09/08/2008

Managerial Economics in a Global Economy, 5th Edition by Dominick Salvatore

Chapter 10 Game Theory and Strategic Behavior

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 1

Strategic Behavior
Decisions that take into account the predicted reactions of rival firms
Interdependence of outcomes

Game Theory
Players Strategies Payoff matrix

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 2

09/08/2008

Advertising Example 1

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 3

Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses to advertise?

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 4

09/08/2008

Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses to advertise? If Firm A chooses to advertise, the payoff is 4. Otherwise, the payoff is 2. The optimal strategy is to advertise. Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Firm A

Advertise Don't Advertise

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 5

Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses not to advertise?

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 6

09/08/2008

Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses not to advertise? If Firm A chooses to advertise, the payoff is 5. Otherwise, the payoff is 3. Again, the optimal strategy is to advertise. Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Firm A

Advertise Don't Advertise

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 7

Advertising Example 1
Regardless of what Firm B decides to do, the optimal strategy for Firm A is to advertise. The dominant strategy for Firm A is to advertise.

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 8

09/08/2008

Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses to advertise?

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 9

Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses to advertise? If Firm B chooses to advertise, the payoff is 3. Otherwise, the payoff is 1. The optimal strategy is to advertise. Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Firm A

Advertise Don't Advertise

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 10

09/08/2008

Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses not to advertise?

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 11

Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses not to advertise? If Firm B chooses to advertise, the payoff is 5. Otherwise, the payoff is 2. Again, the optimal strategy is to advertise. Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Firm A

Advertise Don't Advertise

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 12

09/08/2008

Advertising Example 1
Regardless of what Firm A decides to do, the optimal strategy for Firm B is to advertise. The dominant strategy for Firm B is to advertise.

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 13

Advertising Example 1
The dominant strategy for Firm A is to advertise and the dominant strategy for Firm B is to advertise. The Nash equilibrium is for both firms to advertise.

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 14

09/08/2008

Advertising Example 2

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 15

Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses to advertise?

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 16

09/08/2008

Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses to advertise? If Firm A chooses to advertise, the payoff is 4. Otherwise, the payoff is 2. The optimal strategy is to advertise. Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Firm A

Advertise Don't Advertise

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 17

Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses not to advertise?

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 18

09/08/2008

Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses not to advertise? If Firm A chooses to advertise, the payoff is 5. Otherwise, the payoff is 6. In this case, the optimal strategy is not to advertise. Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Firm A

Advertise Don't Advertise

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 19

Advertising Example 2
The optimal strategy for Firm A depends on which strategy is chosen by Firms B. Firm A does not have a dominant strategy.

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 20

10

09/08/2008

Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses to advertise?

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 21

Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses to advertise? If Firm B chooses to advertise, the payoff is 3. Otherwise, the payoff is 1. The optimal strategy is to advertise. Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Firm A

Advertise Don't Advertise

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 22

11

09/08/2008

Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses not to advertise?

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 23

Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses not to advertise? If Firm B chooses to advertise, the payoff is 5. Otherwise, the payoff is 2. Again, the optimal strategy is to advertise. Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Firm A

Advertise Don't Advertise

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 24

12

09/08/2008

Advertising Example 2
Regardless of what Firm A decides to do, the optimal strategy for Firm B is to advertise. The dominant strategy for Firm B is to advertise.

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (6, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 25

Advertising Example 2
The dominant strategy for Firm B is to advertise. If Firm B chooses to advertise, then the optimal strategy for Firm A is to advertise. The Nash equilibrium is for both firms to advertise.

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (4, 3) (5, 1) (2, 5) (3, 2)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 26

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09/08/2008

Prisoners Dilemma
Two suspects are arrested for armed robbery. They are immediately separated. If convicted, they will get a term of 10 years in prison. However, the evidence is not sufficient to convict them of more than the crime of possessing stolen goods, which carries a sentence of only 1 year. The suspects are told the following: If y confess and p g you your accomplice does not, you will go free. If you do not confess and your accomplice does, you will get 10 years in prison. If you both confess, you will both get 5 years in prison.
Prepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 27

Prisoners Dilemma
Payoff Matrix ( g y (negative values) )

Individual A

Confess Don't Confess

Individual B Confess Don't Confess (5, 5) (0, 10) (10, 0) (1, 1)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 28

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09/08/2008

Prisoners Dilemma
Dominant Strategy gy Both Individuals Confess (Nash Equilibrium) Individual B Confess Don't Confess (5, 5) (0, 10) (10, 0) (1, 1)

Individual A

Confess Don't Confess

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 29

Prisoners Dilemma
Application: Price Competition pp p

Firm A

Low Price High Price

Low Price (2, 2) (1, 5)

Firm B High Price (5, 1) (3, 3)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 30

15

09/08/2008

Prisoners Dilemma
Application: Price Competition pp p Dominant Strategy: Low Price

Firm A

Low Price High Price

Firm B Low Price High Price (2, 2) (5, 1) (1, 5) (3, 3)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 31

Prisoners Dilemma
Application: Nonprice Competition pp p p

Firm A

Advertise Don't Advertise

Advertise (2, 2) (1, 5)

Firm B Don't Advertise (5, 1) (3, 3)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 32

16

09/08/2008

Prisoners Dilemma
Application: Nonprice Competition pp p p Dominant Strategy: Advertise

Firm A

Advertise Don't Advertise

Firm B Advertise Don't Advertise (2, 2) (5, 1) (1, 5) (3, 3)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 33

Prisoners Dilemma
Application: Cartel Cheating pp g

Firm A

Cheat Don't Cheat

Cheat (2, 2) (1, 5)

Firm B Don't Cheat (5, 1) (3, 3)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 34

17

09/08/2008

Prisoners Dilemma
Application: Cartel Cheating pp g Dominant Strategy: Cheat

Firm A

Cheat Don't Cheat

Firm B Cheat Don't Cheat (2, 2) (5, 1) (1, 5) (3, 3)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 35

Entry Deterrence
No Credible Entry Deterrence

Firm A

Low Price High Price

Firm B Enter Do Not Enter (4, -2) (6, 0) (7, 2) (10, 0)

Credible Entry Deterrence

Firm A

Low Price High Price

Firm B Enter Do Not Enter (4, -2) (6, 0) (3, 2) (8, 0)

Slide 36

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

18

09/08/2008

Entry Deterrence
No Credible Entry Deterrence

Firm A

Low Price High Price

Enter (4, -2) (7, 2)

Firm B Do Not Enter (6, 0) (10, 0)

Credible Entry Deterrence

Firm A

Low Price High Price

Enter (4, -2) (3, 2)

Firm B Do Not Enter (6, 0) (8, 0)

Slide 37

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

International Competition
Boeing Versus Airbus Industrie

Boeing

Produce Don't Produce

Airbus Produce Don t Don't Product (-10, -10) (100, 0) (0, 100) (0, 0)

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Slide 38

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