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Game Theory in a Hot Dog Stand Duopoly

http://www.theinnovativemanager.com/game-theory-examples-location/

This is an interesting article about the applications of game theory in terms of business competition, specifically in regards to restaurant location. The author gives an example of two competing hot dog stands along a busy street. If there is only one hot dog stand, the business owner can place it wherever he wants along the street–in the example, he places it at the far west side of the street–because the workers have no choice but to visit the single hot dog stand that exists. However, if hot dog stand #2 enters the fray, the two competing hot dog stands will gradually inch more and more toward the middle of the street until they are back-to-back, and one hot dog stand dominates the entire east side of the street while the other hot dog stand dominates the entire west side of the street.

The result that is achieved, two similar hot dog stands right next to each other in the middle of the street, is known as the “Principle of Minimum Differentiation” and is a common strategy among companies selling commodity goods and services. All the competitors “inch toward the middle” so that there is very little resistance or switching cost to jump to one’s product from a competitor’s product, especially since the consumer has learned to accept a baseline set of characteristics from that specific goods market.

I think that this article ties in well with the game theory scenarios and strategies that we have been learning in class. Game theory is a great way to approach businesses that are competing over customers because you have multiple parties making decisions that affect their own well being, along with the well being of the competitors involved. However, unlike the examples we have in class, real-world businesses seldom have clearly-defined “payoffs” for each of their decisions, so businesses must use whatever financial data they have available to muster up a best guess. Real businesses also have to defend against unknown strategies, collusion by competitors, and other externalities–and it is hard to integrate all of these elements into a 2×2 matrix, but it is a good place to start.

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