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Managerial Economics and Organizational Architecture, 5e Chapter 9: Economics of Strategy: Game Theory McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill.

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Presentation on theme: "Managerial Economics and Organizational Architecture, 5e Chapter 9: Economics of Strategy: Game Theory McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill."— Presentation transcript:

1 Managerial Economics and Organizational Architecture, 5e Chapter 9: Economics of Strategy: Game Theory McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.

2 Game Theory Managers must put themselves in their rival’s shoes
Determine how they will respond to your actions Assume all decision agents are rational each attempts to anticipate actions of rivals 9-2

3 Simultaneous-Move, Non-Repeated Interaction
Rivals must make decisions without knowledge of each other’s decisions Nonrepeated The interaction occurs only once 9-3

4 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 9-4

5 Strategic Form Dominant Strategy
Airbus Airbus Low Price Airbus High Price $500 $1000 Boeing Low Price $500 $0 Boeing $0 $750 Boeing High Price $1000 $750 9-5

6 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 circle technique to identify Nash equilibrium 9-6

7 Nash Equilibrium Airbus Airbus Low Price Airbus High Price $500 $1000
Boeing Low Price $500 $0 Boeing $600 $750 Boeing High Price $1000 $750 9-7

8 Nash Equilibrium This is a stable outcome
No firm has an incentive to make another choice When dominant strategies exist, firms have strong incentives to choose them More likely to occur when rivals have good information about potential payoffs 9-8

9 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 9-9

10 Coordination Game: Two Nash Equilibria
Airbus Airbus Alpha Airbus Beta $100 $50 Boeing Alpha Boeing Boeing Beta 9-10

11 Coordination/Competition Game
Airbus Airbus Alpha Airbus Beta $100 $40 Boeing Alpha $50 $40 Boeing $25 $50 Boeing Beta $25 $100 9-11

12 Coordination/Cooperation
In the previous example, Boeing prefers Alpha and Airbus prefers Beta Credible statements about upcoming choices may help 9-12

13 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 9-13

14 Mixed Strategy Airbus Negative campaign Positive campaign $10 -$10
Boeing -$10 $10 Positive campaign $10 -$10 9-14

15 Managerial Implications
Estimate payoffs given the potential actions of your firm and your competitors If a firm has a dominant strategy, follow it Make best estimate of what competitor will do and identify best action 9-15

16 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 9-16

17 Extensive Form Sequential Game
If Boeing chooses Alpha, Airbus chooses Alpha Boeing 100 Equilibrium Alpha Airbus 50 Airbus Beta Alpha Boeing 40 Airbus 40 Boeing Boeing 25 Alpha Airbus 25 Beta Airbus Beta If Boeing chooses Beta, Airbus chooses Beta Boeing 50 Airbus 100 9-17

18 Repeated Strategic Interaction
Strategic choices can come to incorporate more than short-term payoffs The cooperative outcome is more likely if long-run gains from cooperating are greater than short-run gains from not cooperating It is easier to recognize whether cooperation has occurred The expected length of the relationship is long 9-18

19 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 A labor contract paying a share of output may solve this problem 9-19

20 Mixed Strategy Lenin Shirk Don’t shirk -$5 $15 Don’t monitor $15 $10
Kiana $0 $10 Monitor $10 $5 9-20


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