MANAGERIAL ECONOMICS

12th Edition

By
Mark Hirschey
Game Theory and
Competitive Strategy
Chapter 14
 Chapter 14
OVERVIEW
 Game Theory Basics
 Prisoner’s Dilemma
 Nash Equilibrium
 Infinitely Repeated Games
 Finitely Repeated Games
 Game Theory and Auction Strategy
 Competitive Strategy
 Pricing Strategies
 Non-price Competition
 Chapter 14
KEY CONCEPTS
 game theory
 zero-sum game
 positive-sum game
 negative-sum game
 cooperative game
 sequential game
 look ahead and extrapolate back
 simultaneous-move game
 equilibrium outcome
 game-theory strategy
 payoff matrix
 Prisoner’s Dilemma
 one-shot game
 repeated game
 dominant strategy
 secure strategy
 Nash equilibrium
 randomized strategies
 Nash bargaining
 infinitely repeated game
 finitely repeated game
 trigger strategy
 end-of-game problem
 multistage games
 first-mover advantage
 English auction
 winner’s curse
 sealed bid auction
 Vickrey auction
 Dutch auction
 competitive advantage
 comparative advantage
 limit pricing
 predatory pricing
 customer lock-in effect
 network externalities
 market penetration pricing
 non-price competition
 Game Theory Basics
 Types of Games
 Zero-sum game: offsetting gains/losses.
 Positive sum game: potential for mutual gain.
 Negative-sum game: potential for mutual loss.
 Cooperative games: joint action is favored.
 Role of Interdependence
 Sequential games involve successive moves.
 Simultaneous-move games incorporate
coincident moves.
 Prisoner’s Dilemma
 Classic Riddle
 Rational individual behavior can give
suboptimal group result.
 Rationality can hamper beneficial
cooperation.
 Business Application
 Dominant strategy gives best result
regardless of moves by other players.
 Secure strategy gives best result assuming
the worst possible scenario.
 Nash Equilibrium
 Nash Equilibrium Concept
 Neither player can improve their payoff through a
unilateral change in strategy.
 Nash equilibrium concept is broader than the concept
of a dominant strategy equilibrium.
• Every dominant strategy equilibrium is also a Nash
equilibrium.
• Nash equilibrium can exist where there is no dominant
strategy equilibrium.
 Nash Bargaining
 Any haggling over valued item.
 Infinitely Repeated Games
 Role of Reputation
 Infinitely repeated games occur over and over again
without boundary or limit.
 Firms receive sequential payoffs that shape current
and future strategies.
 Reputations for high quality give consumers
confidence for repeat transactions.
 Product Quality Games
 In a one-shot game, poor quality can fool customers.
 In an infinitely repeated game, poor quality is
shunned by customers.
 Finitely Repeated Games
 Uncertain Final Period
 Finitely repeated games have limited duration.
 With end point uncertainty, a finitely repeated game
mirrors an infinitely repeated game.
 End-of-game Problem
 Enforcing end-of-game performance is difficult.
 Solution: simply extend the game!
 First-mover Advantages
 Benefits earned by the player able to make the initial
move in a sequential move or multistage game.
 Competitive Strategy
 Basic Concepts
 Effective competitive strategy involves search for
uniquely attractive products.
 Competitive Advantage
 Unique or rare ability to create, distribute, or service
products valued by customers.
 Business-world analog to national comparative
advantage.
 When Large Size Is a Disadvantage
 Nimble firms sometimes translate the benefits of
small size into a distinct competitive advantage.
Game Theory and Auction Strategy
 Auction Types
 English auction winner is the highest public bidder.
 Sealed-bid auction winner is the highest secret
bidder.
 Vickrey auction winner pays the second-highest
sealed bid.
 Dutch auction winner is the first party willing to pay
the auctioneer’s price
 Public Policy Implications
 Auctions are a proven tool for marketing public
resources.
 Winners sometimes overpay (“winner’s curse”).
 Pricing Strategies
 Limit Pricing
 Limit pricing strategy sets less than monopoly prices
to deter entry by competitors
 Predatory pricing is pricing below marginal cost (rare).
 Limit pricing is often confused with predatory pricing.
 Market Penetration Pricing
 Market penetration pricing sets very low (or zero)
prices to create a new market or grab market share.
 Objective is to gain a critical mass of customers,
make network effects, and generate viable business.
 Non-price Competition
 Advantages of Non-price Competition
 Non-price competition can be an effective means for
growing market share and profitability.
 Nonprice competition can be difficult to imitate.
 Optimal Level of Advertising
 Profit-maximizing level of non-price competition is
found by setting activity MR = MC.
 Set MRA = MCA to determine optimal advertising.