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Chapter 9: Economics of Strategy: Game theory
Brickley, Smith, and Zimmerman, Managerial Economics and Organizational Architecture, 4th ed. Chapter 9: Economics of Strategy: Game theory
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Game theory learning objectives
Structure a simple game in both matrix and tree formats Specify a simple game Identify Nash equilibria Identify dominant strategies
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Game theory overview General analysis of strategic interaction
Optimal decision making when all decision agents are presumed rational each attempts to anticipate actions of rivals
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Simultaneous-move, non-repeated interaction
Rivals must make decisions with no knowledge of each other’s decisions Nonrepeated? The interaction occurs only once
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Example Boeing and Airbus individually choose and simultaneously submit a bid price (high or low) for 10 planes Each cell entry represents the payoffs A dominant strategy is one the firm chooses no matter what its rival does
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Strategic form dominant strategy
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Nash equilibrium revisited
In the absence of a dominant strategy, Nash equilibrium may predict outcome Nash equilibrium is set of strategies where firm does its best given rival’s actions Use arrow technique to identify Nash equilibrium
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Nash equilibrium
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Competition versus cooperation
Boeing and Airbus make simultaneous choices of new communications systems two technologies: Alpha & Beta both benefit with same choice Results in two Nash equilibria benefits from pre-commitment communication
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Coordination game two Nash equilibria
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Coordination/competition game
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Mixed strategies Mixed strategy offers an element of surprise
Boeing and Airbus must simultaneously commit to an advertising campaign Boeing benefits most from same strategy Airbus benefits most from differentiation Randomization with p=.5 is Nash equilibrium for both
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Mixed strategy
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Sequential interactions
Boeing & Airbus communications technology choice Boeing chooses first Analyze with backward induction Boeing must take Airbus’s best response into account in making its choice Boeing has first mover advantage Credible commitment by second mover can alter first mover choice
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Extensive form sequential game
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Repeated strategic interaction
Boeing and Airbus compete often Strategic choices can come to incorporate more than short-term payoffs
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Strategic interaction and organizational architecture
Kiana manages Lenin Len must choose between working and shirking Kiana must choose whether to incur monitoring costs No pure strategy equilibrium exists
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Interactive game no pure strategy equilibrium
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