Chapter 7
Game Theory and
Competitive Strategy
西南民族大学Game Theory Slide 2
Topics to be Discussed
? Gaming and Strategic Decisions
? Dominant Strategies
? The Nash Equilibrium Revisited
? Repeated Games
西南民族大学Game Theory Slide 3
Topics to be Discussed
? Sequential Games
? Threats,Commitments,and Credibility
? Entry Deterrence
? Bargaining Strategy
? Auctions
西南民族大学Game Theory Slide 4
Gaming and Strategic Decisions
?, If I believe that my competitors are
rational and act to maximize their own
profits,how should I take their
behavior into account when making my own
profit-maximizing decisions?”
西南民族大学Game Theory Slide 5
Gaming and Strategic Decisions
? Noncooperative versus Cooperative Games
?Cooperative Game
?Players negotiate binding contracts that
allow them to plan joint strategies
?Example,Buyer and seller negotiating the
price of a good or service or a joint
venture by two firms (i.e,Microsoft and
Apple)
?Binding contracts are possible
西南民族大学Game Theory Slide 6
Gaming and Strategic Decisions
?Noncooperative versus Cooperative
Games
?Noncooperative Game
?Negotiation and enforcement of a binding
contract are not possible
?Example,Two competing firms assuming
the others behavior determine,
independently,pricing and advertising
strategy to gain market share
?Binding contracts are not possible
西南民族大学Game Theory Slide 7
Gaming and Strategic Decisions
? Noncooperative versus Cooperative
Games
?,The strategy design is based on
understanding your opponent’s point
of view,and (assuming you opponent is
rational) deducing how he or she is
likely to respond to your actions”
西南民族大学Game Theory Slide 8
Gaming and Strategic Decisions
? An Example,How to buy a dollar bill
1) Auction a dollar bill
2) Highest bidder receives the dollar in
return for the amount bid
西南民族大学Game Theory Slide 9
Gaming and Strategic Decisions
? An Example
3) Second highest bidder must pay the
amount he or she bid
4) How much would you bid for a
dollar?
西南民族大学Game Theory Slide 10
Acquiring a Company
? Scenario
?Company A,The Acquirer
?Company T,The Target
?A will offer cash for all of T’s
shares
? What price to offer?
西南民族大学Game Theory Slide 11
Acquiring a Company
? Scenario
?The value of T depends on the outcome
of a current oil exploration project.
?Failure,T’s value = $0
?Success,T’s value = $100/share
?All outcomes are equally likely
西南民族大学Game Theory Slide 12
Acquiring a Company
? Scenario
?T’s value will be 50% greater with
A’s management.
?A,must submit the proposal before
the exploration outcome is known.
?T will not choose to accept or reject
until after the outcome is known only
to T.
? How much should A offer?
西南民族大学Game Theory Slide 13
Dominant Strategies
? Dominant Strategy
?One that is optimal no matter what an
opponent does.
?An Example
?A & B sell competing products
?They are deciding whether to
undertake advertising campaigns
西南民族大学Game Theory Slide 14
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10,5 15,0
10,26,8
西南民族大学Game Theory Slide 15
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10,5 15,0
10,26,8
? Observations
? A,regardless
of B,
advertising is
the best
? B,regardless
of A,
advertising is
best
西南民族大学Game Theory Slide 16
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10,5 15,0
10,26,8
? Observations
?Dominant strategy
for A & B is to
advertise
?Do not worry about
the other player
?Equilibrium in
dominant strategy
西南民族大学Game Theory Slide 17
Dominant Strategies
? Game Without Dominant Strategy
?The optimal decision of a player
without a dominant strategy will
depend on what the other player does.
西南民族大学Game Theory Slide 18
10,5 15,0
20,26,8
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
Modified Advertising Game
西南民族大学Game Theory Slide 19
10,5 15,0
20,26,8
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
Modified Advertising Game
? Observations
?A,No dominant
strategy; depends
on B’s actions
?B,Advertise
? Question
?What should A do?
(Hint,consider
B’s decision
西南民族大学Game Theory Slide 20
The Nash Equilibrium Revisited
? Dominant Strategies
?“I’m doing the best I can no matter
what you do.”
?“You’re doing the best you can no
matter what I do.”
西南民族大学Game Theory Slide 21
The Nash Equilibrium Revisited
? Nash Equilibrium
?“I’m doing the best I can given what
you are doing”
?“You’re doing the best you can given
what I am doing.”
西南民族大学Game Theory Slide 22
? Examples With A Nash Equilibrium
?Two cereal companies
?Market for one producer of crispy cereal
?Market for one producer of sweet cereal
?Each firm only has the resources to introduce
one cereal
?Noncooperative
The Nash Equilibrium Revisited
Product Choice Problem
西南民族大学Game Theory Slide 23
Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5,-5 10,10
-5,-510,10
西南民族大学Game Theory Slide 24
Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5,-5 10,10
-5,-510,10
? Question
?Is there a
Nash
equilibrium
?If not,
why?
?If so,how
can it be
reached
西南民族大学Game Theory Slide 25
Beach Location Game
? Scenario
?Two competitors,Y and C,selling soft drinks
?Beach 200 yards long
?Sunbathers are spread evenly along the beach
?Price Y = Price C
?Customer will buy from the closest vendor
西南民族大学Game Theory Slide 26
Beach Location Game
Where will the competitors locate
(i.e,where is the Nash
equilibrium)?
Ocean
0 B Beach A 200 yards
C
西南民族大学Game Theory Slide 27
Beach Location Game
2) Examples of this decision problem
include:
?Locating a gas station
?Presidential elections
Ocean
0 B Beach A 200 yards
C
西南民族大学Game Theory Slide 28
The Nash Equilibrium Revisited
? Maximin Strategies
?Scenario
?Two firms compete selling file-
encryption software
?They both use the same encryption
standard (files encrypted by one
software can be read by the other -
advantage to consumers)
西南民族大学Game Theory Slide 29
The Nash Equilibrium Revisited
? Maximin Strategies
?Scenario
?Firm 1 has a much larger market
share than Firm 2
?Both are considering investing in a
new encryption standard
西南民族大学Game Theory Slide 30
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0,0 -10,10
20,10-100,0
Don’t invest
Invest
西南民族大学Game Theory Slide 31
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0,0 -10,10
20,10-100,0
Don’t invest
Invest
? Observations
?Dominant strategy
Firm 2,Invest
?Nash equilibrium
?Firm 1,invest
?Firm 2,Invest
西南民族大学Game Theory Slide 32
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0,0 -10,10
20,10-100,0
Don’t invest
Invest
? Observations
?If Firm 2 does not
invest,Firm 1
incurs significant
losses
?Firm 1 might play
don’t invest
?Minimize losses
to 10 --
maximin
strategy
西南民族大学Game Theory Slide 33
? If both are rational and informed
?Both firms invest
?Nash equilibrium
The Nash Equilibrium Revisited
Maximin Strategy
西南民族大学Game Theory Slide 34
? Consider
?If Player 2 is not rational or completely
informed
?Firm 1’s maximin strategy is to not
invest
?Firm 2’s maximin strategy is to invest.
?If 1 knows 2 is using a maximin strategy,
1 would invest
The Nash Equilibrium Revisited
Maximin Strategy
西南民族大学Game Theory Slide 35
Prisoners’ Dilemma
Prisoner A
Confess Don’t Confess
Confess
Don’t
Confess
Prisoner B
-5,-5 -1,-10
-2,-2-10,-1
西南民族大学Game Theory Slide 36
Prisoners’ Dilemma
Prisoner A
Confess Don’t Confess
Confess
Don’t
Confess
Prisoner B
-5,-5 -1,-10
-2,-2-10,-1
? What is the:
?Dominant
strategy
?Nash
equilibrium
?Maximin
solution
西南民族大学Game Theory Slide 37
? Pure Strategy
?Player makes a specific choice
? Mixed Strategy
?Player makes a random choice among two
or more possible actions based on a
set of chosen probabilities
The Nash Equilibrium Revisited
Mixed Strategy
西南民族大学Game Theory Slide 38
Matching Pennies
Player A
Heads Tails
Heads
Tails
Player B
1,-1 -1,1
1,-1-1,1
西南民族大学Game Theory Slide 39
Matching Pennies
Player A
Heads Tails
Heads
Tails
Player B
1,-1 -1,1
1,-1-1,1
? Observations
? Pure strategy,No
Nash equilibrium
? Mixed strategy,
Random choice is a
Nash equilibrium
? Would a firm set
price based on
random choice
assumption?
西南民族大学Game Theory Slide 40
The Battle of the Sexes
Jim
Wrestling Opera
Wrestling
Opera
Joan
2,1 0,0
1,20,0
西南民族大学Game Theory Slide 41
The Battle of the Sexes
Jim
Wrestling Opera
Wrestling
Opera
Joan
2,1 0,0
1,20,0
? Pure Strategy
?Both watch
wrestling
?Both watch opera
? Mixed Strategy
?Jim chooses
wrestling
?Joan chooses
wrestling
西南民族大学Game Theory Slide 42
Repeated Games
? Oligopolistic firms play a repeated
game.
? With each repetition of the
Prisoners’ Dilemma,firms can
develop reputations about their
behavior and study the behavior of
their competitors.
西南民族大学Game Theory Slide 43
Pricing Problem
Firm 1
Low Price High Price
Low Price
High Price
Firm 2
10,10 100,-50
50,50-50,100
西南民族大学Game Theory Slide 44
Pricing Problem
Firm 1
Low Price High Price
Low Price
High Price
Firm 2
10,10 100,-50
50,50-50,100
? Non-repeated
game
?Strategy is
Low1,Low2
? Repeated game
?Tit-for-tat
strategy is the
most profitable
西南民族大学Game Theory Slide 45
Repeated Games
? Conclusion:
?With repeated game
?The Prisoners’ Dilemma can have
a cooperative outcome with tit-
for-tat strategy
西南民族大学Game Theory Slide 46
Repeated Games
? Conclusion:
?This is most likely to occur in a
market with:
?Few firms
?Stable demand
?Stable cost
西南民族大学Game Theory Slide 47
Repeated Games
? Conclusion
?Cooperation is difficult at best since
these factors may change in the long-
run.
西南民族大学Game Theory Slide 48
Oligopolistic Cooperation
in the Water Meter Industry
? Characteristics of the Market
?Four Producers
?Rockwell International (35%),Badger
Meter,Neptune Water Meter Company,
and Hersey Products (Badger,
Neptune,and Hersey combined have
about a 50 to 55% share)
西南民族大学Game Theory Slide 49
Oligopolistic Cooperation
in the Water Meter Industry
? Characteristics of the Market
?Very inelastic demand
?Not a significant part of the budget
西南民族大学Game Theory Slide 50
? Characteristics of the Market
?Stable demand
?Long standing relationship between
consumer and producer
?Barrier
?Economies of scale
?Barrier
Oligopolistic Cooperation
in the Water Meter Industry
西南民族大学Game Theory Slide 51
? Characteristics of the Market
?This is a Prisoners’ Dilemma
?Lower price to a competitive level
?Cooperate
?Repeated Game
? Question
?Why has cooperation prevailed?
Oligopolistic Cooperation
in the Water Meter Industry
西南民族大学Game Theory Slide 52
? What Do You Think?
?Is there cooperation & collusion in
the airline industry?
Competition and Collusion
in the Airline Industry
西南民族大学Game Theory Slide 53
Sequential Games
? Players move in turn
? Players must think through the
possible actions and rational
reactions of each player
西南民族大学Game Theory Slide 54
Sequential Games
? Examples
?Responding to a competitor’s ad
campaign
?Entry decisions
?Responding to regulatory policy
西南民族大学Game Theory Slide 55
? Scenario
?Two new (sweet,crispy) cereals
?Successful only if each firm produces
one cereal
?Sweet will sell better
?Both still profitable with only one
producer
Sequential Games
The Extensive Form of a Game
西南民族大学Game Theory Slide 56
Modified Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5,-5 10,20
-5,-520,10
西南民族大学Game Theory Slide 57
Modified Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5,-5 10,20
-5,-520,10
? Question
? What is the likely
outcome if both
make their
decisions
independently,
simultaneously,
and without
knowledge of the
other’s
intentions?
西南民族大学Game Theory Slide 58
? Assume that Firm 1 will introduce
its new cereal first (a sequential
game).
? Question
?What will be the outcome of this game?
Modified Product Choice Problem
The Extensive Form of a Game
西南民族大学Game Theory Slide 59
Sequential Games
? The Extensive Form of a Game
?Using a decision tree
?Work backward from the best outcome
for Firm 1
The Extensive Form of a Game
西南民族大学Game Theory Slide 60
Product Choice Game in Extensive Form
Crispy
Sweet
Crispy
Sweet
-5,-5
10,20
20,10
-5,-5
Firm 1
Crispy
Sweet
Firm 2
Firm 2
西南民族大学Game Theory Slide 61
Sequential Games
? The Advantage of Moving First
?In this product-choice game,there is
a clear advantage to moving first.
西南民族大学Game Theory Slide 62
Sequential Games
? Assume,Duopoly
F i rm/1 0 0 10 a n d 10
0
P ro d u c t i o n T o t a l
30
21
21
????
?
???
??
?PQQ
MC
QQQ
QP
The Advantage of Moving First
西南民族大学Game Theory Slide 63
Sequential Games
? Duopoly
25.56 50.1 1 2
50.7 a n d 5.7 15
rg )(S t a c k e l b eF i rs t M o v e s F i rm
F i rm/50.1 1 2 15 a n d 5.7
Co l l u s i o nWi t h
21
21
21
??
???
????
??
?
PQQ
PQQ
The Advantage of Moving First
西南民族大学Game Theory Slide 64
Choosing Output
Firm 1
7.5
Firm 2
112.50,112.50 56.25,112.50
0,0112.50,56.25
125,93.75 50,75
93.75,125
75,50
100,100
10 15
7.5
10
15
西南民族大学Game Theory Slide 65
Choosing Output
Firm 1
7.5
Firm 2
112.50,112.50 56.25,112.50
0,0112.50,56.25
125,93.75 50,75
93.75,125
75,50
100,100
10 15
7.5
10
15
? This payoff matrix
illustrates various
outcomes
? Move together,both
produce 10
? Question
?What if Firm 1
moves first?
西南民族大学Game Theory Slide 66
Threats,Commitments,and Credibility
? Strategic Moves
?What actions can a firm take to gain
advantage in the marketplace?
?Deter entry
?Induce competitors to reduce output,
leave,raise price
?Implicit agreements that benefit one
firm
西南民族大学Game Theory Slide 67
? How To Make the First Move
?Demonstrate Commitment
?Firm 1 must constrain his behavior to
the extent Firm 2 is convinced that he
is committed
Threats,Commitments,and Credibility
西南民族大学Game Theory Slide 68
? Empty Threats
?If a firm will be worse off if it
charges a low price,the threat of a
low price is not credible in the eyes
of the competitors.
Threats,Commitments,and Credibility
西南民族大学Game Theory Slide 69
Pricing of Computers and Word Processors
Firm 1
High Price Low Price
High Price
Low Price
Firm 2
100,80 80,100
10,2020,0
西南民族大学Game Theory Slide 70
Pricing of Computers and Word Processors
Firm 1
High Price Low Price
High Price
Low Price
Firm 2
100,80 80,100
10,2020,0
? Question
?Can Firm 1
force Firm 2
to charge a
high price
by
threatening
to lower its
price?
西南民族大学Game Theory Slide 71
? Scenario
?Race Car Motors,Inc,(RCM) produces
cars
?Far Out Engines (FOE) produces
specialty car engines and sells most
of them to RCM
?Sequential game with RCM as the leader
?FOE has no power to threaten to build
big since RCM controls output.
Threats,Commitments,and Credibility
西南民族大学Game Theory Slide 72
Production Choice Problem
Far Out Engines
Small cars Big cars
Small engines
Big engines
Race Car Motors
3,6 3,0
8,31,1
西南民族大学Game Theory Slide 73
? Question
?How could FOE force RCM to shift to
big cars?
Threats,Commitments,and Credibility
西南民族大学Game Theory Slide 74
Modified Production Choice Problem
0,6 0,0
8,31,1
Far Out Engines
Small cars Big cars
Small engines
Big engines
Race Car Motors
西南民族大学Game Theory Slide 75
? Questions
1) What is the risk of this strategy?
2) How could irrational behavior give
FOE some power to control output?
Modified Production Choice Problem
西南民族大学Game Theory Slide 76
Wal-Mart Stores’
Preemptive Investment Strategy
?Question
?How did Wal-Mart become the largest
retailer in the U.S,when many established
retail chains were closing their doors?
?Hint
?How did Wal-Mart gain monopoly power?
?Preemptive game with Nash equilibrium
西南民族大学Game Theory Slide 77
The Discount Store Preemption Game
Wal-Mart
Enter Don’t enter
Enter
Don’t enter
Company X
-10,-10 20,0
0,00,20
西南民族大学Game Theory Slide 78
The Discount Store Preemption Game
Wal-Mart
Enter Don’t enter
Enter
Don’t enter
Company X
-10,-10 20,0
0,00,20
? Two Nash
equilibrium
? Low left
? Upper right
? Must be
preemptive to
win
西南民族大学Game Theory Slide 79
Entry Deterrence
? To deter entry,the incumbent firm must
convince any potential competitor that
entry will be unprofitable.
西南民族大学Game Theory Slide 80
Entry Possibilities
Incumbent
Enter Stay out
High price
(accommodation)
Low Price
(warfare)
Potential Entrant
100,20 200,0
130,070,-10
西南民族大学Game Theory Slide 81
Entry Deterrence
? Scenario
?Incumbent monopolist (I) and
prospective entrant (X)
?X single cost = $80 million to build
plant
西南民族大学Game Theory Slide 82
Entry Deterrence
? Scenario
?If X does not enter I makes a profit
of $200 million.
?If X enters and charges a high price I
earns a profit of $100 million and X
earns $20 million.
?If X enters and charges a low price I
earns a profit of $70 million and X
earns $-10 million.
西南民族大学Game Theory Slide 83
Entry Deterrence
? Question
?How could I keep X out?
?Is the threat credible?
西南民族大学Game Theory Slide 84
Entry Deterrence
? How could I keep X out?
1) Make an investment before entry
(irrevocable commitment)
2) Irrational behavior
西南民族大学Game Theory Slide 85
Entry Deterrence
Incumbent
Enter Stay out
High price
(accommodation)
Low Price
(warfare)
Potential
Entrant
50,20 150,0
130,070,-10
After $50 million Early Investment
西南民族大学Game Theory Slide 86
Entry Deterrence
Incumbent
Enter Stay out
High price
(accommodation)
Low Price
(warfare)
Potential Entrant
50,20 150,0
130,070,-10
After $50 million Early Investment
? Warfare likely
? X will stay out
西南民族大学Game Theory Slide 87
? Airbus vs,Boeing
?Without Airbus being subsidized,the
payoff matrix for the two firms would
differ significantly from one showing
subsidization,
Entry Deterrence
西南民族大学Game Theory Slide 88
Development of a New Aircraft
Boeing
Produce Don’t produce
Airbus
-10,-10 100,0
0,00,120
Produce
Don’t produce
西南民族大学Game Theory Slide 89
Development of a New Aircraft
Boeing
Produce Don’t produce
Airbus
-10,-10 100,0
0,00,120
Produce
Don’t produce
? Boeing will
produce
? Airbus will not
produce
西南民族大学Game Theory Slide 90
Development of a Aircraft
After European Subsidy
Boeing
Produce Don’t produce
Airbus
-10,10 100,0
0,00,120
Produce
Don’t produce
西南民族大学Game Theory Slide 91
Boeing
Produce Don’t produce
Airbus
-10,10 100,0
0,00,120
Produce
Don’t produce
? Airbus will
produce
? Boeing will not
produce
Development of a Aircraft
After European Subsidy
西南民族大学Game Theory Slide 92
Diaper Wars
? Even though there are only two
major firms,competition is
intense.
? The competition occurs mostly in
the form of cost-reducing
innovation.
西南民族大学Game Theory Slide 93
Competing Through R & D
P&G
R&D No R&D
R&D
No R&D
Kimberly-Clark
40,20 80,-20
60,40-20,60
西南民族大学Game Theory Slide 94
Competing Through R & D
P&G
R&D No R&D
R&D
No R&D
Kimberly-Clark
40,20 80,-20
60,40-20,60
? Both spend on
R&D
? Question
?Why not
cooperate
西南民族大学Game Theory Slide 95
Bargaining Strategy
? Alternative outcomes are possible
if firms or individuals can make
promises that can be enforced.
西南民族大学Game Theory Slide 96
Bargaining Strategy
? Consider:
?Two firms introducing one of two
complementary goods.
西南民族大学Game Theory Slide 97
Bargaining Strategy
Firm 1
Produce A Produce B
Produce A
Produce B
Firm 2
40,5 50,50
5,4560,40
西南民族大学Game Theory Slide 98
Bargaining Strategy
Firm 1
Produce A Produce B
Produce A
Produce B
Firm 2
40,5 50,50
5,4560,40
? With collusion:
?Produce A1B2
? Without
collusion:
?Produce A1B2
?Nash
equilibrium
西南民族大学Game Theory Slide 99
Bargaining Strategy
? Suppose
?Each firm is also bargaining on the
decision to join in a research
consortium with a third firm.
西南民族大学Game Theory Slide 100
Bargaining Strategy
Firm 1
Work alone Enter consortium
Work alone
Enter
consortium
Firm 2
10,10 10,20
40,4020,10
西南民族大学Game Theory Slide 101
Bargaining Strategy
Firm 1
Work alone Enter consortium
Work alone
Enter
consortium
Firm 2
10,10 10,20
40,4020,10
? Dominant
strategy
? Both enter
西南民族大学Game Theory Slide 102
Bargaining Strategy
? Linking the Bargain Problem
?Firm 1 announces it will join the
consortium only if Firm 2 agrees to
produce A and Firm 1 will produce B.
?Firm 1’s profit increases from 50
to 60
西南民族大学Game Theory Slide 103
Bargaining Strategy
? Strengthening Bargaining Power
?Credibility
?Reducing flexibility
西南民族大学Game Theory Slide 104
Auctions
? Auction Formats
?Traditional English (oral)
?Dutch auction
?Sealed-bid
?First price
?Second price
西南民族大学Game Theory Slide 105
Auctions
? How to choose an auction format
?Private-value auction,bidders
uncertain about the other bidders
reservation price
?Common-value auction,bidders
uncertain what the value is
Valuation and Information
西南民族大学Game Theory Slide 106
Auctions
? Second-price sealed auction,bid
your reservation price
? English auction,Bid in small
increments until you reach your
reservation price
Private Value Auction
西南民族大学Game Theory Slide 107
Auctions
? The winning bids in both auctions
is the reservation price of the
second highest bidder
Private Value Auction
西南民族大学Game Theory Slide 108
Auctions
? Sealed-bid auction
?First-price auction,lowers the bid
?Second-price auction,bid just above
the second highest reservation price
? Both yield the same revenue
Private Value Auction
西南民族大学Game Theory Slide 109
Auctions
? Winner’s Curse
?The winner is worse off than those who
did not win
Common Value Auction
西南民族大学Game Theory Slide 110
Auctions
? Examples
?Bidding on a construction job
?Bidding on offshore oil reserves
Common Value Auction
西南民族大学Game Theory Slide 111
Auctions
? Question
?How can you avoid the winner’s curse?
Common Value Auction
西南民族大学Game Theory Slide 112
Auctions
? Private-value Auction
?Have as many bidders as possible
? Common-value Auction
?Use open-bid format
?Release information about value
Maximizing Auction Revenue
西南民族大学Game Theory Slide 113
Internet Auctions
? A Few Caveats
?Now quality control function
?Poor seller feedback
?Bid manipulation may occur
西南民族大学Game Theory Slide 114
Summary
? A game is cooperative if the
players can communicate and arrange
binding contracts; otherwise it is
noncooperative.
? A Nash equilibrium is a set of
strategies such that all players
are doing their best,given the
strategies of the other players.
西南民族大学Game Theory Slide 115
Summary
? Some games have no Nash equilibrium in
pure strategies,but have one or more
equilibria in mixed strategies.
? Strategies that are not optimal for a
one-shot game may be optimal for a
repeated game.
? In a sequential game,the players move
in turn.
西南民族大学Game Theory Slide 116
Summary
? An empty threat is a threat that one
would have no incentive to carry out.
? To deter entry,an incumbent firm must
convince any potential competitor that
entry will be unprofitable.
? Bargaining situations are examples of
cooperative games.
西南民族大学Game Theory Slide 117
Summary
? Auctions can be conducted in a
number of formats which influence
the revenue raised and the price
paid by the buyer.
End of Chapter 7
Game Theory and
Competitive Strategy
Game Theory and
Competitive Strategy
西南民族大学Game Theory Slide 2
Topics to be Discussed
? Gaming and Strategic Decisions
? Dominant Strategies
? The Nash Equilibrium Revisited
? Repeated Games
西南民族大学Game Theory Slide 3
Topics to be Discussed
? Sequential Games
? Threats,Commitments,and Credibility
? Entry Deterrence
? Bargaining Strategy
? Auctions
西南民族大学Game Theory Slide 4
Gaming and Strategic Decisions
?, If I believe that my competitors are
rational and act to maximize their own
profits,how should I take their
behavior into account when making my own
profit-maximizing decisions?”
西南民族大学Game Theory Slide 5
Gaming and Strategic Decisions
? Noncooperative versus Cooperative Games
?Cooperative Game
?Players negotiate binding contracts that
allow them to plan joint strategies
?Example,Buyer and seller negotiating the
price of a good or service or a joint
venture by two firms (i.e,Microsoft and
Apple)
?Binding contracts are possible
西南民族大学Game Theory Slide 6
Gaming and Strategic Decisions
?Noncooperative versus Cooperative
Games
?Noncooperative Game
?Negotiation and enforcement of a binding
contract are not possible
?Example,Two competing firms assuming
the others behavior determine,
independently,pricing and advertising
strategy to gain market share
?Binding contracts are not possible
西南民族大学Game Theory Slide 7
Gaming and Strategic Decisions
? Noncooperative versus Cooperative
Games
?,The strategy design is based on
understanding your opponent’s point
of view,and (assuming you opponent is
rational) deducing how he or she is
likely to respond to your actions”
西南民族大学Game Theory Slide 8
Gaming and Strategic Decisions
? An Example,How to buy a dollar bill
1) Auction a dollar bill
2) Highest bidder receives the dollar in
return for the amount bid
西南民族大学Game Theory Slide 9
Gaming and Strategic Decisions
? An Example
3) Second highest bidder must pay the
amount he or she bid
4) How much would you bid for a
dollar?
西南民族大学Game Theory Slide 10
Acquiring a Company
? Scenario
?Company A,The Acquirer
?Company T,The Target
?A will offer cash for all of T’s
shares
? What price to offer?
西南民族大学Game Theory Slide 11
Acquiring a Company
? Scenario
?The value of T depends on the outcome
of a current oil exploration project.
?Failure,T’s value = $0
?Success,T’s value = $100/share
?All outcomes are equally likely
西南民族大学Game Theory Slide 12
Acquiring a Company
? Scenario
?T’s value will be 50% greater with
A’s management.
?A,must submit the proposal before
the exploration outcome is known.
?T will not choose to accept or reject
until after the outcome is known only
to T.
? How much should A offer?
西南民族大学Game Theory Slide 13
Dominant Strategies
? Dominant Strategy
?One that is optimal no matter what an
opponent does.
?An Example
?A & B sell competing products
?They are deciding whether to
undertake advertising campaigns
西南民族大学Game Theory Slide 14
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10,5 15,0
10,26,8
西南民族大学Game Theory Slide 15
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10,5 15,0
10,26,8
? Observations
? A,regardless
of B,
advertising is
the best
? B,regardless
of A,
advertising is
best
西南民族大学Game Theory Slide 16
Payoff Matrix for Advertising Game
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
10,5 15,0
10,26,8
? Observations
?Dominant strategy
for A & B is to
advertise
?Do not worry about
the other player
?Equilibrium in
dominant strategy
西南民族大学Game Theory Slide 17
Dominant Strategies
? Game Without Dominant Strategy
?The optimal decision of a player
without a dominant strategy will
depend on what the other player does.
西南民族大学Game Theory Slide 18
10,5 15,0
20,26,8
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
Modified Advertising Game
西南民族大学Game Theory Slide 19
10,5 15,0
20,26,8
Firm A
Advertise
Don’t
Advertise
Advertise
Don’t
Advertise
Firm B
Modified Advertising Game
? Observations
?A,No dominant
strategy; depends
on B’s actions
?B,Advertise
? Question
?What should A do?
(Hint,consider
B’s decision
西南民族大学Game Theory Slide 20
The Nash Equilibrium Revisited
? Dominant Strategies
?“I’m doing the best I can no matter
what you do.”
?“You’re doing the best you can no
matter what I do.”
西南民族大学Game Theory Slide 21
The Nash Equilibrium Revisited
? Nash Equilibrium
?“I’m doing the best I can given what
you are doing”
?“You’re doing the best you can given
what I am doing.”
西南民族大学Game Theory Slide 22
? Examples With A Nash Equilibrium
?Two cereal companies
?Market for one producer of crispy cereal
?Market for one producer of sweet cereal
?Each firm only has the resources to introduce
one cereal
?Noncooperative
The Nash Equilibrium Revisited
Product Choice Problem
西南民族大学Game Theory Slide 23
Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5,-5 10,10
-5,-510,10
西南民族大学Game Theory Slide 24
Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5,-5 10,10
-5,-510,10
? Question
?Is there a
Nash
equilibrium
?If not,
why?
?If so,how
can it be
reached
西南民族大学Game Theory Slide 25
Beach Location Game
? Scenario
?Two competitors,Y and C,selling soft drinks
?Beach 200 yards long
?Sunbathers are spread evenly along the beach
?Price Y = Price C
?Customer will buy from the closest vendor
西南民族大学Game Theory Slide 26
Beach Location Game
Where will the competitors locate
(i.e,where is the Nash
equilibrium)?
Ocean
0 B Beach A 200 yards
C
西南民族大学Game Theory Slide 27
Beach Location Game
2) Examples of this decision problem
include:
?Locating a gas station
?Presidential elections
Ocean
0 B Beach A 200 yards
C
西南民族大学Game Theory Slide 28
The Nash Equilibrium Revisited
? Maximin Strategies
?Scenario
?Two firms compete selling file-
encryption software
?They both use the same encryption
standard (files encrypted by one
software can be read by the other -
advantage to consumers)
西南民族大学Game Theory Slide 29
The Nash Equilibrium Revisited
? Maximin Strategies
?Scenario
?Firm 1 has a much larger market
share than Firm 2
?Both are considering investing in a
new encryption standard
西南民族大学Game Theory Slide 30
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0,0 -10,10
20,10-100,0
Don’t invest
Invest
西南民族大学Game Theory Slide 31
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0,0 -10,10
20,10-100,0
Don’t invest
Invest
? Observations
?Dominant strategy
Firm 2,Invest
?Nash equilibrium
?Firm 1,invest
?Firm 2,Invest
西南民族大学Game Theory Slide 32
Maximin Strategy
Firm 1
Don’t invest Invest
Firm 2
0,0 -10,10
20,10-100,0
Don’t invest
Invest
? Observations
?If Firm 2 does not
invest,Firm 1
incurs significant
losses
?Firm 1 might play
don’t invest
?Minimize losses
to 10 --
maximin
strategy
西南民族大学Game Theory Slide 33
? If both are rational and informed
?Both firms invest
?Nash equilibrium
The Nash Equilibrium Revisited
Maximin Strategy
西南民族大学Game Theory Slide 34
? Consider
?If Player 2 is not rational or completely
informed
?Firm 1’s maximin strategy is to not
invest
?Firm 2’s maximin strategy is to invest.
?If 1 knows 2 is using a maximin strategy,
1 would invest
The Nash Equilibrium Revisited
Maximin Strategy
西南民族大学Game Theory Slide 35
Prisoners’ Dilemma
Prisoner A
Confess Don’t Confess
Confess
Don’t
Confess
Prisoner B
-5,-5 -1,-10
-2,-2-10,-1
西南民族大学Game Theory Slide 36
Prisoners’ Dilemma
Prisoner A
Confess Don’t Confess
Confess
Don’t
Confess
Prisoner B
-5,-5 -1,-10
-2,-2-10,-1
? What is the:
?Dominant
strategy
?Nash
equilibrium
?Maximin
solution
西南民族大学Game Theory Slide 37
? Pure Strategy
?Player makes a specific choice
? Mixed Strategy
?Player makes a random choice among two
or more possible actions based on a
set of chosen probabilities
The Nash Equilibrium Revisited
Mixed Strategy
西南民族大学Game Theory Slide 38
Matching Pennies
Player A
Heads Tails
Heads
Tails
Player B
1,-1 -1,1
1,-1-1,1
西南民族大学Game Theory Slide 39
Matching Pennies
Player A
Heads Tails
Heads
Tails
Player B
1,-1 -1,1
1,-1-1,1
? Observations
? Pure strategy,No
Nash equilibrium
? Mixed strategy,
Random choice is a
Nash equilibrium
? Would a firm set
price based on
random choice
assumption?
西南民族大学Game Theory Slide 40
The Battle of the Sexes
Jim
Wrestling Opera
Wrestling
Opera
Joan
2,1 0,0
1,20,0
西南民族大学Game Theory Slide 41
The Battle of the Sexes
Jim
Wrestling Opera
Wrestling
Opera
Joan
2,1 0,0
1,20,0
? Pure Strategy
?Both watch
wrestling
?Both watch opera
? Mixed Strategy
?Jim chooses
wrestling
?Joan chooses
wrestling
西南民族大学Game Theory Slide 42
Repeated Games
? Oligopolistic firms play a repeated
game.
? With each repetition of the
Prisoners’ Dilemma,firms can
develop reputations about their
behavior and study the behavior of
their competitors.
西南民族大学Game Theory Slide 43
Pricing Problem
Firm 1
Low Price High Price
Low Price
High Price
Firm 2
10,10 100,-50
50,50-50,100
西南民族大学Game Theory Slide 44
Pricing Problem
Firm 1
Low Price High Price
Low Price
High Price
Firm 2
10,10 100,-50
50,50-50,100
? Non-repeated
game
?Strategy is
Low1,Low2
? Repeated game
?Tit-for-tat
strategy is the
most profitable
西南民族大学Game Theory Slide 45
Repeated Games
? Conclusion:
?With repeated game
?The Prisoners’ Dilemma can have
a cooperative outcome with tit-
for-tat strategy
西南民族大学Game Theory Slide 46
Repeated Games
? Conclusion:
?This is most likely to occur in a
market with:
?Few firms
?Stable demand
?Stable cost
西南民族大学Game Theory Slide 47
Repeated Games
? Conclusion
?Cooperation is difficult at best since
these factors may change in the long-
run.
西南民族大学Game Theory Slide 48
Oligopolistic Cooperation
in the Water Meter Industry
? Characteristics of the Market
?Four Producers
?Rockwell International (35%),Badger
Meter,Neptune Water Meter Company,
and Hersey Products (Badger,
Neptune,and Hersey combined have
about a 50 to 55% share)
西南民族大学Game Theory Slide 49
Oligopolistic Cooperation
in the Water Meter Industry
? Characteristics of the Market
?Very inelastic demand
?Not a significant part of the budget
西南民族大学Game Theory Slide 50
? Characteristics of the Market
?Stable demand
?Long standing relationship between
consumer and producer
?Barrier
?Economies of scale
?Barrier
Oligopolistic Cooperation
in the Water Meter Industry
西南民族大学Game Theory Slide 51
? Characteristics of the Market
?This is a Prisoners’ Dilemma
?Lower price to a competitive level
?Cooperate
?Repeated Game
? Question
?Why has cooperation prevailed?
Oligopolistic Cooperation
in the Water Meter Industry
西南民族大学Game Theory Slide 52
? What Do You Think?
?Is there cooperation & collusion in
the airline industry?
Competition and Collusion
in the Airline Industry
西南民族大学Game Theory Slide 53
Sequential Games
? Players move in turn
? Players must think through the
possible actions and rational
reactions of each player
西南民族大学Game Theory Slide 54
Sequential Games
? Examples
?Responding to a competitor’s ad
campaign
?Entry decisions
?Responding to regulatory policy
西南民族大学Game Theory Slide 55
? Scenario
?Two new (sweet,crispy) cereals
?Successful only if each firm produces
one cereal
?Sweet will sell better
?Both still profitable with only one
producer
Sequential Games
The Extensive Form of a Game
西南民族大学Game Theory Slide 56
Modified Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5,-5 10,20
-5,-520,10
西南民族大学Game Theory Slide 57
Modified Product Choice Problem
Firm 1
Crispy Sweet
Crispy
Sweet
Firm 2
-5,-5 10,20
-5,-520,10
? Question
? What is the likely
outcome if both
make their
decisions
independently,
simultaneously,
and without
knowledge of the
other’s
intentions?
西南民族大学Game Theory Slide 58
? Assume that Firm 1 will introduce
its new cereal first (a sequential
game).
? Question
?What will be the outcome of this game?
Modified Product Choice Problem
The Extensive Form of a Game
西南民族大学Game Theory Slide 59
Sequential Games
? The Extensive Form of a Game
?Using a decision tree
?Work backward from the best outcome
for Firm 1
The Extensive Form of a Game
西南民族大学Game Theory Slide 60
Product Choice Game in Extensive Form
Crispy
Sweet
Crispy
Sweet
-5,-5
10,20
20,10
-5,-5
Firm 1
Crispy
Sweet
Firm 2
Firm 2
西南民族大学Game Theory Slide 61
Sequential Games
? The Advantage of Moving First
?In this product-choice game,there is
a clear advantage to moving first.
西南民族大学Game Theory Slide 62
Sequential Games
? Assume,Duopoly
F i rm/1 0 0 10 a n d 10
0
P ro d u c t i o n T o t a l
30
21
21
????
?
???
??
?PQQ
MC
QQQ
QP
The Advantage of Moving First
西南民族大学Game Theory Slide 63
Sequential Games
? Duopoly
25.56 50.1 1 2
50.7 a n d 5.7 15
rg )(S t a c k e l b eF i rs t M o v e s F i rm
F i rm/50.1 1 2 15 a n d 5.7
Co l l u s i o nWi t h
21
21
21
??
???
????
??
?
PQQ
PQQ
The Advantage of Moving First
西南民族大学Game Theory Slide 64
Choosing Output
Firm 1
7.5
Firm 2
112.50,112.50 56.25,112.50
0,0112.50,56.25
125,93.75 50,75
93.75,125
75,50
100,100
10 15
7.5
10
15
西南民族大学Game Theory Slide 65
Choosing Output
Firm 1
7.5
Firm 2
112.50,112.50 56.25,112.50
0,0112.50,56.25
125,93.75 50,75
93.75,125
75,50
100,100
10 15
7.5
10
15
? This payoff matrix
illustrates various
outcomes
? Move together,both
produce 10
? Question
?What if Firm 1
moves first?
西南民族大学Game Theory Slide 66
Threats,Commitments,and Credibility
? Strategic Moves
?What actions can a firm take to gain
advantage in the marketplace?
?Deter entry
?Induce competitors to reduce output,
leave,raise price
?Implicit agreements that benefit one
firm
西南民族大学Game Theory Slide 67
? How To Make the First Move
?Demonstrate Commitment
?Firm 1 must constrain his behavior to
the extent Firm 2 is convinced that he
is committed
Threats,Commitments,and Credibility
西南民族大学Game Theory Slide 68
? Empty Threats
?If a firm will be worse off if it
charges a low price,the threat of a
low price is not credible in the eyes
of the competitors.
Threats,Commitments,and Credibility
西南民族大学Game Theory Slide 69
Pricing of Computers and Word Processors
Firm 1
High Price Low Price
High Price
Low Price
Firm 2
100,80 80,100
10,2020,0
西南民族大学Game Theory Slide 70
Pricing of Computers and Word Processors
Firm 1
High Price Low Price
High Price
Low Price
Firm 2
100,80 80,100
10,2020,0
? Question
?Can Firm 1
force Firm 2
to charge a
high price
by
threatening
to lower its
price?
西南民族大学Game Theory Slide 71
? Scenario
?Race Car Motors,Inc,(RCM) produces
cars
?Far Out Engines (FOE) produces
specialty car engines and sells most
of them to RCM
?Sequential game with RCM as the leader
?FOE has no power to threaten to build
big since RCM controls output.
Threats,Commitments,and Credibility
西南民族大学Game Theory Slide 72
Production Choice Problem
Far Out Engines
Small cars Big cars
Small engines
Big engines
Race Car Motors
3,6 3,0
8,31,1
西南民族大学Game Theory Slide 73
? Question
?How could FOE force RCM to shift to
big cars?
Threats,Commitments,and Credibility
西南民族大学Game Theory Slide 74
Modified Production Choice Problem
0,6 0,0
8,31,1
Far Out Engines
Small cars Big cars
Small engines
Big engines
Race Car Motors
西南民族大学Game Theory Slide 75
? Questions
1) What is the risk of this strategy?
2) How could irrational behavior give
FOE some power to control output?
Modified Production Choice Problem
西南民族大学Game Theory Slide 76
Wal-Mart Stores’
Preemptive Investment Strategy
?Question
?How did Wal-Mart become the largest
retailer in the U.S,when many established
retail chains were closing their doors?
?Hint
?How did Wal-Mart gain monopoly power?
?Preemptive game with Nash equilibrium
西南民族大学Game Theory Slide 77
The Discount Store Preemption Game
Wal-Mart
Enter Don’t enter
Enter
Don’t enter
Company X
-10,-10 20,0
0,00,20
西南民族大学Game Theory Slide 78
The Discount Store Preemption Game
Wal-Mart
Enter Don’t enter
Enter
Don’t enter
Company X
-10,-10 20,0
0,00,20
? Two Nash
equilibrium
? Low left
? Upper right
? Must be
preemptive to
win
西南民族大学Game Theory Slide 79
Entry Deterrence
? To deter entry,the incumbent firm must
convince any potential competitor that
entry will be unprofitable.
西南民族大学Game Theory Slide 80
Entry Possibilities
Incumbent
Enter Stay out
High price
(accommodation)
Low Price
(warfare)
Potential Entrant
100,20 200,0
130,070,-10
西南民族大学Game Theory Slide 81
Entry Deterrence
? Scenario
?Incumbent monopolist (I) and
prospective entrant (X)
?X single cost = $80 million to build
plant
西南民族大学Game Theory Slide 82
Entry Deterrence
? Scenario
?If X does not enter I makes a profit
of $200 million.
?If X enters and charges a high price I
earns a profit of $100 million and X
earns $20 million.
?If X enters and charges a low price I
earns a profit of $70 million and X
earns $-10 million.
西南民族大学Game Theory Slide 83
Entry Deterrence
? Question
?How could I keep X out?
?Is the threat credible?
西南民族大学Game Theory Slide 84
Entry Deterrence
? How could I keep X out?
1) Make an investment before entry
(irrevocable commitment)
2) Irrational behavior
西南民族大学Game Theory Slide 85
Entry Deterrence
Incumbent
Enter Stay out
High price
(accommodation)
Low Price
(warfare)
Potential
Entrant
50,20 150,0
130,070,-10
After $50 million Early Investment
西南民族大学Game Theory Slide 86
Entry Deterrence
Incumbent
Enter Stay out
High price
(accommodation)
Low Price
(warfare)
Potential Entrant
50,20 150,0
130,070,-10
After $50 million Early Investment
? Warfare likely
? X will stay out
西南民族大学Game Theory Slide 87
? Airbus vs,Boeing
?Without Airbus being subsidized,the
payoff matrix for the two firms would
differ significantly from one showing
subsidization,
Entry Deterrence
西南民族大学Game Theory Slide 88
Development of a New Aircraft
Boeing
Produce Don’t produce
Airbus
-10,-10 100,0
0,00,120
Produce
Don’t produce
西南民族大学Game Theory Slide 89
Development of a New Aircraft
Boeing
Produce Don’t produce
Airbus
-10,-10 100,0
0,00,120
Produce
Don’t produce
? Boeing will
produce
? Airbus will not
produce
西南民族大学Game Theory Slide 90
Development of a Aircraft
After European Subsidy
Boeing
Produce Don’t produce
Airbus
-10,10 100,0
0,00,120
Produce
Don’t produce
西南民族大学Game Theory Slide 91
Boeing
Produce Don’t produce
Airbus
-10,10 100,0
0,00,120
Produce
Don’t produce
? Airbus will
produce
? Boeing will not
produce
Development of a Aircraft
After European Subsidy
西南民族大学Game Theory Slide 92
Diaper Wars
? Even though there are only two
major firms,competition is
intense.
? The competition occurs mostly in
the form of cost-reducing
innovation.
西南民族大学Game Theory Slide 93
Competing Through R & D
P&G
R&D No R&D
R&D
No R&D
Kimberly-Clark
40,20 80,-20
60,40-20,60
西南民族大学Game Theory Slide 94
Competing Through R & D
P&G
R&D No R&D
R&D
No R&D
Kimberly-Clark
40,20 80,-20
60,40-20,60
? Both spend on
R&D
? Question
?Why not
cooperate
西南民族大学Game Theory Slide 95
Bargaining Strategy
? Alternative outcomes are possible
if firms or individuals can make
promises that can be enforced.
西南民族大学Game Theory Slide 96
Bargaining Strategy
? Consider:
?Two firms introducing one of two
complementary goods.
西南民族大学Game Theory Slide 97
Bargaining Strategy
Firm 1
Produce A Produce B
Produce A
Produce B
Firm 2
40,5 50,50
5,4560,40
西南民族大学Game Theory Slide 98
Bargaining Strategy
Firm 1
Produce A Produce B
Produce A
Produce B
Firm 2
40,5 50,50
5,4560,40
? With collusion:
?Produce A1B2
? Without
collusion:
?Produce A1B2
?Nash
equilibrium
西南民族大学Game Theory Slide 99
Bargaining Strategy
? Suppose
?Each firm is also bargaining on the
decision to join in a research
consortium with a third firm.
西南民族大学Game Theory Slide 100
Bargaining Strategy
Firm 1
Work alone Enter consortium
Work alone
Enter
consortium
Firm 2
10,10 10,20
40,4020,10
西南民族大学Game Theory Slide 101
Bargaining Strategy
Firm 1
Work alone Enter consortium
Work alone
Enter
consortium
Firm 2
10,10 10,20
40,4020,10
? Dominant
strategy
? Both enter
西南民族大学Game Theory Slide 102
Bargaining Strategy
? Linking the Bargain Problem
?Firm 1 announces it will join the
consortium only if Firm 2 agrees to
produce A and Firm 1 will produce B.
?Firm 1’s profit increases from 50
to 60
西南民族大学Game Theory Slide 103
Bargaining Strategy
? Strengthening Bargaining Power
?Credibility
?Reducing flexibility
西南民族大学Game Theory Slide 104
Auctions
? Auction Formats
?Traditional English (oral)
?Dutch auction
?Sealed-bid
?First price
?Second price
西南民族大学Game Theory Slide 105
Auctions
? How to choose an auction format
?Private-value auction,bidders
uncertain about the other bidders
reservation price
?Common-value auction,bidders
uncertain what the value is
Valuation and Information
西南民族大学Game Theory Slide 106
Auctions
? Second-price sealed auction,bid
your reservation price
? English auction,Bid in small
increments until you reach your
reservation price
Private Value Auction
西南民族大学Game Theory Slide 107
Auctions
? The winning bids in both auctions
is the reservation price of the
second highest bidder
Private Value Auction
西南民族大学Game Theory Slide 108
Auctions
? Sealed-bid auction
?First-price auction,lowers the bid
?Second-price auction,bid just above
the second highest reservation price
? Both yield the same revenue
Private Value Auction
西南民族大学Game Theory Slide 109
Auctions
? Winner’s Curse
?The winner is worse off than those who
did not win
Common Value Auction
西南民族大学Game Theory Slide 110
Auctions
? Examples
?Bidding on a construction job
?Bidding on offshore oil reserves
Common Value Auction
西南民族大学Game Theory Slide 111
Auctions
? Question
?How can you avoid the winner’s curse?
Common Value Auction
西南民族大学Game Theory Slide 112
Auctions
? Private-value Auction
?Have as many bidders as possible
? Common-value Auction
?Use open-bid format
?Release information about value
Maximizing Auction Revenue
西南民族大学Game Theory Slide 113
Internet Auctions
? A Few Caveats
?Now quality control function
?Poor seller feedback
?Bid manipulation may occur
西南民族大学Game Theory Slide 114
Summary
? A game is cooperative if the
players can communicate and arrange
binding contracts; otherwise it is
noncooperative.
? A Nash equilibrium is a set of
strategies such that all players
are doing their best,given the
strategies of the other players.
西南民族大学Game Theory Slide 115
Summary
? Some games have no Nash equilibrium in
pure strategies,but have one or more
equilibria in mixed strategies.
? Strategies that are not optimal for a
one-shot game may be optimal for a
repeated game.
? In a sequential game,the players move
in turn.
西南民族大学Game Theory Slide 116
Summary
? An empty threat is a threat that one
would have no incentive to carry out.
? To deter entry,an incumbent firm must
convince any potential competitor that
entry will be unprofitable.
? Bargaining situations are examples of
cooperative games.
西南民族大学Game Theory Slide 117
Summary
? Auctions can be conducted in a
number of formats which influence
the revenue raised and the price
paid by the buyer.
End of Chapter 7
Game Theory and
Competitive Strategy
