Game Theory

Life must be understood backward,

but it must be lived
forward.
- Soren Kierkegaard

Mike Shor

Review

Recognize dominant and

dominated strategies
Dominant strategies are always played
Dominated strategies are never played

Equilibrium: likely outcome of a game

Dominance solvable
Iterated deletion of dominated strategies
Game Theory - Mik

Cell-by-Cell Inspection

Games of Assurance
The good equilibrium is risky
Need assurances

Games of Coordination
Failure to agree leads to no profits
Cant agree on what to agree on

Games of Chicken

Game Theory - Mik

Games of Chicken

A monopolist faces a potential entrant

Monopolist can accommodate or fight
Potential entrant can enter or stay out

Potential
Entrant

Monopolist
In
Out

Accommodate
50 , 50
0 , 100

Fight
-50 , -50
0 , 100

Game Theory - Mik

Equilibrium

Use best reply method

to find equilibria

Potential
Entrant

Monopolist
In
Out

Accommodate
50 , 50
0 , 100

Game Theory - Mik

Fight
-50 , -50
0 , 100

Importance of Order

Two equilibria exist

( In, Accommodate )
( Out, Fight )

Only one makes temporal sense

Fight is a threat, but not credible
Not sequentially rational

Simultaneous outcomes may not

make sense for sequential games.
Game Theory - Mik

Sequential Games
The Extensive Form

t
u
o

0 , 100

in

t
h
fig

-50 , -50

ac
c

50 , 50
Game Theory - Mik

Looking Forward

Entrant makes the first move:

Must consider how monopolist will respond

If enter:
M

t
h
g
fi

-50 , -50

ac
c

50 , 50

Monopolist accommodates
Game Theory - Mik

 And Reasoning Back

Now consider entrants move

E

in

0 , 100

t
u
o

acc

50 , 50

Only ( In, Accommodate ) is

sequentially rational
Game Theory - Mik

Sequential Rationality
COMMANDMENT
Look forward and reason back.
Anticipate what your rivals will do
tomorrow
in response to your actions
today

Game Theory - Mik

10

Solving Sequential Games

Start with the last move in the game
Determine what that player will do
Trim the tree

Eliminate the dominated strategies

This results in a simpler game

Repeat the procedure

Game Theory - Mik

11

Voting Revisited
Gore v. Bush
Four judges prefer:
Three judges prefer:
Two judges prefer:

to
to
to

G
R
B

to
to
to

R
B
G

Majority rule results:

B beats G

B
G
R

G beats R

R beats B

What if you want Bush to Win?

R vs. G

then winner vs. B

Game Theory - Mik

B
12

Extensive Form
B vs. R

R vs. G

G
B

B vs. G

Game Theory - Mik

13

Looking Forward
B vs. R

B
A majority prefers R to B

R
B

B vs. G

B
A majority prefers B to G
G
Game Theory - Mik

14

Trim The Tree

B vs. R
R

R vs. G

G
B

B vs. G
Game Theory - Mik

15

Reasoning Back

First stage, in effect vote between R & B

Gore supporters prefer G>R>B, vote R
B vs. R
R vs. G

G
B

B vs. G
Game Theory - Mik

16

What Happened?

Gore supporters have preferences

Gore > Remand > Bush
In first round, vote between R and G
Gore supporters prefer Gore
But vote for G is in effect a vote for B!
So Gore supporters vote for remand.
Guarantee themselves second best choice

Game Theory - Mik

17

Rollback in Voting and

Being Political

Not necessarily good to vote

your true preferences

Amendments to make bad bills worse

Crossing over in open primaries
Centrist voting in primaries
Supporting your second-best option

STILL Outcome predetermined

AGENDA SETTING!
Game Theory - Mik

18

Predatory Pricing

An incumbent firm operates in three

markets, and faces entry in each
Market 1 in year 1, Market 2 in year 2, etc.

Each time, I can slash prices, or

accommodate the new entry

What should I do the first year?

Game Theory - Mik

19

Predatory Pricing
E3

E2

E1

t
ou

in

t
u
o

t
h
fig

ac
c

in

t
h
fig

ac
c

Game Theory - Mik

20

Predatory Pricing

E3

The end of the tree: year 3

0 , 100 + previous

t
u
o

in

t
h
fig

-50 , -50 + previous

ac
c

50 , 50 + previous

In year 3: ( In, Accommodate )

Game Theory - Mik

21

Rollback

Trim the tree:

E3

E2

t
ou

in

t
h
fig

ac
c

in

M acc

in

acc

in

acc

0 , 100 + previous

-50 , -50 + previous

50 , 50 + previous

Game Theory - Mik

22

Predatory Pricing
Since the Incumbent will not fight
Entrant 3, he will not fight Entrant 2
Same for Entrant 1
Only one Rollback Equilibrium

All entrants play In

Incumbent plays Accommodate

Why do we see predatory pricing?

Game Theory - Mik

23

Game Theory

Example
Sequential Entry

Market Opportunity Analysis

Assesses the potential of a
geographic market for a specific set
of products, providing a
prioritization of market coverage
voids and recommending market
entry strategies.
Game Theory - Mik

25

Market Analysis
700
SBCs

400
SBCs

Game Theory - Mik

26

Extended Market Analysis

If enter 400 SBC market:

Next entrant, to break even,
must expect market share of 300/400
Must expect market share of 75%

If enter 700 SBC market:

Next entrant, to break even,
must expect market share of 300/700
Must expect market share of 43%

Real decision:

All of 400 or
halfTheory
of 700
Game
- Mik

27

Breakfast Cereals
vertical axis:
(in thousands)
600

sales

product development costs:

$1.2M per product

500
400
300
200
100
000
1

less
sweet

Game Theory - Mik

10

more
sweet

11

28

1
First Product Entry
Profit = x base x height F
= x 5 x 600 1200
= 1500 1200

600
500

400

300

300
200
100
000
1

less
sweet

Game Theory - Mik

10

more
sweet

11

29

2
Second Product Entry
Profit = 2 x 300
=

600

600

500
400
300
200
100
000
1

less
sweet

Game Theory - Mik

10

more
sweet

11

30

3
Third Product Entry
Profit = 600 + 1500 1200 480
=

600

420

500
400
300
200
100
000
1

less
sweet

Game Theory - Mik

10

more
sweet

11

31

4
Competitor Enters
Profit = 600 - 240
=

600

360

500
400
300
200
100
000
1

less
sweet

Game Theory - Mik

10

more
sweet

11

32