Dr.

Adrian Teja

Issues to be discussed
Game Theory
Game Theory Cases

Game Theory
Cooperative Game Theory
Non Cooperative Game Theory
Seeks to predict the behavior of rational, intelligent
firms competing independently.

Firms are rational if they make decisions by maximizing their

subjective expected utility.
Firms are intelligent if they recognize that other firms are
rational. Intelligent firms can put themselves in the other
firms positions and reasons from their points of view.

Applications of Game Theory

Product and price competition
Coordination in channels of distribution
Price war

Implicit collusion
First mover advantage
Price as a signal of quality

The winners curse in competitive bidding.

Games Consist of
Players or agents who make decisions.
Planned actions of players, called strategies.
Payoff of players under different strategy scenarios.

A description of the order of play.

A description of the frequency of play or interaction.

The Essence of Competition

Interdependence.
Interdependence means that the consequences to a firm
of taking an action depend not just on that firms action.
Conflict of interest.
Firm must not be able to collude.

Rules of The Games Means Complete

Descriptions of The Game
The number of firms
Their feasible sets of actions at every juncture in the

game
Their utilities (profits) for each combination of moves
The sequence of the moves
The structure of information about moves (who knows
what? When?).

Order of Decisions in Games

Simultaneous-move game
Game in which each player makes decisions without the
knowledge of the other players decisions.
Sequential-move game
Game in which one player makes a move after observing
the other players move.

Frequency of Interaction in Games

One-shot game
Game in which players interact to make decisions only
once.
Repeated game
Game in which players interact to make decisions more
than once.

Possible Strategies

Dominant strategy

Secure strategy

A strategy that results in the highest payoff to a player regardless of

the opponents action.
A strategy that guarantees the highest payoff given the worst
possible scenario.

Nash equilibrium strategy

A condition describing a set of strategies in which no player can

improve her payoff by unilaterally changing her own strategy, given
the other players strategies.

10-11

Dominant Strategy
Player B
Strategy

Player A
Player A

Left B
Player

Strategy
Up
Up
Down
Down

10, Left
20
10, 20
-10 , 7
-10 , 7

Right
Right
15, 8
15, 8
10, 10
10, 10

Player A has a dominant strategy: Up

Player B has no dominant strategy

10-12

Simultaneous-Move, One-Shot
Games

Secure Strategy
Player B
Strategy
Player A

Left
Player B

Strategy
Up
Player A

Up
Down
Down

Right

10, 20Left

15,
8
Right

10, 20
-10 , 7
-10 , 7

15, 8
10, 10
10, 10

Player As secure strategy: Up guarantees at least a $10 payoff

Player Bs secure strategy: Right guarantees at least an $8 payoff

10-13

Simultaneous-Move, One-Shot
Games

Nash Equilibrium Strategy

Prisoners Dilemma

10-14

A Game of Complete Information Vs

A Game of Incomplete Information
A game of complete information is one in which the rules

of the game are common knowledge among the firms.

Every firm knows the rules,
Every firm knows that every other firm knows the rule,
Every firm knows that the other firms know that it knows the

rules, etc.

A game of incomplete information is one in which the rules

of the game are not common knowledge among the firms.

There is some asymmetry in the information at the start of

the game.

Most real-world games are games of

incomplete information
Firms often do not know the motivations of their
competitors they do not know their costs and hence
their profits from various actions, nor even whether they
are guided by profits or some other objective.
2. Firms often do not know the technological capabilities of
their competitors, that is, they do not know the feasible
sets of actions of their competitors.
3. Firms differ in their knowledge of the world, i.e. one firm
may know more about the commercial potential of a new
drug than its competitors because it has done more
product development than others.
1.

Pricing Game
Two Airlines, A and B, serve a given route
A is the price leader it moves first - and choose

between 2 moves, the ticket prices $200 and $300

B is the follower, observes As move, then choose
between $200 and $300
A have 2 strategy and 2 moves
B have 4 strategy and 2 moves

Extensive Form Representation of a Pricing Game

Strategic Form Representation of A Pricing Game

Advertising Decision (1)

Firm B

Firm A

Strategy

Advertise

Don't Advertise

Advertise

$4K, $4K

$20K,$1K

Don't Advertise

$1K,$20K

$10K,$10K

Advertising Decision (2)

Leader's Strategies

Challenger's Strategies

Strategy

Advertise in Medium 1

Advertise in Medium 2

Advertise in Medium 1

1,0

0,1

Advertise in Medium 2

0,1

1,0

Monitoring Employee
Worker
Strategy
Manager

Monitor

Dont Monitor

-1, 1

1, -1

1, -1

-1, 1

Monitor

Dont Monitor

Coordination Game
Firm B
Strategy
120-Volt Outlets

90-Volt Outlets

120-Volt Outlets

$100, $100

$0, $0

90-Volt Outlets

$0 , $0

$100, $100

Firm A

Entry Game (1)

Entry Game (2)

Conclusion
When there are multiple equilibria in a game, the

Nash Equilibrium loses some of its predictive power.

When multiple perfect equilibria exist, the firm must
pick what it sees as the more promising equilibrium.
To do so, the firm must necessarily bring into play
considerations that were not part of the formal game
(e.g. personality, history, culture).
Several iteration game is not the same as one iteration
game.