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Princeton's John Nash earned the Nobel prize in economics for his work in game theory, a method of strategic thinking. Nash was portrayed by Russell Crowe in the 2001 movie A Beautiful Mind.
Fortunately, you don't need a Ph.D in economics to apply basic game theory in everyday life.
Below are five different ways to use game theory in every day life to earn or save more money.
In Salary Negotiations
Since receiving an increase in salary often affects other salaries in the company, more people are involved and these types of games are more complex than simple one on one negotiations. The more people involved the more difficult it is to negotiate, so breaking negotiations down to one partner and using game theory with him is advised rather than attempting to negotiate with multiple people.
In order to attain a higher salary in negotiations using game theory, one must attempt to minimize risk, make the first offer, beware of precedence, have credibility, maintain continuity, and have a reciprocal relationship with the partner being negotiated with.
There first must be a need for your services, so you cannot simply receive a raise just because you want one. But if you are up for a raise and in negotiations, you can work down the chain at the potential responses from your employer and have a counter-argument ready for each. You must know the partner well and understand the path to the optimal amount you are seeking.
Read more at DigitalTonto
To Save Money When Buying A Car
As we posted yesterday, game theory can be used to purchase a car at a much cheaper price than simply going to a dealership and haggling with a car salesman.
Finding each dealership that has the car you are looking for in a given radius is the first step. Then calling each and stating that you will buy from whichever dealer gives you the lower price at a certain time is the next step. The dealer will then say that he does not negotiate over the phone, but you respond by saying that you know negotiations are done over the phone because you know many deals that have been agreed to over the phone. He then will attempt to beat the other dealers by going to a lower price than he would in a normal situation.
A professor at NYU has said this method has worked for him in 11 different car purchases.
Watch the strategy on Business Insider
To Make Money In The Markets
Using risk arbitrage in order to make a profit is a way to exploit game theory in the markets.
Suppose company A (the “acquirer”) offers to swap one of its shares for every two shares of company T (the “target”). A’sstockis selling for $50 per share and B’s stock was selling for $20 per share before the offer. Therefore, T’s shareholders should all accept the deal, and the value of B’s stock should rise to $25. If T’s shares rise only to $24, it presents a merger arbitrage opportunity. Investors can buy two shares of company T for $48, short one share of company A to get $50. They can then swap their two T shares for one A share, use that to cover their short, and have $2 riskless profit.
Risk arbitrage, or merger arbitrage, is the simultaneous purchase of stock in a company that has announced that it will be acquired along with the sale of the company that has announced the acquisition.
Read more at Business Insider
In Real Estate Negotiations
Even if unaware, game theory is often present in real estate negotiations. Most negotiating moves are previously understood in real estate negotiations, which makes the game a bit more clear than in other situations. However, in multi-offer deals, the situations change immensely.
If you have submitted a bid and the real estate agent then announces that you are in a multi-offer situation, you are left with three choices.
You can keep your original offer, withdraw your offer, or offer a higher price. Since the winner on the bid will probably have to overbid in order to win, the latter choice is necessary in order to win. You should then bid exactly the number that you have calculated it to take in order to win the bid on the home.
If someone overbids and beats you, you have done your due diligence and calculated that you made the optimal play. In essence, even though you lost, you did everything correctly and should not be upset that your bid was not the winning one as you made no incorrect decisions in the process.
Read more at Meyers North Shore
In Fantasy Sports
Millions of people play fantasy sports and often for a cash prize at the end of season. A replacement-level draft strategy involves assigning a certain value to each player. Using online projection systems or your own system if you are so inclined, you then assign the expected value worst projected starter at any position. For instance, if you have a 10 team fantasy football league and expect Joe Flacco to be the 20th quarterback and achieve 100 fantasy points, replacement level would be 100 points. If you are attempting to calculate Aaron Rodgers's value above replacement, you then subtract his projected points by 100.
Fantasy football is an N-player game, meaning there are more than two players participating.
"N-player games cannot be 'solved' the same way as 2-player games can, as I demonstrated with the example of the run-pass balance problem. But in game theory, there is usually a 'minimax' solution to zero-sum games. Also known as a Nash equilibrium, the minimax solution is the strategy with the maximum assured minimum gain for a player. (Technically, it's the strategy that minimizes the opponent's maximum possible score, which is effectively the same for a zero-sum game.)"
With this strategy in place, you simply take each player with the highest value over replacement player available. This should net you a near optimal team based on projections.
While the chances are high that not every player will be using the value over replacement method during the fantasy draft, you can alter your rankings to include the next best available player after evaluating the quality of the league's participants.
Read more at Advanced Football Stats
In bluffing at a not too often but not too infrequent pace, game theory can be used to help get an edge in a poker game. First make sure the odds you are getting are equal to the odds your opponent gets in the pot, and if done at the correct odds you would be taking advantage of any decision your opponent makes.
Much like in the real estate example, playing your hand the optimal strategy is always the best decision, in game theory. While you may not always end up with the winning hand despite entering with the best odds, making the calculated optimal decision throughout the hand is always recommended.
Basically, study the odds of poker and play the odds, and even if you lose trust that you played the hand correctly rather than continually altering your style to fit situations. Going with the optimal strategy is expected to yield the best results more often than not, even though the optimal strategies may sometime lead to lost hands.
Read more at Odds Checker
If you are looking to auction off an asset, say an art piece, then deciding on which type of auction you use is important. There are several different ways to set an auction, but William Vickrey of Columbia University recommends using a second-prize auction to maximize your return. In this auction, each participant bids in a sealed number and the highest bid wins.
However, the highest bid does not pay the highest bid price, he pays the second highest bid price. This creates an incentive for participants to bid higher but they often spend more than they would like on the asset. In doing this, you are optimizing your potential return by forcing the bidders to offer more than they would in a normal, highest bid wins and pays that bid situation.
Read more at Beyond Discovery
Game Theory: How to Make Better Decisions - YouTube
The Prisoner's Dilemma is the most well-known example of game theory. Consider the example of two criminals arrested for a crime. Prosecutors have no hard evidence to convict them. However, to gain a confession, officials remove the prisoners from their solitary cells and question each one in separate chambers.
Game theory is a framework for understanding choice in situations among competing players. Game theory can help players reach optimal decision-making when confronted by independent and competing actors in a strategic setting.
Game theory studies interactive decision-making, where the outcome for each participant or "player" depends on the actions of all. If you are a player in such a game, when choosing your course of action or "strategy" you must take into account the choices of others.
- Game Theory: Stanford University.
- Game Theory II: Advanced Applications: Stanford University.
- Welcome to Game Theory: The University of Tokyo.
- Social and Economic Networks: Models and Analysis: Stanford University.