Game Theory

THINKING STRATEGICALLY
Outline of the program: Theme A B C D E F Topic
Strategic Decision Making (Sessi
Credible Commitment (Session 3
Repetition and Reputation (Sessi Bargaining (Session 5)
Tenders, Auctions, and Bidding (
Choosing the Right Game (Sessi
Quotable Quotes Game Theory:
When government auctioneers need world advice, where can they turn? To mathem economists, of course ... As for the rm want to get their hands on a sliver of the airwaves, their best bet is to go out rst hire themselves a good game theorist. The Economist, July 23, 1994, p.70. the most dramatic example of game theor power ... It was a triumph, not only for t and the taxpayers, but also for game the (and game theorists). Fortune, February 6, 1995, p.36. Game theory, long an intellectual pastime into its own as a business tool. Forbes, July 3, 1995, p.62.
Game Theory
aaConventional economics takes the struct
markets as xed. People are thought of simple stimulus-response machines. Sel and buyers assume that products and pr are xed, and they optimize production a consumption accordingly. Conventional economics has its place in describing th operation of established, mature markets it doesnt capture peoples creativity in new ways of interacting with one another
But ...
Game theory is a different way of looking the world. In game theory, nothing is xe The economy is dynamic and evolving. T players create new markets and take on multiple roles. They innovate. No one ta products or prices as given. If this soun the free-form and rapidly transforming marketplace, thats why game theory may the kernel of a new economics for the ne economy.bb
Brandenburger & Foreword to Co-
Theme A: Strategic Decision M

Business is war and peace. Cooperation in creating value. Competition in dividing it up.

Business is war and peace. Cooperation in creating value. Competition in dividing it up. No cycles of War, Peace, War, .... but simultaneously war and peace.
You have to compete and cooperate a same time. Ray Noorda of Novell.

Business is war and peace. Cooperation in creating value. Competition in dividing it up. No cycles of War, Peace, War, .... but simultaneously war and peace.
You have to compete and cooperate a same time. Ray Noorda of Novell.
Co-opetition
(See Theme F later and Brandenburger & N in the Folder.)
Manual for Co-opetition
How to: cooperate without being a saint compete without killing the oppositio
Game Theory
A Case: The New York Post v. the N York News
Rupert Murdochs New York Post takes o New York Daily News. N.Y. Post January 1994 40
N.Y
Rupert Murdochs New York Post takes o New York Daily News. N.Y. Post January 1994 February 1994 40 50
N.Y
Rupert Murdochs New York Post takes o New York Daily News. N.Y. Post January 1994 February 1994 March 1994 40 50 25 (in Staten Island)
N.Y
Rupert Murdochs New York Post takes o New York Daily News. N.Y. Post January 1994 February 1994 March 1994 July 1994 40 50 25 (in Staten Island) 50
N.Y
What happened?
Until Feb 1994 both papers were sold at 40 the Post raised its price to 50 but the New 40 (since it was used to being the rst mo
What happened?
So in March the Post dropped its Staten Isl price to 25 but kept its price elsewhere at until News raised its price to 50 in July, ha lost market share in Staten Island to the Po having accepted that the Post would hence the leader in any price hike.
What happened?
So in March the Post dropped its Staten Isl price to 25 but kept its price elsewhere at until News raised its price to 50 in July, ha lost market share in Staten Island to the Po having accepted that the Post would hence the leader in any price hike.
So both were now priced at 50 everywhere NYC.
1. Business is a Game, of Sorts
Business is a game, but different from stru board games or arcade games or computer
it is not win-lose (not zero-sum): possib players to win
it is not win-lose (not zero-sum): possib players to win apart from the law, there is no rule book
it is not win-lose (not zero-sum): possib players to win apart from the law, there is no rule book others will change the game to their adv
it is not win-lose (not zero-sum): possib players to win apart from the law, there is no rule book others will change the game to their adv the game is made up of ve PARTS (see
it is not win-lose (not zero-sum): possib players to win apart from the law, there is no rule book others will change the game to their adv the game is made up of ve PARTS (see success comes from playing the right g
it is not win-lose (not zero-sum): possib players to win apart from the law, there is no rule book others will change the game to their adv the game is made up of ve PARTS (see success comes from playing the right g
So game theory provides a framework for a rapidly changing world.
The PARTS of the Business Game
Players: customers, suppliers, rivals, allies Change any, including yourself.
Players: customers, suppliers, rivals, allies Change any, including yourself. Added Values: what each player adds to th (taking the player out would subtract added value). Ways to raise yours, or lower theirs.
Players: customers, suppliers, rivals, allies Change any, including yourself. Added Values: what each player adds to th (taking the player out would subtract added value). Ways to raise yours, or lower theirs. Rules: give structure to the game; in busin no universal set of rules from law, custom, practicality, or con Can revise exiting rules, or devise ne
More PARTS ...
Tactics: moves to shape the way: players perceive the game, and he how they play Tactics to reduce misperception, or t or maintain misperception.
More PARTS ...
Tactics: moves to shape the way: players perceive the game, and he how they play Tactics to reduce misperception, or t or maintain misperception. Scope: the bounds of the game: expand or
More PARTS ...
Tactics: moves to shape the way: players perceive the game, and he how they play Tactics to reduce misperception, or t or maintain misperception. Scope: the bounds of the game: expand or
PARTS does more than give a framework, i provides a complete set of levers.
PARTS provides a method to promote nonthinking.
Wider issues.
In Theme F we go beyond the more micro i wider issues:
Which game should your rm/organisation
Its no good sticking to your knitting if theres no demand for jumpers.
We elaborate on the ve PARTS, and introd Value Net.
Question: Left or Right?

You can choose Left or Right: Prots: Left You Rival $40 m $20 m Right $80 m $160 m
(Write down your answer.)
2. A Gentle Introduction
Piemax Inc. bakes and sells dessert pies. Its decision:
price high or low for todays pies?
price high or low for todays pies? Things to be considered: prices of rivals pies?
price high or low for todays pies? Things to be considered: prices of rivals pies? prices of non-pie substitutes?
price high or low for todays pies? Things to be considered: prices of rivals pies? prices of non-pie substitutes? A nave option:
simply optimise its pricing policy giv beliefs about rivals prices, or
Think strategically...
Alternative: try to predict those prices,
using Piemax knowledge of the indu
in particular: its knowledge that its r choose their prices based on their ow predictions of the market environme including Piemax own prices.
in particular: its knowledge that its r choose their prices based on their ow predictions of the market environme including Piemax own prices.
Game Theory Piemax should build a model of behaviour of each individual competitor, Which behaviour would be mos reasonable to expect?
Later: what is an equilibrium?
Later: ought Piemax to believe that the mar Now: what kind of model?
The simplest kind of model.
All bakers operate for one day only (a called one-shot model) All bakers know the production techn and objectives of the others Study with the tools of: payoff matrix games and Nash equilibrium
John Forbes Nash Equilibrium.
Nash Equilibrium: no player has any incent change his or her action, assuming that the player(s) have chosen their best actions fo themselves.
Nash Equilibrium: no player has any incent change his or her action, assuming that the player(s) have chosen their best actions fo themselves. Nash equilibria are self-reinforcing.
Nash Equilibrium: no player has any incent change his or her action, assuming that the player(s) have chosen their best actions fo themselves. Nash equilibria are self-reinforcing.
In two-player games, a Nash equilibrium pr strategies that are mutually best response universally best responses, as with domina strategies).
Repeated interactions.
If more than one day (a repeated game or interaction): then Piemaxs objectives? (more than maximising todays prots
If more than one day (a repeated game or interaction): then Piemaxs objectives? (more than maximising todays prots e.g. low price today may: customers switch from a rival b increase Piemax market share future
If more than one day (a repeated game or interaction): then Piemaxs objectives? (more than maximising todays prots e.g. low price today may: customers switch from a rival b increase Piemax market share future e.g. baking a large batch of pies may allow learning by doing by the staff & lower production costs in the future.
But there are dangers!
Its rivals may be inuenced by Piemaxs pr today a low Piemax price may trigger a price war.
But there are dangers!
Its rivals may be inuenced by Piemaxs pr today a low Piemax price may trigger a price war.
Such dynamic games can be dealt with usi extensive-form game trees and the solution concept of subgame perf
Subgame Perfect Equilibrium: a Nash equilibrium that does not rely on no credible threats (that satises backwards induction).
How about information?
What if Piemax is uncertain of the cos
functions or the long-term objectives rivals? Has Cupcake Pty Ltd just made breakthrough in large-batch prod Does Sweetstuff plc care more a market share than about current And how much do these rivals k about Piemax? Incomplete information games. Acting in a fog: perceptions rule!
And learning?
If the industry continues for several per then Piemax ought to learn about Cupca and Sweetstuffs private information fro current pricing behaviour and use this information to improve its f strategy. In anticipation, Cupcake and Sweetstuff loath to let their prices reveal informatio enhances Piemaxs competitive position They may attempt to manipulate Piemax information.
In a nutshell ...
Game theory is the study of rational behav situations involving interdependence:
In a nutshell ...
May involve common interests: coordina
In a nutshell ...
May involve common interests: coordina May involve competing interests: rivalry
In a nutshell ...
May involve common interests: coordina May involve competing interests: rivalry Rational behaviour: players do the best can, in their eyes; Because of the players interdependenc rational decision in a game must be bas prediction of others responses.
In a nutshell ...
May involve common interests: coordina May involve competing interests: rivalry Rational behaviour: players do the best can, in their eyes; Because of the players interdependenc rational decision in a game must be bas prediction of others responses. Put yourself in the others shoes and pr what action the other person will choos can decide your own best action.
3. Strategic Interaction
Game theory a game plan, a speci
of actions covering all possible event in strategic interactions.
of actions covering all possible event in strategic interactions. Strategic situations: involving two or more participa each trying to inuence, to outguess, adapt to the decisions or lines of beh that others have just adopted or are e to adopt (Tom Schelling).
of actions covering all possible event in strategic interactions. Strategic situations: involving two or more participa each trying to inuence, to outguess, adapt to the decisions or lines of beh that others have just adopted or are e to adopt (Tom Schelling). Look forward and reason backwards!
The at tyre and myopia ...
Two college students, very condent abou mid-term exam performance in a subject, d to attend a party the weekend before the n exam. The party was so good that they ove the whole Sunday.
Instead of taking the exam unprepared on M they pleaded to the professor to give them up exam. Their excuse was a at tyre witho spare and any help. The professor agreed.
On Tuesday morning, the professor placed separate rooms and handed them the test. test had just one question:
On Tuesday morning, the professor placed separate rooms and handed them the test. test had just one question: Which tyre?
And the applications ...
a procurement manager trying to indu subcontractor to search for cost-redu innovations
a procurement manager trying to indu subcontractor to search for cost-redu innovations an entrepreneur negotiating a royalty arrangement with a manufacturing r license the use of a new technology
a procurement manager trying to indu subcontractor to search for cost-redu innovations an entrepreneur negotiating a royalty arrangement with a manufacturing r license the use of a new technology a sales manager devising a commissi payments scheme to motivate salespe
a procurement manager trying to indu subcontractor to search for cost-redu innovations an entrepreneur negotiating a royalty arrangement with a manufacturing r license the use of a new technology a sales manager devising a commissi payments scheme to motivate salespe a production manager deciding betwe piece-rate and wage payments to wor
a procurement manager trying to indu subcontractor to search for cost-redu innovations an entrepreneur negotiating a royalty arrangement with a manufacturing r license the use of a new technology a sales manager devising a commissi payments scheme to motivate salespe a production manager deciding betwe piece-rate and wage payments to wor designing a managerial incentive sys how low to bid for a government proc contract
how high to bid in an auction
how high to bid in an auction a takeover raiders decision on what p offer for a rm
how high to bid in an auction a takeover raiders decision on what p offer for a rm a negotiation between a multinational foreign government over the setting u manufacturing plant
how high to bid in an auction a takeover raiders decision on what p offer for a rm a negotiation between a multinational foreign government over the setting u manufacturing plant the haggling between a buyer and sel used car
how high to bid in an auction a takeover raiders decision on what p offer for a rm a negotiation between a multinational foreign government over the setting u manufacturing plant the haggling between a buyer and sel used car collective bargaining between a trade union/employees and an employer
4. Some Interactions
4.1 Auctioning a Five-Dollar Note
4. Some Interactions
4.1 Auctioning a Five-Dollar Note
Rules: First bid: 20 Lowest step in bidding: 20 (or multiples of 20) The auction lasts until the clock starts r The highest bidder pays bid to auctione gets $5 in return. The second-highest bidder also pays he auctioneer, but gets nothing.
The Five-Dollar Auction

Write down the situation as seen by 1. the high bidder, and 2. the second highest bidder.
The Five-Dollar Auction

Write down the situation as seen by 1. the high bidder, and 2. the second highest bidder. What happened? Escalation and entrapment Examples?
4.2 Schellings Game
Rules: Single play, $4 to play: by writing your n the slip Vote C (Cooperate) or D (Defect). Sign your ballot. (and commit to pay the fee.) If x% vote C and (100 x)% vote D: x then Cs net payoff = ( $6) $ 100 then Ds net payoff = C payoff + Or: You neednt play at all.
Schellings Game
8 6 4 2 0 0 25 50 75 100 Percentage of participants voting C D C
$ per participant
Note: the game costs $4 to join.
Schellings Game
What happened? numbers & payoffs. previous years? coo perate for the common good Dilemma: defect for oneself Public/private information
Schellings n-person Game

Examples? price tax avoidance individual negotiation coal exports market development others?
4.3 The Ice-Cream Sellers

(See Marks in the Folder) L C R
Demonstration Payoff matrix Incentives for movement? Examples?
Modelling the ice-cream sellers.
We can model this interaction with a simpli each seller can either: move to the centre of the beach (M), or not move (stay put) (NM).
The share of ice-creams each sells (to the t population of 80 sunbathers) depends on it and that of its rival.
The share of ice-creams each sells (to the t population of 80 sunbathers) depends on it and that of its rival.
Since each has two choices for its location are 2 2 = 4 possibilities.
Analysing the Interaction
We use arrows and a payoff matrix, which c outlines the possible actions of each and th resulting outcomes.
Payoffs? What are the sales if neither moves (or b NM)? Each sells to half the beach.
Payoffs? What are the sales if neither moves (or b NM)? Each sells to half the beach. What are the sales if You move to the ce and your rival stays put (NM) at the thre quarter point?
Payoffs? What are the sales if neither moves (or b NM)? Each sells to half the beach. What are the sales if You move to the ce and your rival stays put (NM) at the thre quarter point? What if you both move (both M)?
Payoffs? What are the sales if neither moves (or b NM)? Each sells to half the beach. What are the sales if You move to the ce and your rival stays put (NM) at the thre quarter point? What if you both move (both M)? Given the analysis, what should you do?
The Sellers Payoff Matrix

The Other Seller M NM M You NM 30, 50 40, 40 40, 40 50, 30





The payoff matrix (You, Other).

The payoff matrix (You, Other). A non-cooperative, zero-sum game, with a dominant strategy, or dominant move.
Real-World Ice-Cream Sellers
Think of the beach as a product spectrum, end representing a particular niche, and th representating the most popular product.
Demand is largest for the most popular pro but so is competition.
This simple model: a tendency to avoid ext especially with barriers to entry for new pla
Examples:
the convergence of fashion the similarity of commercia radio programming? the copy-cat policies of pol parties? the parallel scheduling of Qantas/JetStar and Ansett/
A twist: What if the centre is too far for som bathers (at the ends of the beach) to walk?
Then the tendency for the sellers to offer th product (at the centre) is reduced, and they differentiate their products.
4.4 The Prisoners Dilemma

(See Marks in the Folder) Case: Telstra and Optus and advertising.

David Ogilvy: Half the money spent on adv is wasted; the problem is identifying which

David Ogilvy: Half the money spent on adv is wasted; the problem is identifying which
Telstra and Optus independently must deci heavily to advertise.
Advertising is expensive, but if one telco c to advertise moderately while the other adv heavily, then the rst loses out while the se does well.
Payoffs
Lets assume if both Advertise Heavily then nets $70,000, while Optus nets $50,000.
But if Telstra Advertises Heavily while Optu Advertises Moderately only, then Telstra ne $140,000 while Optus nets only $25,000, an versa.
If both Advertise Moderately, then Telstra n $120,000 and Optus nets $90,000. What to do? Consider the payoff matrix:
The Advertising Game

Optus Heavy Moderate Heavy Telstra Moderate 25, 140 120, 90 70, 50 140, 25






Both choose Heavy advertising, although e would be better off with Moderate advertisi

Both choose Heavy advertising, although e would be better off with Moderate advertisi Prisoners Dilemma.
Each players rankings are sufcient:
Or, could rank outcomes for each player: 4 1 is worst.

Optus Heavy Moderate
Heavy Telstra Moderate
2, 2
4, 1
1, 4
3, 3

2, 2
4, 1
1, 4
3, 3

2, 2
4, 1
1, 4
3, 3

2, 2
4, 1
1, 4
3, 3

2, 2
4, 1
1, 4
3, 3

2, 2
4, 1
1, 4
3, 3
Neednt have exact knowledge of the payof
The Traditional, Symmetric Payoffs for Prisoners Dilemma: The Payoff Matrix: The Cheaters Reward = 5 The Suckers Payoff = 0 Mutual defection = 2 Mutual cooperation = 4
These are chosen so that: 5 + 0 < 4 + 4 so that C,C is efcient in a repeated ga
The Prisoners Dilemma

A need for: 3 communication 3 coordination 3 trust 3 or?
Efcient Outcome: there is no other combination of actions or strategies th would make at least one player better without making any other player worse

Spill Spill Ned Mum 20, 0 1, 1 8, 8 Kelly Mum 0, 20





Years of prison (Ned, Kell
The choices: Spill the beans to the cop keep Mum.

Years of prison (Ned, Kell
The choices: Spill the beans to the cop keep Mum.
Nash Equilibrium = {Spill, Spill}, despi longer sentences.
Case: Du Ponts Titanium doxide capa
Titanium dioxide is a whitener for paint, p and plastics.
In 1972 du Pont, with 34% of the U.S. mar titanium dioxide, announced additional ca which would after six years result in its s rising to 65%.
Du Pont resisted others price rises, but slackening demand growth meant its plan reduced in size and delayed.
Du Pont resisted others price rises, but slackening demand growth meant its plan reduced in size and delayed.
Nonetheless, it is now the global leader in titanium dioxide supply and its exclusive production is the lowest-cost technology. Du Ponts credibility was important.
4.5 The Capacity Game
Two rms each produce identical prod and each must decide whether to Expa its capacity in the next year or not (DN
A larger capacity will increase its shar market, but at a lower price.
The simultaneous capacity game betw Alpha and Beta can be written as a 2 payoff matrix.
The Capacity Game

DNE DNE Alpha Expand $20, $15 $16, $16 $18,$18 Beta Expand $15, $20
The Capacity Game

The Capacity Game

The Capacity Game

The Capacity Game

The Capacity Game

The payoff matrix (Alpha, Beta).
The Capacity Game

The payoff matrix (Alpha, Beta). A non cooperative, positive-sum game, with dominant strategy. Nash Equilibrium at _____
Equilibrium.
At a Nash equilibrium, each player is d the best it can, given the strategies of other players.
We can use arrows in the payoff matrix what each player should do, given the players action.
The Nash equilibrium is a self-reinforc focal point, and expectations of the oth behaviour are fullled. Not necessaril efcient.
An example of the Prisoners Dilemma one-shot version there is a conict bet collective interest and self-interest.
5. Modelling Players Preferenc
Without uncertainty or any dice-rolling best, good, bad, worst:
we need only rank the four combinatio
payoffs of 4, 3, 2, and 1, respectively 2 interaction.
6. More Interactions
6.1 Battle of the Bismark Sea
6. More Interactions
6.1 Battle of the Bismark Sea
Its 1943: Actors: Admiral Imamura: ordered to transp Japanese troops across the Bismar to New Guinea, and Admiral Kenney: wishes to bomb Imamuras troop transports.
Decisions/Actions: Imamura chooses: a shorter Northern route (2 da a longer Southern route (3 day
Kenney: where to send his planes t for Imamuras ships; he can recall h planes if the rst decision was wron then loses one day of bombing.
Kenney: where to send his planes t for Imamuras ships; he can recall h planes if the rst decision was wron then loses one day of bombing. Some ships are bombed in all four combinations.
Kenney: where to send his planes t for Imamuras ships; he can recall h planes if the rst decision was wron then loses one day of bombing.
Some ships are bombed in all four combinations. Kenney and Imamura each have the sa action set {North, South} but thei payoffs are never the same. Imamura losses are Kenneys gains: a zero-sum
The Battle of the Bismark Sea
Does any player have a dominant strategy? What is the most obvious way the g should be played? Lets look at the payoff matrix:

Imamura North South 2, 2 1, 1 2, 2 3, 3
North Kenney South

North Kenney South

North Kenney South

North Kenney South

North Kenney South

North Kenney South
The payoff matrix (Kenney, Imamura).
A non-cooperative, zero-sum gam with an iterated dominant strategy equi

North Kenney South
The payoff matrix (Kenney, Imamura).
A non-cooperative, zero-sum gam with an iterated dominant strategy equi
No other equilibrium: with all other combinations, at least one of the player stands to gain by changing his action, g the others action.
Players choices.
Neither player has a dominant strategy Kenney would choose North if he thought Imamura w choose North, but South if he thought Imamura w choose South. So Kenneys best response is function of what Imamura doe
Imamura would choose North if he thought Kenney wo choose South, but either if he thought Kenney wo choose North. For Imamura, North is weakly dominant.
And Kenney knows it and chooses No
Imamura would choose North if he thought Kenney wo choose South, but either if he thought Kenney wo choose North. For Imamura, North is weakly dominant.
And Kenney knows it and chooses No
(North, North) is an iterated dominant strategy equilibrium. (It was the outco 1943.)
Equilibrium. (North, North) is a (Nash) equilibrium:
Kenney has no incentive to alter his ac from North to South so long as Imamu chooses North, and Imamura gains nothing by changing h from North to South so long as Kenne chooses North. And neither player has a (strictly) dom strategy. South is a (weakly) dominated strategy Imamura.
A market analogue ?
Two companies, K and I, trying to max their shares of a market of constant si choosing between two product design S.
K has a marketing advantage, and wou to compete head-to-head with I, while I would rather carve out its own instead of head-to-head competition.
6.2 The Battle of the Sexes

A coordination game: video VHS v. Sonys Betamax;
now the competing standards for digit audio disks: SACD (Sony & Philips) v. (Toshiba, Matsushita, Pioneer etc.)
and DVD recording: DVD+R, DVD-R, DV RAM.
and the high-denition DVD: Blu-ray D HD-DVD.
The Players & Actions: a man (Hal) who wants to go to the and a woman (Shirl) who wants to go to Concert.
While selsh, they are deeply in love, a would, if necessary, sacrice their preferences to be with each other.
The Players & Actions: a man (Hal) who wants to go to the and a woman (Shirl) who wants to go to Concert.
While selsh, they are deeply in love, a would, if necessary, sacrice their preferences to be with each other.
The payoff matrix (measuring the scale happiness) is below. What are all equilibria?
(Which pairs of actions are mutually be response?)
The Battle of the Sexes

Theatre Theatre Hal Concert 2, 1 1, 1 Shirl Concert 1, 1 1, 2





The payoff matrix (Hal, Shirl).

The payoff matrix (Hal, Shirl).
A non-cooperative, positive-sum ga with two Nash equilibria.
There is no iterated dominant strategy equilibrium.
There are two Nash equilibria: (Theatre, Theatre): given that Hal ch Theatre, so does Shirl. (Concert, Concert), by the same reasoning. How do the players know which to cho (A coordination game.)
Players choices.
If they do not talk beforehand, Hal mig the Concert and Shirl to the Theatre, e mistaken about the others beliefs.
Players choices.
If they do not talk beforehand, Hal mig the Concert and Shirl to the Theatre, e mistaken about the others beliefs. Focal points?
Players choices.
Repetition? Each of the Nash equilibria is collectiv rational (efcient): no other strategy combination increases the payoff of on player without reducing that of the oth
Players choices.
Repetition? Each of the Nash equilibria is collectiv rational (efcient): no other strategy combination increases the payoff of on player without reducing that of the oth There is a rst-mover advantage in this sequential-move game.
Market analogue ? Battle over an industry-wide standa The choice of language used in a co when two rms want to formalise a agreement but prefer different term Bought a DVD player recently? DVD, CDV, MP3, CD, DVD+, etc. Digital audio disks: SACD (Sony & P v. DVD-A (Toshiba, Matsushita, Pion Emerging standards mean choice a decisions for early adopters. others?
6.3 The Ultimatum Game
Your daughter, Maggie, asks for you advice. She has agreed to participate in a la experiment. The experiment is two-player barga with Maggie as Player 1. She is to be given $10, and will be a to divide it between herself and Pla whose identity is unknown to her.
Maggie must make Player 2 an offer Then Player 2 can either: accept the offer, in which case receive whatever Maggie offer or he can reject, in which case ne player receives anything.
Maggie must make Player 2 an offer Then Player 2 can either: accept the offer, in which case receive whatever Maggie offer or he can reject, in which case ne player receives anything. How much should Maggie offer?
Maggies choices. Distinguish: the rationalists answer from the just agreement.
the likely agreement in practice fr
The rationalist: Player 1 should offer Player 2 5 (th smallest coin). Player 2 will accept, since 5 is bett nothing. But offering only 5 seems risky, si Player 2 is insulted, it would cost hi 5 to reject it. Maybe Maggie should offer more. B much more? In-class exercise.
6.4 The Inheritance Game
The players: Elizabeth, an aged mother, wishes t an heirloom to one of her several daughters.
The game: E. wants to benet the daughter wh values it most. But the daughters may be dishones has an incentive to exaggerate its w her.
A second-price auction. so E. devises the following scheme asks the daughters to tell her condentially (i.e. a sealed bid values, and promises to give it to the one reports the highest value the highest bidder gets the he but only pays the second-high reported valuation.
Will Elizabeths scheme (a Vickrey auc second-price auction) make honesty th policy?
A second-price auction. so E. devises the following scheme asks the daughters to tell her condentially (i.e. a sealed bid values, and promises to give it to the one reports the highest value the highest bidder gets the he but only pays the second-high reported valuation.
Will Elizabeths scheme (a Vickrey auc second-price auction) make honesty th policy? Yes.
Why? Thinking through the options.
Consider your reasoning as one of the daughters: three options: truthfulness, exagge or understatement. The amount you pay is independen what you say its worth, so the only effect of your report is t determine whether or not you win t heirloom, and hence what you mus
Exaggeration Exaggeration: the possibility that y make the highest report when you w not otherwise have, had you been h
i.e., that the second-highest report, one you now exceed, is higher than true valuation.
But that what you must pay (the second-highest report) is more than you think the heirloom is worth.
Exaggeration not in your interest
Understatement Understating changes the outcome when you would have won with an h report;
but now you report a value lower th of one of your sisters, so you do no the heirloom. Not in your interest either.
It works.
So the mothers scheme works, and th is obtainedbut at a price, to Elizabet Mum. E. receives a payment less than the successful daughters valuation,
so this daughter earns a prot: = her valuation the 2nd-highest valua = the premium the mother forgoes to in honesty
Market Analogue ?
Think: how can the neighbours who pr building a park overcome each househ temptation to free-ride on the others e by claiming not to care about the park contributions should reect the house valuation of the park?
How can the users of a satellite be ind reveal their prots so that the operatin of the satellite can be divided accordin the prot each user earns?
7. Concepts Used:
Best response means the players bes when faced with a particular action or her rival
7. Concepts Used:
Best response means the players bes when faced with a particular action or her rival
Nash equilibrium is the outcome that r when all players are simultaneously their best responses to the others actions;
Thus at an equilibrium all players a doing the best they can, given the o decisions; that is, all are playing th responses.
If, conversely, the game is not at an equilibrium, then at least one of the players could have done better by a differently.
A Nash equilibrium is self-reinfor given that the others dont deviate, player has any incentive to change her strategy.
If, conversely, the game is not at an equilibrium, then at least one of the players could have done better by a differently.
A Nash equilibrium is self-reinfor given that the others dont deviate, player has any incentive to change her strategy. An efcient outcome is an outcome wh there exists no other outcome that players prefer.
8. What Have We Learnt?

Rule 1: Look ahead and reason back.

Rule 2: If you have a dominant strateg use it.

Rule 3: Eliminate any dominated strat from consideration, and go on doin successively.

Rule 3: Eliminate any dominated strat from consideration, and go on doin successively.
Rule 4: Look for an equilibrium, a pair strategies in which each players ac the best response to the others.
9. Summary of Strategic Decisi Making
The following concepts & tools are introduced: The Ice-Cream Sellers: payoff matrix incentives to change use arr dominant strategy The Prisoners Dilemma The Capacity possibility of repetition efcient outcome non-zero-sum game inefcient equilibria
The Battle of the Bismark Sea: zero-sum game iterated dominant strategy Nash equilibrium The Battle of the Sexes: coordination, not rivalry rst-mover advantage focal points

Game Theory

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THINKING STRATEGICALLY

Outline of the program: Theme A B C D E F Topic

Strategic Decision Making (Sessi

Credible Commitment (Session 3

Repetition and Reputation (Sessi Bargaining (Session 5)

Tenders, Auctions, and Bidding (

Choosing the Right Game (Sessi

Quotable Quotes Game Theory:

aaConventional economics takes the struct

Brandenburger & Foreword to Co-

Theme A: Strategic Decision M

Theme A: Strategic Decision M

Theme A: Strategic Decision M

(See Theme F later and Brandenburger & N in the Folder.)

Manual for Co-opetition

A Case: The New York Post v. the N York News

A Case: The New York Post v. the N York News

A Case: The New York Post v. the N York News

A Case: The New York Post v. the N York News

So both were now priced at 50 everywhere NYC.

1. Business is a Game, of Sorts

it is not win-lose (not zero-sum): possib players to win

1. Business is a Game, of Sorts

1. Business is a Game, of Sorts

1. Business is a Game, of Sorts

1. Business is a Game, of Sorts

1. Business is a Game, of Sorts

So game theory provides a framework for a rapidly changing world.

The PARTS of the Business Game

The PARTS of the Business Game

Players: customers, suppliers, rivals, allies Change any, including yourself.

The PARTS of the Business Game

The PARTS of the Business Game

More PARTS ...

More PARTS ...

More PARTS ...

PARTS provides a method to promote nonthinking.

In Theme F we go beyond the more micro i wider issues:

Which game should your rm/organisation

Its no good sticking to your knitting if theres no demand for jumpers.

We elaborate on the ve PARTS, and introd Value Net.

Question: Left or Right?

(Write down your answer.)

price high or low for todays pies?

using Piemax knowledge of the indu

using Piemax knowledge of the indu

using Piemax knowledge of the indu

Later: what is an equilibrium?

The simplest kind of model.

John Forbes Nash Equilibrium.

John Forbes Nash Equilibrium.

John Forbes Nash Equilibrium.

But there are dangers!

But there are dangers!

How about information?

What if Piemax is uncertain of the cos

Game theory is the study of rational behav situations involving interdependence:

Game theory is the study of rational behav situations involving interdependence:

May involve common interests: coordina

Game theory is the study of rational behav situations involving interdependence:

Game theory is the study of rational behav situations involving interdependence:

Game theory is the study of rational behav situations involving interdependence:

Game theory a game plan, a speci