Game Theory Models

Game theory is an approach to modeling behavior in situations where the outcome of your decisions depends on the decisions of others. Game theory is the study of strategic, interactive decision making among rational individuals or organizations.

The classic example of game theory is the Prisoner’s Dilemma, where two suspects are in police custody as accomplices for the same crime, but there is not enough evidence for a felony conviction. They are held and interrogated separately. If one prisoner testifies against the other while the other stays silent, the testifying prisoner goes free and the silent prisoner is convicted and serves ten years. If both prisoners stay silent, both are convicted on a minor charge and serve six months. If both prisoners testify against each other, each serves five years. How should the prisoners act? (The answer is that both prisoners should testify against the other, an outcome that is known as a Nash equilibrium.)

Game theory provides a mathematical framework for understanding the optimal outcome and what the tradeoffs are to achieve that outcome. We build models using game theory to help our clients make strategic and tactical decisions within the context of many possible scenarios and competitive responses.

Case Study: One of our clients had a drug with dominant market share in a therapeutic area that is competitive, yet has few players. One of their competitors was behaving aggressively from a pricing perspective (e.g., continually matching and beating the client’s price, even though the competitor gained little or no market share from such actions). The competitor was in the process of running a clinical trial to improve their product’s label. Our client wished to know how the competitor might behave depending on our client’s next price move and the outcome of the clinical trial. The conclusion of the exercise was that engaging in a price war would not benefit any of the competitors. Therefore, keeping the price high and trading “market share for peace” would be the most profitable strategy.

Slides 2

For more information, please download the Game Theory Approach (pdf).

 

Unknown

Return to Decision Analysis & Modeling