Economics Game Theory Game Theory Is a Essay

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Economics

Game Theory

Game theory is a model that can be used to examine and explain the way that different actors in a given situation may choose to act and develop strategy, using a mathematic approach. The model looks at how players will make decisions which will be based on both the firms own position and resources as well as the way their competitors are or are expected to act. Game theory can therefore be used to help try and identify the optimal course of action (McEachern, 2009).

There are many scenarios where Game Theory will be useful; in the commercial environment game theory is most applicable in oligopoly situations

To consider the application of the theory the concept needs to be described. The situation examined is a game. For there to be a game players are required; these are the firms (Nellis and Parker, 2006). For a game to commence there need to be at least two players making decision which will impact on each other. Each set of decision made by the players is referred to as the payoff (McEachern, 2009). An effective way of examining game theory is to look at an example and the way decision impact on the different players. A good example may be the airline industry, where there are only a limited number of airlines travelling each route.

In this example there will be two airlines, Airline A and Airline B, travelling the same route.

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It is assumed they are both flying the same route. Airline A wants to increase their profit, as they know that the passengers like the loyalty program they are considering increasing their investment. Enhancing the loyalty program will increase costs, but the firm also believes that this will also attract more customers, which will create more profit. Therefore, the decision to be made is whether or not to invest in a loyalty scheme.

If Airline A invests in their loyalty scheme it is likely they will gain more business, which will result in Airline B. loosing passengers. If this occurs Airline B. is then likely to invest in their own loyalty program to try and regain the lost customers from Airline A. The net result may be that both airlines have increased their costs by investing in the loyalty schemes, but do not have a net gain, as they have both followed the same strategy.

In game theory there is the ability to look forward at the way the game will play out, in stages, and determine the potential net result (Nellis and Parker, 2006). In this scenario it may be argued that the best course of action would be for the two airlines to reach an agreement where they can protect their profits and avoid….....

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