1. Chapter 9: Economics of Strategy: Game theory
Brickley, Smith, and Zimmerman, Managerial Economics and Organizational Architecture, 4th ed.
Chapter 9: Economics of Strategy: Game theory

2. Game theory learning objectives
Structure a simple game in both matrix and tree formats
Specify a simple game
Identify Nash equilibria
Identify dominant strategies

3. Game theory overview General analysis of strategic interaction
Optimal decision making when
all decision agents are presumed rational
each attempts to anticipate actions of rivals

4. Simultaneous-move, non-repeated interaction
Rivals must make decisions with no knowledge of each other’s decisions
Nonrepeated?
The interaction occurs only once

5. Example
Boeing and Airbus individually choose and simultaneously submit a bid price (high or low) for 10 planes
Each cell entry represents the payoffs
A dominant strategy is one the firm chooses no matter what its rival does

6. Strategic form dominant strategy

7. Nash equilibrium revisited
In the absence of a dominant strategy, Nash equilibrium may predict outcome
Nash equilibrium is set of strategies where firm does its best given rival’s actions
Use arrow technique to identify Nash equilibrium

8. Nash equilibrium

9. Competition versus cooperation
Boeing and Airbus make simultaneous choices of new communications systems
two technologies: Alpha & Beta
both benefit with same choice
Results in two Nash equilibria
benefits from pre-commitment communication

10. Coordination game two Nash equilibria

11. Coordination/competition game

12. Mixed strategies Mixed strategy offers an element of surprise
Boeing and Airbus must simultaneously commit to an advertising campaign
Boeing benefits most from same strategy
Airbus benefits most from differentiation
Randomization with p=.5 is Nash equilibrium for both

13. Mixed strategy

14. Sequential interactions
Boeing & Airbus communications technology choice
Boeing chooses first
Analyze with backward induction
Boeing must take Airbus’s best response into account in making its choice
Boeing has first mover advantage
Credible commitment by second mover can alter first mover choice

15. Extensive form sequential game

16. Repeated strategic interaction
Boeing and Airbus compete often
Strategic choices can come to incorporate more than short-term payoffs

17. Strategic interaction and organizational architecture
Kiana manages Lenin
Len must choose between working and shirking
Kiana must choose whether to incur monitoring costs
No pure strategy equilibrium exists

18. Interactive game no pure strategy equilibrium