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Chapter 9: Economics of Strategy: Game theory

Chapter 9: Economics of Strategy: Game theory. Brickley, Smith, and Zimmerman, Managerial Economics and Organizational Architecture , 4th ed. Game theory learning objectives. Structure a simple game in both matrix and tree formats Specify a simple game Identify Nash equilibria

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Chapter 9: Economics of Strategy: Game theory

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  1. Chapter 9: Economics of Strategy:Game theory Brickley, Smith, and Zimmerman, Managerial Economics and Organizational Architecture, 4th ed.

  2. Game theorylearning objectives • Structure a simple game in both matrix and tree formats • Specify a simple game • Identify Nash equilibria • Identify dominant strategies

  3. 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

  4. Simultaneous-move,non-repeated interaction • Simultaneous? • Rivals must make decisions with no knowledge of each other’s decisions • Nonrepeated? • The interaction occurs only once

  5. 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

  6. Strategic formdominant strategy

  7. Nash equilibriumrevisited • 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

  8. Nash equilibrium

  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

  10. Coordination gametwo Nash equilibria

  11. Coordination/competition game

  12. 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

  13. Mixed strategy

  14. 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

  15. Extensive formsequential game

  16. Repeated strategic interaction • Boeing and Airbus compete often • Strategic choices can come to incorporate more than short-term payoffs

  17. 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

  18. Interactive gameno pure strategy equilibrium

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