1. MANAGERIAL ECONOMICS 12th EditionBy
Mark Hirschey

2. Game Theory and Competitive Strategy
Chapter 14

3. Chapter 14 OVERVIEW Game Theory Basics Prisoner’s Dilemma
Nash Equilibrium
Infinitely Repeated Games
Finitely Repeated Games
Game Theory and Auction Strategy
Competitive Strategy
Pricing Strategies
Non-price Competition

4. Chapter 14 KEY CONCEPTS game theory zero-sum game positive-sum game
negative-sum game
cooperative game
sequential game
look ahead and extrapolate back
simultaneous-move game
equilibrium outcome
game-theory strategy
payoff matrix
Prisoner’s Dilemma
one-shot game
repeated game
dominant strategy
secure strategy
Nash equilibrium
randomized strategies
Nash bargaining
infinitely repeated game
finitely repeated game
trigger strategy
end-of-game problem
multistage games
first-mover advantage
English auction
winner’s curse
sealed bid auction
Vickrey auction
Dutch auction
competitive advantage
comparative advantage
limit pricing
predatory pricing
customer lock-in effect
network externalities
market penetration pricing
non‑price competition

5. Game Theory Basics Types of Games Role of Interdependence
Zero-sum game: offsetting gains/losses.
Positive sum game: potential for mutual gain.
Negative-sum game: potential for mutual loss.
Cooperative games: joint action is favored.
Role of Interdependence
Sequential games involve successive moves.
Simultaneous-move games incorporate coincident moves.

6. Prisoner’s Dilemma Classic Riddle Business Application
Rational individual behavior can give suboptimal group result.
Rationality can hamper beneficial cooperation.
Business Application
Dominant strategy gives best result regardless of moves by other players.
Secure strategy gives best result assuming the worst possible scenario.

7. Nash Equilibrium Nash Equilibrium Concept Nash Bargaining
Neither player can improve their payoff through a unilateral change in strategy.
Nash equilibrium concept is broader than the concept of a dominant strategy equilibrium.
Every dominant strategy equilibrium is also a Nash equilibrium.
Nash equilibrium can exist where there is no dominant strategy equilibrium.
Nash Bargaining
Any haggling over valued item.

8. Infinitely Repeated Games
Role of Reputation
Infinitely repeated games occur over and over again without boundary or limit.
Firms receive sequential payoffs that shape current and future strategies.
Reputations for high quality give consumers confidence for repeat transactions.
Product Quality Games
In a one-shot game, poor quality can fool customers.
In an infinitely repeated game, poor quality is shunned by customers.

9. Finitely Repeated Games
Uncertain Final Period
Finitely repeated games have limited duration.
With end point uncertainty, a finitely repeated game mirrors an infinitely repeated game.
End-of-game Problem
Enforcing end-of-game performance is difficult.
Solution: simply extend the game!
First-mover Advantages
Benefits earned by the player able to make the initial move in a sequential move or multistage game.

10. Competitive Strategy Basic Concepts Competitive Advantage
Effective competitive strategy involves search for uniquely attractive products.
Competitive Advantage
Unique or rare ability to create, distribute, or service products valued by customers.
Business-world analog to national comparative advantage.
When Large Size Is a Disadvantage
Nimble firms sometimes translate the benefits of small size into a distinct competitive advantage.

11. Game Theory and Auction Strategy
Auction Types
English auction winner is the highest public bidder.
Sealed-bid auction winner is the highest secret bidder.
Vickrey auction winner pays the second-highest sealed bid.
Dutch auction winner is the first party willing to pay the auctioneer’s price
Public Policy Implications
Auctions are a proven tool for marketing public resources.
Winners sometimes overpay (“winner’s curse”).

13. Pricing Strategies Limit Pricing Market Penetration Pricing
Limit pricing strategy sets less than monopoly prices to deter entry by competitors
Predatory pricing is pricing below marginal cost (rare).
Limit pricing is often confused with predatory pricing.
Market Penetration Pricing
Market penetration pricing sets very low (or zero) prices to create a new market or grab market share.
Objective is to gain a critical mass of customers, make network effects, and generate viable business.

15. Non-price Competition
Advantages of Non-price Competition
Non-price competition can be an effective means for growing market share and profitability.
Nonprice competition can be difficult to imitate.
Optimal Level of Advertising
Profit-maximizing level of non-price competition is found by setting activity MR = MC.
Set MRA = MCA to determine optimal advertising.