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Strategic Behavior
• Decisions that take into account the
predicted reactions of rival firms
–Interdependence of outcomes
• Game Theory
– Players
– Strategies – Payoff matrix
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Strategic Behavior
• Types of Games
– ero!sum games
– "on#ero!sum games• "ash $%uili&rium
– $ach player chooses a strategy that is
optimal given the strategy of the other
player
– ' strategy is dominant if it is optimal
regardless of (hat the other player does
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
3hat is the optimal strategy for 2irm ' if 2irm B chooses to
advertise4
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
3hat is the optimal strategy for 2irm ' if 2irm B chooses to
advertise4
If 2irm ' chooses to advertise- the payoff is ,5 6ther(ise-
the payoff is 15 The optimal strategy is to advertise5
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
3hat is the optimal strategy for 2irm ' if 2irm B chooses
not to advertise4
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
3hat is the optimal strategy for 2irm ' if 2irm B chooses
not to advertise4
If 2irm ' chooses to advertise- the payoff is 05 6ther(ise-
the payoff is .5 'gain- the optimal strategy is to advertise5
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
7egardless of (hat 2irm B decides to do- the optimal
strategy for 2irm ' is to advertise5 The dominant strategy
for 2irm ' is to advertise5
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
3hat is the optimal strategy for 2irm B if 2irm ' chooses to
advertise4
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
3hat is the optimal strategy for 2irm B if 2irm ' chooses to
advertise4
If 2irm B chooses to advertise- the payoff is .5 6ther(ise-
the payoff is )5 The optimal strategy is to advertise5
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
3hat is the optimal strategy for 2irm B if 2irm ' chooses
not to advertise4
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
3hat is the optimal strategy for 2irm B if 2irm ' chooses
not to advertise4
If 2irm B chooses to advertise- the payoff is 05 6ther(ise-
the payoff is 15 'gain- the optimal strategy is to advertise5
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
7egardless of (hat 2irm ' decides to do- the optimal
strategy for 2irm B is to advertise5 The dominant strategy
for 2irm B is to advertise5
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'dvertising $xample )
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
The dominant strategy for 2irm ' is to advertise and the
dominant strategy for 2irm B is to advertise5 The "ash
e%uili&rium is for &oth firms to advertise5
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'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
'dvertising $xample 1
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'dvertising $xample 1
3hat is the optimal strategy for 2irm ' if 2irm B chooses to
advertise4
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertising $xample 1
3hat is the optimal strategy for 2irm ' if 2irm B chooses to
advertise4
If 2irm ' chooses to advertise- the payoff is ,5 6ther(ise-
the payoff is 15 The optimal strategy is to advertise5
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertising $xample 1
3hat is the optimal strategy for 2irm ' if 2irm B chooses
not to advertise4
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertising $xample 1
3hat is the optimal strategy for 2irm ' if 2irm B chooses
not to advertise4
If 2irm ' chooses to advertise- the payoff is 05 6ther(ise-
the payoff is 85 In this case- the optimal strategy is not toadvertise5
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
'dvertising $xample 1
The optimal strategy for 2irm ' depends on (hich strategy
is chosen &y 2irms B5 2irm ' does not have a dominant
strategy5
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'dvertising $xample 1
3hat is the optimal strategy for 2irm B if 2irm ' chooses to
advertise4
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertising $xample 1
3hat is the optimal strategy for 2irm B if 2irm ' chooses to
advertise4
If 2irm B chooses to advertise- the payoff is .5 6ther(ise-
the payoff is )5 The optimal strategy is to advertise5
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertising $xample 1
3hat is the optimal strategy for 2irm B if 2irm ' chooses
not to advertise4
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertising $xample 1
3hat is the optimal strategy for 2irm B if 2irm ' chooses
not to advertise4
If 2irm B chooses to advertise- the payoff is 05 6ther(ise-
the payoff is 15 'gain- the optimal strategy is to advertise5
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertising $xample 1
7egardless of (hat 2irm ' decides to do- the optimal
strategy for 2irm B is to advertise5 The dominant strategy
for 2irm B is to advertise5
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +8- 1/
2irm B
2irm '
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'dvertising $xample 1
'dvertise Don*t 'dvertise
'dvertise +,- ./ +0- )/Don*t 'dvertise +1- 0/ +.- 1/
2irm B
2irm '
The dominant strategy for 2irm B is to advertise5 If 2irm B
chooses to advertise- then the optimal strategy for 2irm '
is to advertise5 The "ash e%uili&rium is for &oth firms to
advertise5
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Prisoners9 Dilemma
T(o suspects are arrested for armed ro&&ery5 They are
immediately separated5 If convicted- they (ill get a term
of ): years in prison5 ;o(ever- the evidence is not
sufficient to convict them of more than the crime ofpossessing stolen goods- (hich carries a sentence of
only ) year5
The suspects are told the follo(ing< If you confess and
your accomplice does not- you (ill go free5 If you do notconfess and your accomplice does- you (ill get ):
years in prison5 If you &oth confess- you (ill &oth get 0
years in prison5
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Prisoners9 Dilemma
=onfess Don*t =onfess
=onfess +0- 0/ +:- ):/Don*t =onfess +):- :/ +)- )/
Individual B
Individual '
Payoff >atrix +negative values/
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Prisoners9 Dilemma
=onfess Don*t =onfess
=onfess +0- 0/ +:- ):/Don*t =onfess +):- :/ +)- )/
Individual B
Individual '
Dominant Strategy
Both Individuals =onfess
+"ash $%uili&rium/
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?o( Price ;igh Price
?o( Price +1- 1/ +0- )/;igh Price +)- 0/ +.- ./
2irm B
2irm '
Prisoners9 Dilemma
'pplication< Price =ompetition
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?o( Price ;igh Price
?o( Price +1- 1/ +0- )/;igh Price +)- 0/ +.- ./
2irm B
2irm '
Prisoners9 Dilemma
'pplication< Price =ompetition
Dominant Strategy< ?o( Price
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'dvertise Don*t 'dvertise
'dvertise +1- 1/ +0- )/Don*t 'dvertise +)- 0/ +.- ./
2irm B
2irm '
Prisoners9 Dilemma
'pplication< "onprice =ompetition
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Prisoners9 Dilemma
'pplication< "onprice =ompetition
Dominant Strategy< 'dvertise
'dvertise Don*t 'dvertise
'dvertise +1- 1/ +0- )/Don*t 'dvertise +)- 0/ +.- ./
2irm B
2irm '
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=heat Don*t =heat
=heat +1- 1/ +0- )/Don*t =heat +)- 0/ +.- ./
2irm B
2irm '
Prisoners9 Dilemma
'pplication< =artel =heating
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=heat Don*t =heat
=heat +1- 1/ +0- )/Don*t =heat +)- 0/ +.- ./
2irm B
2irm '
Prisoners9 Dilemma
'pplication< =artel =heating
Dominant Strategy< =heat
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$xtensions of Game Theory
• 7epeated Games
– >any consecutive moves and
countermoves &y each player • Tit!for!Tat Strategy
– Do to your opponent (hat your
opponent has @ust done to you
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$xtensions of Game Theory
• Tit!for!Tat Strategy
– Sta&le set of players
– Small num&er of players
– $asy detection of cheating
– Sta&le demand and cost conditions
– Game repeated a large anduncertain num&er of times
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$xtensions of Game Theory
• Threat Strategies
– =redi&ility
– 7eputation
– =ommitment
– $xample< $ntry deterrence
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$ntry Deterrence
$nter Do "ot $nter
?o( Price +,- !1/ +8- :/;igh Price +A- 1/ +):- :/
2irm B
2irm '
$nter Do "ot $nter
?o( Price +,- !1/ +8- :/
;igh Price +.- 1/ +- :/
2irm B
2irm '
=redi&le $ntry Deterrence
"o =redi&le $ntry Deterrence
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$ntry Deterrence
$nter Do "ot $nter
?o( Price +,- !1/ +8- :/;igh Price +A- 1/ +):- :/
2irm B
2irm '
$nter Do "ot $nter
?o( Price +,- !1/ +8- :/
;igh Price +.- 1/ +- :/
2irm B
2irm '
=redi&le $ntry Deterrence
"o =redi&le $ntry Deterrence
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International =ompetition
Produce Don*t Product
Produce +!):- !):/ +)::- :/Don*t Produce +:- )::/ +:- :/
'ir&us
Boeing
Boeing Cersus 'ir&us Industrie
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Se%uential Games
• Se%uence of moves &y rivals
• Payoffs depend on entire se%uence
• Decision trees
– Decision nodes
– Branches +alternatives/
• Solution &y reverse induction
– 2rom final decision to first decision
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;igh!Price- ?o(!Price
Strategy Game
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;igh!Price- ?o(!Price
Strategy Game
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;igh!Price- ?o(!Price
Strategy Game
Solution<
Both firms
choose lo(
price5
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'ir&us and Boeing
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'ir&us and Boeing
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'ir&us and Boeing
Solution< 'ir&us &uilds
'.: and
Boeing &uildsSonic =ruiser5
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