Thinking Strategically: The Competitive Edge in Business, Politics, and Everyday Life.

Posted on November 19, 2007
Filed Under Books, Business & Entrepreneurship, Finance & Economics |

I just finished the book Thinking Strategically: the competitive edge in business, politics, and everyday life by Avinash K. Dixit and Barry J. Nalebuff. It is the single best narrative (non-math) introduction to game theory that I have ever read. Here is the epilogue from part I, which paints the big picture incredibly well:

“A game is a situation of strategic interdependence: the outcome of your choices (strategies) depends upon the choices of another person or persons acting purposively. The decision makers involved in a game are called players, and their choices are called moves. The interests of the players in a game may be in strict conflict; one person’s gain is always another’s loss. Such games are called zero-sum. But more typically, there are zones of commonality of interests as well as of conflict; there can be combinations of mutually gainful or mutually harmful strategies. Nevertheless, we usually refer to the other players in a game as one’s rivals.

The moves in a game may be sequential or simultaneous. In a game of sequential moves, there is a linear chain of thinking: If I do this, my rival can do that, and in turn I can respond in the following way….Such a game is studies by drawing the game tree. The best choices of moves can be found by applying Rule 1: Look forward, and reason backwards.

In a game with simultaneous moves, there is a logical circle of reasoning: I think that he thinks that I think that….This circle must be squared; one must see through the rival’s action even though one cannot see it when making one’s own move. To tackle such a game, construct a table that shows the outcomes corresponding to all conceivable combinations of choices. Then proceed in the following steps.

Begin by seeing if either side has a dominated strategy - one that outperforms all of that side’s other strategies, irrespective of the rival’s choice. This leads to Rule 2: If you have a dominant strategy, use it. If you don’t have a dominant strategy, but your rival does, then count on his using it, and choose your best response accordingly.

Next, if neither side has a dominant strategy, see if either has a dominated strategy - one that is uniformly worse for the side playing it than another of its strategies. If so, apply Rule 3: Eliminate dominated strategies from consideration. Go on doing so successively. If during the process any dominate strategies emerge in the smaller games, they should be chosen succesively. If this procedure ends in a unique outcome, you have found the prescriptions of action for the players and the outcome of the game. Even if the procedure does not lead to a unique outcome, it can reduce the size of the game to a more manageable level. Finally, if there are neither dominate nor dominated strategies, or after the game has been simplified as far as possible using the second step, apply Rule 4: Look for an equilibrium, a pair of strategies in which each player’s action is the best response to the other’s. If there is a unique equilibrium of this kind, there are good arguments why all players should choose it. If there are many such equilibria, one needs a commonly understood rule or convention for choosing one over the others. If there is no such equilibrium, that usually means that any sustematic behavior can be exploited by one’s rivals, and therefore indicates the need for mixing one’s plays.

In practice, games can have some sequential moves and some simultaneous moves; ten a combination of these techniques must be employed to think about and determine one’s best choice of actions. “

The book moves on after part one to talk about resolving the prisoners dilema, making credible commitments, being unpredictable, brinkmanship, cooperation and coordination, the strategy of voting and the role of incentives.

Here are the key takeaways:

1. Figure out if the game is simultaneous of sequential.  If it is both, then you must fit your strategy to the context.
2. Draw game trees in sequential games.
3. Draw game tables in simultaneous games.
4. To punish cheaters, make your threat credible.

If you are looking for a good introduction to game thoery that paints the big picture with plenty of real world applications, you will like this book.

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