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Transcript of Game Theory & Strategy

Managerial Economics in a Global Economy, 5th Edition by Dominick SalvatoreChapter 10 Game Theory and Strategic Behavior

Prepared by Robert F. Brooker, Ph.D.

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.

Slide 2

Strategic Behavior Types of Games Zero-sum games Nonzero-sum games

Nash Equilibrium Each player chooses a strategy that is optimal given the strategy of the other player A strategy is dominant if it is optimal regardless of what the other player doesPrepared by Robert F. Brooker, Ph.D. Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 3

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 4

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

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 5

Advertising Example 1What 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 A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 6

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

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 7

Advertising Example 1What 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 A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 8

Advertising Example 1Regardless 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

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

Prepared by Robert F. Brooker, Ph.D.

Slide 9

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

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 10

Advertising Example 1What 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 A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 11

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

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 12

Advertising Example 1What 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 A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 13

Advertising Example 1Regardless 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

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

Prepared by Robert F. Brooker, Ph.D.

Slide 14

Advertising Example 1The 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

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

Prepared by Robert F. Brooker, Ph.D.

Slide 15

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 16

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

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 17

Advertising Example 2What 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 A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 18

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

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 19

Advertising Example 2What 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 A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 20

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

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 21

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

Firm A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 22

Advertising Example 2What 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 A

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

Prepared by Robert F. Brooker, Ph.D.

Slide 23

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

Firm A