Economic Foundations of Strategy Power Point Set #02b: Game Theory

Game Theory and Strategy Prisoners’ Dilemma Game Row Silence Fink Column -1 -10 -8

Game Theory and Strategy Prisoners’ Dilemma Game Row Player: Dominant Strategy: Fink Column Player: Dominant Strategy: Fink Dominant Strategy (Nash) Equilibrium: (-8, -8) Note: It is a dilemma since if they both cooperated by remaining silent: (-1, -1). -1 -10 -8

Game Theory and Strategy The Prisoners’ Dilemma Game can occur in many contexts: What is best for an individual may not be best for a division; What is best for a division may not be best for a firm; What is best for a firm many not be best for an industry; What is best for an industry may not be best for a nation; and What is best for a nation may not be best for the world.

Game Theory and Strategy Now that we have learned the concept of dominant strategy equilibrium, there is a second important equilibrium concept called a Nash equilibrium. Note: All dominant strategy equilibrium are Nash equilibrium, but not all Nash equilibrium are dominant strategy equilibrium.

Game Theory and Strategy Game with no dominant strategy equilibrium, but a Game with one Nash equilibrium: Row Cooperate Fink Column 5 4 1 9 -1

Game Theory and Strategy A cooperative game with conflict Game with multiple (two) Nash equilibria Man Prize Fight Ballet Woman 2 -1 1 -5

Game Theory and Strategy Suppose this game were played sequentially? Would it be better to go first or second? Man Prize Fight Ballet Woman 2 -1 1 -5

Game Theory and Strategy Would you want to move first or second? Man Prize Fight Ballet Woman 10 100 20 4 90 30 8 6

Game Theory and Strategy Joint Venture GM Cooperate L. Race Toyota 112 123 58 91

How Can “Commitment” Affect A Competitor’s Response? Commitment = An Irreversible Action (Sunk Costs) GM Cooperate L. Race Toyota 112 123 -28 58 91 -51

How Can “Commitment” Affect A Competitor’s Response? Mutual sunk cost commitments GM Cooperate L. Race Toyota 112 -28 58 -51

Game Theory and Strategy Lessons #1: Commitment (sunk costs) can be used to achieve cooperation. The importance of mutual economic hostages: The wise manager should think beyond Machiavelli’s myopic approach to contracting and should seek both to give and receive credible (sunk cost) commitments that facilitate ongoing relationships and adaptation.

Game Theory and Strategy Initial Game (played simultaneously) Airbus No Launch Launch Boeing 400 300 200 -100 -200

How Can “Commitment” Affect A Competitor’s Response? Commitment = An Irreversible Action (Sunk Costs) Competition In The Commercial Aircraft Industry Airbus No Launch Launch Boeing 400 300 200 -100 -200

Game Theory and Strategy: Lessons #2 2. Commitment (sunk costs) can be used to achieve competitive advantage. Preemption strategy