Game theory case study

Heres the latest twist in the auto bailout: Detroits Big Three arent the only automotive companies that want to see the government step in with some much needed financial help. Overseas automakers, most notably Toyota Motor, all endorse some form of federal aid to keep General Motors, Chrysler LLC and possibly Ford Motor out of bankruptcy. [source: CNN "Why Toyota wants GM to be saved"] The news seems strange. Business is a dog eat dog world. The usual response is to kick a competitor while he is down. As McDonalds founder Ray Kroc put it, If any of my competitors were drowning, Id stick a hose in their mouth and turn on the water. So why would Toyota help the Big Three? Game theory tells us to think deeper. The real reason Asian automakers want to help is out of self-interest. The CNN article explains several of the strategic reasons for helping the US automakers. They involve:

supply costs demand issues deterring new entrants

Lets examine each issue in detail. (all quotes are from the CNN article on the bailout) Supply costs While automakers are competitors in car sales, they are indirectly partners in the auto parts supplier market. The more cars that are sold-regardless of who sells them-the greater demand there is for parts, and consequently, the lower the price will be for everyone. Asian companies have a vested interest in protecting demand for the delicate supply market: The overseas automakers, who between them produce more than 3 million vehicles a year at U.S. plants, all worry their production would be hurt if one of the U.S. automakers went under.

Thats because a Big Three failure would likely lead to widespread bankruptcies in the auto parts supplier industry. The risk is increased because many parts only have a single supplier. Ultimately costs and time for production would be increased in the transition period. And increased costs would further damage automakers because of demand issues.

Demand issues All automakers depend on another common item-the health of the U.S. economy. The more severe the recession, the worse car sales will be. Foreign automakers depend on U.S. sales and worry about further declines. The pain has been tangible for Toyota which has had to cut production: The latest cutbacks came Monday when Toyota announced it was putting plans to open a new plant in Mississippi on hold indefinitely, even though it is about 90% complete. The plant was set to start building the first domestically produced Prius in 2011. Sometimes competition can be put aside for bigger issues. Asian companies are guessing that a Big Three bankruptcy would have too large an impact to ignore. Thats why they are worried less about their share of the car market and more about how big the market will be. Deterring new entrants High start-up costs often keep entrants out. They worry about joining a market where an incumbent can price gouge, drive them out, and then recover profits later. In the auto industry, there is also an issue of excess capacity-it might be unprofitable to join a market at current production levels. And this is why Honda and Toyota are scared about the U.S. companies failing. It sets up a chance for entrants to come in much easier: The final concern for the overseas automakers is a longer-term problem. If a U.S. automaker fails, that could open the door for a Chinese or Indian automaker to buy up the assets of the failed automaker and create a new low-cost competitor in the U.S.

While China and India may eventually come into the U.S. market, incumbents would rather have that happen later. In conclusion

The bailout illustrates why it might not always be a good idea to kick your competitor when he is down. Propping him up might be the lesser of two evils.

The Game Tucker began with a little story, like this: two burglars, Bob and Al, are captured near the scene of a burglary and are given the "third degree" separately by the police. Each has to choose whether or not to confess and implicate the other. If neither man confesses, then both will serve one year on a charge of carrying a concealed weapon. If each confesses and implicates the other, both will go to prison for 10 years. However, if one burglar confesses and implicates the other, and the other burglar does not confess, the one who has collaborated with the police will go free, while the other burglar will go to prison for 20 years on the maximum charge. The strategies in this case are: confess or don't confess. The payoffs (penalties, actually) are the sentences served. We can express all this compactly in a "payoff table" of a kind that has become pretty standard in game theory. Here is the payoff table for the Prisoners' Dilemma game: Table 3-1

Al confess don't Bob confess 10,10 don't 20,0 0,20 1,1

The table is read like this: Each prisoner chooses one of the two strategies. In effect, Al chooses a column and Bob chooses a row. The two numbers in each cell tell the outcomes for the two prisoners when the corresponding pair of strategies is chosen. The number to the left of the comma tells the payoff to the person who chooses the rows (Bob) while the number to the right of the column tells the payoff to the person who chooses the columns (Al). Thus (reading down the first column) if they both confess, each gets 10 years, but if Al confesses and Bob does not, Bob gets 20 and Al goes free. So: how to solve this game? What strategies are "rational" if both men want to minimize the time they spend in jail? Al might reason as follows: "Two things can happen: Bob can confess or Bob can keep quiet. Suppose Bob confesses. Then I get 20 years if I don't confess, 10 years if I do, so in that case it's best to confess. On the other hand, if Bob doesn't confess, and I don't either, I get a year; but in that case, if I confess I can go free. Either way, it's best if I confess. Therefore, I'll confess." But Bob can and presumably will reason in the same way -- so that they both confess and go to prison for 10 years each. Yet, if they had acted "irrationally," and kept quiet, they each could have gotten off with one year each.

Dominant Strategies What has happened here is that the two prisoners have fallen into something called a "dominant strategy equilibrium." DEFINITION Dominant Strategy: Let an individual player in a game evaluate separately each of the strategy combinations he may face, and, for each combination, choose from his own strategies the one that gives the best payoff. If the same strategy is chosen for each of the different combinations of strategies the player might face, that strategy is called a "dominant strategy" for that player in that game.

DEFINITION Dominant Strategy Equilibrium: If, in a game, each player has a dominant strategy, and each player plays the dominant strategy, then that combination of (dominant) strategies and the corresponding payoffs are said to constitute the dominant strategy equilibrium for that game. In the Prisoners' Dilemma game, to confess is a dominant strategy, and when both prisoners confess, that is a dominant strategy equilibrium.

Issues With Respect to the Prisoners' Dilemma This remarkable result -- that individually rational action results in both persons being made worse off in terms of their own self-interested purposes -- is what has made the wide impact in modern social science. For there are many interactions in the modern world that seem very much like that, from arms races through road congestion and pollution to the depletion of fisheries and the overexploitation of some subsurface water resources. These are all quite different interactions in detail, but are interactions in which (we suppose) individually rational action leads to inferior results for each person, and the Prisoners' Dilemma suggests something of what is going on in each of them. That is the source of its power. Having said that, we must also admit candidly that the Prisoners' Dilemma is a very simplified and abstract -- if you will, "unrealistic" -- conception of many of these interactions. A number of critical issues can be raised with the Prisoners' Dilemma, and each of these issues has been the basis of a large scholarly literature:

The Prisoners' Dilemma is a two-person game, but many of the applications of the idea are really many-person interactions. We have assumed that there is no communication between the two prisoners. If they could communicate and commit themselves to coordinated strategies, we would expect a quite different outcome. In the Prisoners' Dilemma, the two prisoners interact only once. Repetition of the interactions might lead to quite different results. Compelling as the reasoning that leads to the dominant strategy equilibrium may be, it is not the only way this problem might be reasoned out. Perhaps it is not really the most rational answer after all.

We will consider some of these points in what follows.

Game theory provides a promising approach to understanding strategic problems of all sorts, and the simplicity and power of the Prisoners' Dilemma and similar examples make them a natural starting point. But there will often be complications we must consider in a more complex and realistic application. Let's see how we might move from a simpler to a more realistic game model in a real-world example of strategic thinking: choosing an information system. Quiening teory

The public switched telephone network (PSTN) is designed to accommodate the offered traffic intensity with only a small loss. The performance of loss systems is quantified by theirgrade of service, driven by the assumption that if sufficient capacity is not available, the call is refused and lost. Alternatively, overflow systems make use of alternative routes to divert calls via different paths even these systems have a finite traffic carrying capacity. However, the use of queueing in PSTNs allows the systems to queue their customers' requests until free resources become available. This means that if traffic intensity levels exceed available capacity, customer's calls are not lost; customers instead wait until they can be served. This method is used in queueing customers for the next available operator. A queueing discipline determines the manner in which the exchange handles calls from customers. It defines the way they will be served, the order in which they are served, and the way in which resources are divided among the customers. Here are details of four queueing disciplines: First in first out This principle states that customers are served one at a time and that the customer that has been waiting the longest is served first. Last in first out This principle also serves customers one at a time, however the customer with the shortest waiting time will be served first. Also known as a stack. Processor sharing Customers are served equally. Network capacity is shared between customers and they all effectively experience the same delay. Priority Customers with high priority are served first.

Queueing is handled by control processes within exchanges, which can be modelled using state equations. Queueing systems use a particular form of state equations known as aMarkov chain that models the system in each state.[9] Incoming traffic to these systems is modelled via a Poisson distribution and is subject to Erlangs queueing theory assumptions viz Pure-chance traffic Call arrivals and departures are random and independent events. Statistical equilibrium Probabilities within the system do not change.[8] Full availability All incoming traffic can be routed to any other customer within the network. Congestion is cleared as soon as servers are free. Classic queueing theory involves complex calculations to determine waiting time, service time, server utilization and other metrics that are used to measure queueing performance.

Queueing Theory, if used appropriately, can describe the a system and its dynamics accurately in order to pave the way for eventually improving the system. Let me illustrate. Lets assume the following scenario. Widgets are made to order in an assembly line that consists of three steps, each performed by a single worker. So, there are a total of 3 workers on the assembly line. Here are a few facts and data for this process: Wait-time between process steps is caused by buildup of work-in-process inventory. Wait-time in front of Step 1 represents the wait-time from an arrival of an order to the start of production. After step 3, the product is delivered immediately to the customer. On average, orders for widgets arrive every 15 minutes. We define Capacity is its maximum sustainable throughput: The # of resources simultaneously performing the activity / The time duration of the activity

Below is the data: Widget Factory Step Average Wait Time Average Service Time 1 28 9

2 3

20 30

8 10

So, given the scenario above, What is the average number of jobs in the system, including orders waiting to be processing PLUS work-in-process? To answer the above question, we need the following: Cycle Time: 28+9+20+8+30+10 = 105 Minutes Average Throughput Rate = 1/15 So, the average number of jobs in the system including orders waiting and current work-inprocess is:

1/15*(105) = 7 Widgets