Strategic Decision-Making: Game Theory and Prospect Theory Analysis

This essay provides a comparative analysis of game theory and prospect theory, two prominent frameworks used in strategic decision-making. Game theory, focusing on rational actors and strategic interactions, is contrasted with prospect theory, which emphasizes how individuals make decisions under risk and uncertainty, often influenced by cognitive biases. The essay highlights the core differences in how each theory approaches decision-making, considering factors such as risk aversion, loss aversion, and framing effects. While game theory assumes rationality, prospect theory acknowledges the psychological aspects of decision-making, particularly in situations involving potential gains and losses. The essay also discusses the limitations of each theory, concluding that prospect theory offers a more nuanced understanding of real-world decision-making processes, especially in the context of strategic management. The essay uses references to support its arguments and provides a comprehensive overview of the two theories' strengths and weaknesses.

Running head: STRATEGIC DECISION-MAKING—COGNITIVE BIAS
STRATEGIC DECISION-MAKING—COGNITIVE BIAS
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Author Note

1STRATEGIC DECISION-MAKING—COGNITIVE BIAS
Game theory generally refers to the study of the matters that are related to the strategic
decision making at the basic levels. The prospect theory on the other hand deals with the ways in
which people choose between several options wherein the probable outcome is known. The
following essay attempts a comparison between the two theories. The game theory is actually
known to have been offering the perspectives that are useful in case of the strategic choices.
The game theory is often defined as the numerical study of the several numerical models
dealing with the competitions as well as the participation of the leaders who tend to demonstrate
knowledge and intelligence. The game theory suggests that people tend to demonstrate the
differences in the choices that are presented to them within the different situations that they
might face. The game theory is generally observed to have been looking into the various ways of
the strategic interaction that is faced by the concerned people in terms of the preferences that are
demonstrated by the concerned people (Murphy, 2017). The game theory tends to put forth an
assumption of the fact that there is a rationality factor that helps the concerned person in making
a decision. The game theory further states that the concerned person attempts to undertake the
best possible measures for the development of the best results that are to be received from the
implemented techniques.
The prospect theory on the other hand attempts a discussion on the ways in which the
people think and work. The propounders of the theory state that it is one of the general
tendencies of the human beings to undertake the decisions at times when they are faced with the
stress and losses rather than the issues that at the times when they might be going through the
situations of gain that they have been going through. The theory further states that people face a
huge psychological setback when they encounter the losses and thus tend to be willing towards
the risk taking in order to achieve the required success in the given field (Frydman & Camerer,

2STRATEGIC DECISION-MAKING—COGNITIVE BIAS
2016). The researchers of the prospect theory further state that the human brain responses
strongly to the possible losses as compared to the reaction that it provides in case of the possible
gains (BBC Horizon, 2016). The process of choosing undertaken by the human brain is known to
be completed in two different phases. The first phase is framing which is followed by the phase
of valuation.
The major areas of contrast between the two theories deal with the issues that are related
to the ways of dealing with the responses to the choices that the person needs to undertake in the
due course of his lifetime. The game theory suggests that the people generally tend to deal with
the choices on the basis of the probable outcomes of the actions. The game theory has a greater
number of disadvantages due to the fact that the theory does not take into consideration the fact
that all the people are not aware of the strategic decisions that should be undertaken in order to
deal with the given situations (Murphy, 2017). On the other hand, the prospect theory sheds
major light on the inclination of the people to undertake the proper decisions at any given point
of time on the basis of the risks that are presented within the given scenario.
Thus, from the above discussion, it might be pointed out that the prospect theory is often
considered to be the best in terms of the strategic management decisions that are undertaken
people in response to a certain scenario.

3STRATEGIC DECISION-MAKING—COGNITIVE BIAS
References
BBC Horizon. (2016). BBC Documentary - How You Really Make Decisions - BBC Horizon -
Video Dailymotion. Retrieved from https://www.dailymotion.com/video/x3q4alx
Frydman, C., & Camerer, C. F. (2016). The psychology and neuroscience of financial decision
making. Trends in cognitive sciences, 20(9), 661-675.
Murphy, P. (2017). Game theory as a paradigm for the public relations process. In Public
relations theory (pp. 173-192). Routledge.