mbmc thinking strategically. mbmc copyright c 2004 by the mcgraw-hill companies, inc. all rights...

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Thinking Strategically

Chapter 10: Thinking Strategically Slide 2

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Copyright c 2004 by The McGraw-HillCompanies, Inc. All rights reserved.

Thinking Strategically

The payoff to many actions will depend onThe actions themselves.When the actions are taken.How the actions relate to those taken by

others.


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The Theory of Games

Basic Elements of a GameThe PlayersTheir StrategiesThe Payoffs


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The Theory of Games

ExampleShould United Airlines spend more on

advertising?


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The Payoff Matrix for an Advertising Game

Raise adspending

Leave adspendingthe same

Raise adspending


American American gets $5,500gets $5,500




United gets United gets $5,500$5,500




American’s Choice

United’s Choice


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The Theory of Games

Dominant StrategyOne that yields a higher payoff no matter

what the other players in a game choose


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The Theory of Games

Dominated StrategyAny other strategy available to a player

who has a dominant strategy


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The Theory of Games

Nash EquilibriumAny combination of strategies in which

each player’s strategy is her or his best choice, given the other player’s strategies


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The Theory of Games

Nash EquilibriumWhen each player has a dominant

strategy, equilibrium occurs when each player follows that strategy


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The Theory of Games

Nash EquilibriumThere can be an equilibrium when players

do not have a dominant strategy


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The Theory of Games

ExampleShould United Airlines spend more on

advertising?


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Equilibrium When One Player Lacks a Dominant Strategy

Raise adspending


Raise adspending










American’s Choice

United’s Choice


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What Should United and American Do If Their Payoff Matrix is Modified?

Raise adspending


Raise adspending










American’s Choice

United’s Choice


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The Prisoner’s Dilemma

Prisoners DilemmaA game in which each player has a

dominant strategy, and when each plays it, the resulting payoffs are smaller than if each had played a dominated strategy


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ExampleShould the prisoners confess?


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The Payoff Matrix for a Prisoner’s Dilemma

ConfessRemainsilent

Confess

Remainsilent

Jasper getsJasper gets5 years5 years




Horace getsHorace gets5 years5 years




Jasper’s Choice

Horace’s Choice


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ExerciseWhich of these games is a prisoner’s

dilemma?


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Which of These GamesIs a Prisoner’s Dilemma?

Don’t Invest

Don’tInvest

Invest

10 for10 forChryslerChrysler




10 for10 forGMGM

4 for4 forGMGM

5 for5 forGMGM

12 for12 forGMGM

Chrysler’s Choice

GM’s Choice

GAME 1

Invest


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Which of These GamesIs a Prisoner’s Dilemma>





4 for4 forGMGM

5 for5 forGMGM

12for12forGMGM

10 for10 forGMGM

Chrysler’s Choice

GM’s Choice

GAME 2

Don’t Invest

Don’tInvest

Invest

Invest


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Prisoner’s Dilemmas Confronting Imperfectly Competitive FirmsCartel

A coalition of firms that agrees to restrict output for the purpose of earning an economic profit


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Economic NaturalistWhy are cartel agreements notoriously

unstable?


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The Market Demandfor Mineral Water

Pric

e $/

bottl

e)

Bottles/day

Assume• 2 firms (Aquapure & Mountain Spring

• MC = 0• Cartel is formed & agree to split output and profits

2,000

D

1.00

1,000

MR

2.00

Impact of Cartel• Q = 1,000 bottles/day• P = $1/bottle• Each firm makes $500/day


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The Temptation to Violate a Cartel Agreement

Pric

e $/

bottl

e)

Bottles/day

D

1.00

1,000 2,000

MR

2.00

1,100

0.90

Aquapure lowers P• P = $.90/bottle• Q = 1,100 bottles/day

Mountains Spring retaliates• P = $.90/bottle• Both firms split 1,100

bottles/day @ $.90• Profit = $495/day


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The Payoff Matrix for a Cartel Agreement

Charge $1 Charge $0.90

Charge$1

Charge$0.90

Mountain Spring’s Choice

Aquapure’s Choice

$990/day for $990/day for Mountain SpringMountain Spring



$500/day for$500/day forAquapureAquapure






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Economic NaturalistWhen will the rival firms stop cutting

prices?


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Economic NaturalistHow did Congress unwittingly solve the

television advertising dilemma confronting cigarette producers?


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Cigarette Advertising as a Prisoner’s Dilemma

Advertise on TV Don’t advertise on TV

Advertise on TV

Don’tAdvertiseon TV

$10 million/year$10 million/yearfor Philip Morrisfor Philip Morris




$10 million/$10 million/year for RJRyear for RJR




Philip Morris’s Choice

RJR’s Choice


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Economic NaturalistWhy do people stand at concerts, even

though they can see just as well when everyone sits?


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Standing versus Sitting at a Concert as a Prisoner’s Dilemma

Stand Sit

Stand

Sit

Other People’s Choice

Your Choice

-$2 for others-$2 for others

-$2 for you-$2 for you $1 for you$1 for you

$0 for you$0 for you-$3 for you-$3 for you

-$3 for others-$3 for others

$1 for others$1 for others $0 for others$0 for others


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Economic NaturalistWhy do people shout at parties?


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Tit-for-Tat and the Repeated Prisoner’s DilemmaCooperation between players will increase

the payoff in a prisoner’s dilemma.There is a motive to enforce cooperation.


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Tit-for-tat strategy for repeated gamesTit-for-tat strategy

Players cooperate on the first move, then mimic their partner’s last move on each successive move


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Tit-for-tat strategy for repeated gamesTit-for-tat strategy requirements

Two playersA stable set of playersPlayers recall other player’s movesPlayers have a stake in future outcomes


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QuestionWhy is the tit-for-tat strategy unsuccessful

in competitive, monopolistically competitive, and oligopolistic markets?


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Games in Which Timing Matters

The Ultimate Bargaining GameShould Michael accept Tom’s offer?

Rules of the gameo Experimenter gives $100 to Tomo Tom proposes how to divide $100 with Michaelo Tom must give Michael at least $1 (X = Tom and

$100 - X = Michael)o Michael must accept the proposalo If he does, Tom and Michael get the moneyo If he does not, the money goes to the experimenter


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Decision Tree for Tom

A

Michaelaccepts

Michaelrefuses

$X for Tom$(100 – X) for Michael

$0 for Tom$0 for Michael

Tom proposes$X for himself,$(100 – X) forMichael

B

Possible Moves and Payoffs


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Tom’s Best Strategy in an Ultimatum Bargaining Game

A

Michaelaccepts

Michaelrefuses



Tom proposes$99 for himself,$1 for Michael

B

• Tom can give Michael a take-it-or-leave-it offer• Tom will propose $1• Michael will accept• The outcome is a Nash Equilibrium


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The Ultimatum Bargaining Gamewith an Acceptance Threshold

A

$X for Tom$(100 – X) for Michael


Michael announces that he will reject any offer less than $Y

B

Tom proposes$X < $(100 - Y) for himself$(100 - X) > Y for Michael

Tom proposes$X > $(100 - Y) for himself$(100 - X) < Y for Michael

New Rule: Michael can specify in advancethe minimum offer he will accept


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Credible Threats and PromisesCredible Threat

A threat to take an action that is in the threatener’s interest to carry out


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ExampleIs it safe to steal Veronica’s briefcase?

Hint....What are the costs and benefits of filing

charges in the theft of a briefcase?


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Credible PromiseA promise to take action that is in the

promiser’s interest to keep


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Decision Tree for the Kidnapper Game

AKidnapperkills victim

Victim goesto police

Victim dies,kidnapper survives

Victim promises to remain silent

B

Kidnapper setsvictim free

CVictim remainssilent

Victim remainsin danger,kidnapper survives

Victim is safe,kidnapper executed

Will the kidnapper release his victim?


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Decision Tree for the Remote Office Game

A

Owner does not open remote office

Manager manages honestly;owner gets $1,000,manager gets $1,000

Managerial candidatepromises to managehonestly

B

Owner opensremote office

C

Manager manages dishonestly;owner gets -$500,manager gets $1,500

Owner gets $0,manager gets $500 byworking elsewhere

Should a business owner open a remote office?Is the outcome an equilibrium?


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Commitment ProblemA situation in which people cannot achieve

their goals because of an inability to make credible threats or promises


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Commitment DeviceA way of changing incentives so as to

make otherwise empty threats or promises credible


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Commitment ProblemsPrisoner’s dilemmaCartelsKidnapperRemote office


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Commitment DevicesUnderworld code, omertaMilitary arms control agreementsTips for waiters


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What do you think?How could the kidnap victim create a

commitment device to remain silent?


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What do you think?Will Sylvester leave a tip when dining on

the road?


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The Strategic Roleof Preferences

Game theory assumes that the goal of the players is to maximize their outcome.

In most games, players do not attain the best outcomes.

Altering psychological incentives may also improve the outcome of a game.


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QuestionIn a moral society, will the business owner

open a remote office?


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The Remote Office Game with an Honest Manager

A

Owner does not open remote office

Manager manages honestly;owner gets $1,000,manager gets $1,000

Managerial candidatepromises to managehonestly

B

Owner opensremote office

C

Manager manages dishonestly;owner gets -$500,manager gets -$8,500

Owner gets $0,manager gets $500 byworking elsewhere

The value of dishonesty to the manager is $10,000


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Are People Fundamentally Selfish?Do you tip at out-of town restaurants?What would be your first offer in the

ultimatum bargaining game?Would you refuse a lopsided offer?


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Are People Fundamentally Selfish?If narrow self-interest is not the only motive

for making choices, then the other motives must be understood to predict and explain human behavior.


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Preferences as Solutions to Commitment ProblemsConcerns about fairness, guilt, humor,

sympathy, etc. do influence the choices people make in strategic interactions.

Commitment to these preferences must be communicated for them to influence choices.

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End ofChapter

mbmc thinking strategically. mbmc copyright c 2004 by the mcgraw-hill companies, inc. all rights...

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