitoring depends upon the “gains” of workers in the form of reduced efficiency. In
the same way, the likelihood of reduced effectiveness depends on how much it costs to the manager to monitor
the workers. If the workers’ gains are greater, or if the expenses for the manager for monitoring them are great,
the probability of reduced efficiency will increase as well. The game begins!

The possible results can be in the following four situations of:

Win-Win

Win-Lose

Lose-Win

Lose-Lose

Note: For the sake of simplicity take the table above as a scoreboard; black digit representing manager
achievement and blue ones as workers’. The purpose is to understand comparative advantage or disadvantage
through quantitative approach.

In the case of no Monitoring:

If the manager does not monitor and workers reduce efficiency, manager get -2 and workers gains by +8. This is
win situation for the player B i.e. the workers and a loss for the manager.
Suppose workers remain efficient even without monitoring, their gain reduce to +4 from +8. Don’t confuse
yourself here by thinking, why the heck they remained efficient without monitoring. Take it just as a possibility
(even if there is 0.000001% chance of such occurrence). It’s a lose situation for the workers and a winning for
the manager.

In the case of Monitoring:

If the manager monitors but still workers don’t perform well, he faces a colossal loss as he has not only suffered
monitoring cost, but also the reduced efficiency of the workers expressed as -8 for manager and 0 for workers.

The win-win situation lies in +4, +4. The manager monitors and the workers perform their duties well.