Chapter 13 Game Theory and Competitive Strategy Topics to be Discussed  Gaming and Strategic Decisions  Dominant Strategies  The Nash Equilibrium Revisited  Repeated Games Chapter 13 Slide Topics to be Discussed  Sequential Games  Threats, Commitments, and Credibility  Entry Deterrence  Bargaining Strategy Chapter 13 Slide Gaming and Strategic Decisions  “If I believe that my competitors are rational and act to maximize their own profits, how should I take their behavior into account when making my own profit-maximizing decisions?”  Definition of a game Chapter 13 Slide Gaming and Strategic Decisions  Noncooperative versus Cooperative Games  Cooperative  Players negotiate binding contracts that allow them to plan joint strategies   Chapter 13 Game Example: Buyer and seller negotiating the price of a good or service or a joint venture by two firms (i.e. Microsoft and Apple) Binding contracts are possible Slide Gaming and Strategic Decisions  Noncooperative versus Cooperative Games  Noncooperative  Negotiation and enforcement of a binding contract are not possible   Chapter 13 Game Example: Two competing firms assuming the others behavior determine, independently, pricing and advertising strategy to gain market share Binding contracts are not possible Slide Gaming and Strategic Decisions  Noncooperative versus Cooperative Games  “The strategy design is based on understanding your opponent’s point of view, and (assuming you opponent is rational) deducing how he or she is likely to respond to your actions” Chapter 13 Slide Dominant Strategies  Dominant Strategy  One that is optimal no matter what an opponent does.  An Example  A & B sell competing products  They are deciding whether to undertake advertising campaigns Chapter 13 Slide Payoff Matrix for Advertising Game Firm B Advertise Advertise Don’t Advertise 10, 15, 6, 10, Firm A Don’t Advertise Chapter 13 Slide Payoff Matrix for Advertising Game  Observations   A: regardless of B, advertising is the best B: regardless of A, advertising is best Chapter 13 Firm B Don’t Advertise Advertise Advertise 10, 15, 6, 10, Firm A Don’t Advertise Slide Development of a New Aircraft   Boeing will produce Airbus will not produce Airbus Produce Produce Don’t produce -10, -10 100, 0, 100 0, Boeing Don’t produce Chapter 13 Slide Development of a Aircraft After European Subsidy Airbus Produce Don’t produce Produce -10, 10 100, Don’t produce 0, 120 0, Boeing Chapter 13 Slide Development of a Aircraft After European Subsidy   Airbus will produce Boeing will not produce Airbus Produce Produce Don’t produce -10, 10 100, 0, 120 0, Boeing Don’t produce Chapter 13 Slide Bargaining Strategy  Alternative outcomes are possible if firms or individuals can make promises that can be enforced. Chapter 13 Slide Bargaining Strategy  Consider:  Two firms introducing one of two complementary goods. Chapter 13 Slide Bargaining Strategy Firm Produce A Produce A Produce B 40, 50, 50 60, 40 5, 45 Firm Produce B Chapter 13 Slide Bargaining Strategy  With collusion:   Produce A1B2 Without collusion:  Produce A1B2 Firm Produce A Nash equilibrium Chapter 13 Produce B 40, 50, 50 60, 40 5, 45 Firm Produce B  Produce A Slide Bargaining Strategy  Suppose  Each firm is also bargaining on the decision to join in a research consortium with a third firm. Chapter 13 Slide Bargaining Strategy Firm Work alone Work alone Enter consortium 10, 10 10, 20 20, 10 40, 40 Firm Enter consortium Chapter 13 Slide Bargaining Strategy  Dominant strategy  Firm Both enter Work alone Work alone Enter consortium 10, 10 10, 20 20, 10 40, 40 Firm Enter consortium Chapter 13 Slide Bargaining Strategy  Linking the Bargain Problem  Firm announces it will join the consortium only if Firm agrees to produce A and Firm will produce B.  Chapter 13 Firm 1’s profit increases from 50 to 60 Slide Bargaining Strategy  Strengthening Bargaining Power  Credibility  Reducing Chapter 13 flexibility Slide Summary  A game is cooperative if the players can communicate and arrange binding contracts; otherwise it is noncooperative.  A Nash equilibrium is a set of strategies such that all players are doing their best, given the strategies of the other players. Chapter 13 Slide Summary  Some games have no Nash equilibrium in pure strategies, but have one or more equilibria in mixed strategies.  Strategies that are not optimal for a one-shot game may be optimal for a repeated game.  In a sequential game, the players move in turn. Chapter 13 Slide Summary  An empty threat is a threat that one would have no incentive to carry out.  To deter entry, an incumbent firm must convince any potential competitor that entry will be unprofitable.  Bargaining situations are examples of cooperative games. Chapter 13 Slide End of Chapter 13 Game Theory and Competitive Strategy [...]... 10 maximin strategy Chapter 13 Slide The Nash Equilibrium Revisited Maximin Strategy Maximin Strategy  If both are rational and informed  Both firms invest  Nash equilibrium Chapter 13 Slide The Nash Equilibrium Revisited Maximin Strategy Maximin Strategy  Consider  If Player 2 is not rational or completely informed  Firm 1’s maximin strategy is to not invest  Firm 2’s maximin strategy is to... profitable Chapter 13 Firm 2 Low Price Low Price High Price 10, 10 100, -50 -50, 100 50, 50 Firm 1 High Price Slide Repeated Games  Conclusion:  With  Chapter 13 repeated game The Prisoners’ Dilemma can have a cooperative outcome with tit-for-tat strategy Slide Repeated Games  Conclusion  Cooperation is difficult at best since these factors may change in the long-run Chapter 13 Slide Sequential Games... actions and rational reactions of each player Chapter 13 Slide Sequential Games  Examples  Responding  Entry decisions  Responding Chapter 13 to a competitor’s ad campaign to regulatory policy Slide Sequential Games The Extensive Form of a Game The Extensive Form of a Game  Scenario  Two new (sweet, crispy) cereals  Successful only if each firm produces one cereal  Sweet  Both Chapter 13 will... a repeated game  With each repetition of the Prisoners’ Dilemma, firms can develop reputations about their behavior and study the behavior of their competitors Chapter 13 Slide Pricing Problem Firm 2 Low Price Low Price High Price 10, 10 100, -50 -50, 100 50, 50 Firm 1 High Price Chapter 13 Slide Pricing Problem  Non-repeated game   Strategy is Low1, Low2 Repeated game  Tit-for-tat strategy is... maximin strategy, 1 would invest Chapter 13 Slide Prisoners’ Dilemma Prisoner B Confess Confess Don’t Confess -5, -5 -1, -10 -10, -1 -2, -2 Prisoner A Don’t Confess Chapter 13 Slide Prisoners’ Dilemma  What is the:    Dominant strategy Prisoner B Confess Don’t Confess Nash equilibrium Maximin solution Confess -5, -5 -1, -10 -10, -1 -2, -2 Prisoner A Don’t Confess Chapter 13 Slide Repeated Games ... standard (files encrypted by one software can be read by the other advantage to consumers) Chapter 13 Slide The Nash Equilibrium Revisited  Maximin Strategies  Scenario  Firm 1 has a much larger market share than Firm 2  Both are considering investing in a new encryption standard Chapter 13 Slide Maximin Strategy Firm 2 Don’t invest Don’t invest Invest 0, 0 -10, 10 -100, 0 20, 10 Firm 1 Invest Chapter. ..Payoff Matrix for Advertising Game  Observations    Dominant strategy for A & B is to advertise Do not worry about the other player Firm B Don’t Advertise Advertise Advertise 10, 5 15, 0 6, 8 10, 2 Firm A Don’t Advertise Equilibrium in dominant strategy Chapter 13 Slide Dominant Strategies  Game Without Dominant Strategy  The optimal decision of a player without a dominant strategy will depend on what... optimal decision of a player without a dominant strategy will depend on what the other player does Chapter 13 Slide Modified Advertising Game Firm B Advertise Advertise Don’t Advertise 10, 5 15, 0 6, 8 20, 2 Firm A Don’t Advertise Chapter 13 Slide Modified Advertising Game  Observations    A: No dominant strategy; depends on B’s actions B: Advertise Question  Firm B Don’t Advertise Advertise Advertise... Don’t invest Don’t invest Invest 0, 0 -10, 10 -100, 0 20, 10 Firm 1 Invest Chapter 13 Slide Maximin Strategy  Observations   Dominant strategy Firm 2: Invest Nash equilibrium  Firm 1: invest  Firm 2: Invest Chapter 13 Firm 2 Don’t invest Don’t invest Invest 0, 0 -10, 10 -100, 0 20, 10 Firm 1 Invest Slide Maximin Strategy  Observations   If Firm 2 does not invest, Firm 1 incurs significant losses... resources to introduce one cereal  Noncooperative Chapter 13 Slide Product Choice Problem Firm 2 Crispy Crispy Sweet -5, -5 10, 10 10, 10 -5, -5 Firm 1 Sweet Chapter 13 Slide Product Choice Problem  Question  Is there a Nash equilibrium?  If not, why?  If so, how can it be reached Firm 2 Crispy Crispy -5, -5 10, 10 10, 10 -5, -5 Firm 1 Sweet Chapter 13 Sweet Slide The Nash Equilibrium Revisited  . Chapter 13 Game Theory and Competitive Strategy Chapter 13 Slide 2 Topics to be Discussed  Gaming and Strategic Decisions  Dominant Strategies  The. Revisited  Repeated Games Chapter 13 Slide 3 Topics to be Discussed  Sequential Games  Threats, Commitments, and Credibility  Entry Deterrence  Bargaining Strategy Chapter 13 Slide 4 Gaming and Strategic. Microsoft and Apple)  Binding contracts are possible Chapter 13 Slide 6 Gaming and Strategic Decisions  Noncooperative versus Cooperative Games  Noncooperative Game  Negotiation and enforcement