Nash equilibrium can be observed in many business settings, particularly in situations where multiple firms are competing with each other.
Nash equilibrium is a game theory concept that defines a situation in which each player in a game has selected the optimum strategy in response to the tactics adopted by the other players. In other words, given the strategies of the other players, no player has the incentive to modify their strategy unilaterally in a Nash equilibrium.
Consider a market in which two firms, A and B, are competing to sell a particular product. Each firm has two pricing strategies available: a high price or a low price. The profits that each firm can earn from the different pricing strategies are shown in the following table:
In this game, the dominant strategy for both firms is to set a low price, regardless of what the other firm does. This is because setting a high price will result in lower profits for the firm, regardless of what the other firm does.
However, if both firms choose to set a low price, they will end up in a Nash equilibrium, where neither firm can increase its profits by unilaterally changing its strategy. This is because if either firm raises its price, it will lose market share to the other firm and end up with lower profits than if it had maintained a low price.
Therefore, in this example, the Nash equilibrium is for both firms to set a low price. This equilibrium represents a stable outcome, where neither firm has the incentive to change its strategy.
Nash equilibrium may also be used to finance, notably in the context of financial corporations’ strategic decision-making. Here are a couple of such examples:
Nash equilibrium provides a valuable framework for analysing financial organisations’ strategic decision-making and anticipating their behaviour in competitive scenarios.