Two competing coffee shops, Cafe A and Cafe B, are deciding whether to offer a discount on their drinks. If both shops decide to offer a discount, they will each make a modest profit. If neither offers a discount, they both maintain higher profits. However, if one offers a discount while the other does not, the discounting shop will attract more customers and significantly increase its profit while the other will lose customers. How does this scenario illustrate the principles of Game Theory?

This scenario illustrates Game Theory by showing how the decisions of Cafe A and Cafe B affect each other's outcomes. Both cafes must consider not only their own profits but also what the other cafe might do. If both offer discounts, they end up sharing a smaller profit, which is a stable but not the best outcome. If one cafe chooses to offer a discount while the other does not, the discounting cafe gains more customers and profits, while the other loses out. This situation highlights the strategic thinking involved in decision-making, as each cafe must weigh the risks and benefits of their choices based on what they expect the other to do.