Brickley, Smith, and Zimmerman,

Managerial Economics and

Organizational Architecture, 4th ed.

Chapter 9: Economics of
Strategy
Game theory

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Game theory
learning objectives
Structure a simple game in both
matrix and tree formats
Specify a simple game
Identify Nash equilibria
Identify dominant strategies

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Game theory overview

General analysis of strategic
interaction
Optimal decision making when
all decision agents are presumed
rational
each attempts to anticipate actions of
rivals

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Simultaneous-move,
non-repeated interaction
Simultaneous?
Rivals must make decisions with no
knowledge of each others decisions

Nonrepeated?
The interaction occurs only once

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Example
Boeing and Airbus individually choose
and simultaneously submit a bid price
(high or low) for 10 planes
Each cell entry represents the payoffs
A dominant strategy is one the firm
chooses no matter what its rival does

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Strategic form
dominant strategy

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Nash equilibrium
revisited
In the absence of a dominant
strategy, Nash equilibrium may
predict outcome
Nash equilibrium is set of strategies
where firm does its best given
rivals actions
Use arrow technique to identify
Nash equilibrium
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Nash equilibrium

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Competition versus
cooperation
Boeing and Airbus make
simultaneous choices of new
communications systems
two technologies: Alpha & Beta
both benefit with same choice

Results in two Nash equilibria

benefits from pre-commitment
communication
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Coordination game
two Nash equilibria

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Coordination/competition
game

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Mixed strategies
Mixed strategy offers an element of
surprise
Boeing and Airbus must simultaneously
commit to an advertising campaign
Boeing benefits most from same strategy
Airbus benefits most from differentiation

Randomization with p=.5 is Nash

equilibrium for both

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Mixed strategy

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Sequential interactions
Boeing & Airbus communications
technology choice
Boeing chooses first

Analyze with backward induction

Boeing must take Airbuss best response
into account in making its choice
Boeing has first mover advantage

Credible commitment by second

mover can alter first mover choice

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Extensive form
sequential game

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

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Strategic interaction and

organizational architecture
Kiana manages Lenin
Len must choose between working
and shirking
Kiana must choose whether to
incur monitoring costs
No pure strategy equilibrium exists

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Interactive game
no pure strategy equilibrium

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Appendix Figures

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Payoffs to two members

single-period setting

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Generalized payoffs to two

members
multiperiod setting

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Payoffs for two team

members
low probability of future work
together

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

Payoffs for two team

members
high probability of future work
together

2007 The McGraw-Hill Companies, Inc., All Rights Reserved.