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62. Behavioral Economics Foundations: Game Theory

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If you’ve been listening to the podcast for a while, you already know that humans aren’t rational (and, honestly, you probably know that just from being a human person too). And the base of economic theory would often incorrectly predict behavior because it assumes logical people making rational choices.  Because humans do not behave this way in practice, new theories needed to be developed which accounted for these irrational choices. And in game theory, it is exactly the same. We humans don’t always make choices that are fully rational. We try to game the system or play the odds. This episode is all about game theory and how it can help your business. We will dig into three basic games: the dictator game, the ultimatum game and the prisoner’s dilemma.  And if you haven’t checked out last week’s episode, it was all about color theory and what really matters when using colors in your business and your brand.

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Show Notes:

  • [03:21] If you’re wondering, Game Theory actually has a lot to do with business.
  • [03:41] Humans aren’t rational. Basic economic theory would predict behavior incorrectly, because it would assume logical people are making rational decisions.
  • [03:45] Since humans aren’t rational, new theories needed to be developed.
  • [05:06] Downton Abbey and Survivor are great examples of game theory in action.
  • [05:22] In behavioral game theory, we need to consider how revenge, fairness and personal gain all play into the outcomes. Three main games that are often used in game theory are the ultimatum game, the prisoner’s dilemma, and the dictator game.
  • [05:38] We start with the dictator game. What it is and how different scenarios can impact your behavior or decision. 
  • [08:38] The ultimatum game is similar, but the second person has an option to respond to the offer. If they reject, both get nothing.
  • [10:18] History has a lot to play in the actions people take, and existing relationships help determine actions.
  • [11:04] The human component – knowing you are playing against a person who is profiting from your situation – has a big impact on the way people respond.
  • [11:57] Think about how the anchor shifts when you have power versus when you don’t.
  • [12:33] It’s important to understand who has what power in each situation when you determine what to offer and think about how they might react.
  • [13:11] Even when money is not changing hands, the process of buying and selling is exactly the same. Other items of value can be bartered. The way people react changes based on the power or belief they have.
  • [13:22] This is worth considering as you put offers out to people and are wondering how they may respond or act. Are you putting power in their hands that makes a generous offer seem stingy?
  • [14:02] In your business, you aren’t limited to the lab style test – your clients know who you are and what you are offering them.
  • [15:29] If you give something, people want to give back (reciprocity).
  • [16:10] The last game is the prisoner’s dilemma. 
  • [17:41] The shifting anchor impacts the position someone takes. Saying something may feel like a win win (even though it often isn’t). 
  • [19:57] The best overall strategy for the extended prisoner’s dilemma is a tit-for-tat strategy in which you cooperate until someone defects then you respond in kind.
  • [21:41] Most of us would likely plan to play fair. Do you expect the same kindness and fairness in others? How does the story you tell yourself about what they think influence your actions? How would your strategy be influenced by the look of the person? 
  • [22:48] Game theory applies in all sorts of business situations. Obviously, this applies in negotiations with potential partners.
  • [23:37] Humans are emotional, and it is not just in the after-the-fact stuff…the thoughts and “what ifs” before a negotiation starts can always influence actions much more than we may think.
  • [23:57] Always have written contracts and agreements.
  • [24:19] Negotiating terms in a cold state is so much better than not doing your due diligence.
  • [24:38] Another example of how this impacts business is in advertising.
  • [26:21] There are countless examples of game theory – it is truly all around us all the time. Pretty much any time you interact with another person or business or entity, game theory comes into play.
  • [27:21] Buying in at the bottom of a recession is game theory in action. It’s all based on what you expect other people will do and how you choose to react to it – before and after the fact.
  • [29:47] The YouTube example of United Breaks Guitars which is the ultimate customer revenge. 
  • [32:15] When emotions take hold, it can cause people to make bad decisions that they may regret in the long run, so try and get some distance and perspective before acting…especially if you feel really betrayed and angry.
  • [32:49] Perspective lets you look at the game in a whole different way and play by the real rules.
  • [33:15] The last point I want to make is this: when it comes to games, many people are playing not to lose, instead of playing to win.
  • [33:47] When you play to win – in games, life or business – you know it is a long game and have a calmer approach. You understand the rules backward and forward. This is much more effective than playing not to lose.
Thanks for listening. Don’t forget to subscribe on Apple Podcasts or Android. If you like what you heard, please leave a review on iTunes and share what you liked about the show. 

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