Welcome to Professor Savings

We teach finance basics.

Hi I’m your host today Rayfil Wong

Today’s topic,

“What is Nash Equilibrium?”

Nash Equilibrium is a key concept of game theory that helps explain how people and groups approach decisions by using strategy.

Named after mathematician “John Nash”, the idea of Nash equilibrium has been used “Economics” and other industry fields.

Nash Equilibrium refers to a condition in which every participant has optimized its outcome, based on the other players’ expected decision.

For instance, let’s saw you have two bakers that have major market share of the cupcake industry in Sugarville.

Jane’s Cupcake and Jill’s Cupcake make 100,000 cupcakes at $1 each and earn an annual profit for $50,000.

Jane figured out that the market for cupcake is bigger and can make 200,000 cupcakes each year and reduce the price of each cupcake to 80 cents.

The profit will jump to $100,000 but the con is that Jill will execute the same strategy.

The market price will drop to 80 cents for Sugarville but since there are now 400,000 cupcakes available in Sugarville Jane’s cupcake profit would be $45,000 below

what she would have made if you only produced 100,000 cupcakes at $1 each for profit of $50,000

In reality, both Jane and Jill cupcakes are already in Nash Equilibrium since both bakeries would not make more money if they increased production.

There would be no benefit.

This example shows why game theory strategies look at decisions to optimize the profit with the least amount of productions.

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