Process PrimerGame Theory and Economic Decision Analysis |
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Game Theory and Economic Decision Analysis are very different approaches to strategic decision making, but are also very complementary to each other and can be used together in a synergistic and integrated process.
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Game Theory
Game Theory Analysis Process
The inputs to Open Options’ Game Theory Analysis are the Players (the parties involved in the issue), the Options (or actions) that each of them has and the Preferences (or how they feel about each of the options) each player has.
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Economic Decision Analysis
The inputs Decision Analysis Process are the Structure of the issue (influence diagram or decision tree), with the identified Options and external Uncertainties and decision variables. Uncertain future events are represented as Decision Trees or Probability Distributions. Decision Analysis models typically handle two to four actions (or decisions). The outcome is a recommended or preferred set of decisions for the Client, and the expected value in dollars of that set of decisions. Examples of external uncertainties that Economic Decision Analysis can be used to assess the impact of include:
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Which Approach Should I Use?
| Game Theory | Economic Decision Analysis |
| For issues where the critical driver is actions and preferences of other players. | For issues where the critical driver is a few quantifiable uncertain variables. |
| Where there are multiple value measures. | Where a single value measure such as dollars is feasible. |
| Typically about 15 hours of Client team involvement. | Typically longer enagements with weeks of Client interaction. |
| Typical models have millions of outcomes. | Typical models have a relatively small number of decisions. |
| A mathematically rigorous qualitative approach. | A mathematically rigorous quantitative approach. |
| Output is a strategic plan that accounts for multiple player interactions. | Output is a decision path that will ead to the best financial result. |
Can I Use Both Approaches?
While Game Theory and Economic Decision Analysis are both powerful tools to analyze a decision, it is possible to use both techniques in a reiterative, complementary way. As the diagram on the left illustrates, the outputs from one process can inform the inputs to the other. For example, the preferences of the players are critical inputs to Game Theory Analysis and can be informed and refined by using Economic Decision Analysis to examine external probabilistic uncertainties. Conversely, as Economic Decision Analysis is best at handling only a few key decisions, Game Theory Analysis can identify which decisions affect the final outcome significantly and are therefore the most important to model in depth.
A Simple Labor Relations Example
In an initial Game Theory Analysis, management strongly wanted to cut wages, was unconcerned with limiting early retirement and believed the financial impact of a short strike could be absorbed. Game Theory Analysis revealed that a strike was likely and that many workers would seek early retirement.
A subsequent Economic Decision Analysis revealed that the cost of a strike would be very high, but that allowing early retirement would be even more costly. Using the outputs of Economic Decision Analysis, management revised their preferences to strongly seek limits on early retirement and to be more averse to a short strike.
In this case, Game Theory Analysis was able to focus the Economic Decision Analysis on the key factors including early retirement which was not previously top of mind for management. With a tighter focus, Economic Decision Analysis was able to more quickly and more clearly identify the expected value of the alternative causes of action.
