Game Theory and Competitive Strategy

1
Chapter 13

• Game Theory and Competitive Strategy

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Payoff Matrix for Advertising Game
Firm B
Dont Advertise
Advertise
Advertise
Firm A
Dont Advertise
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Payoff Matrix for Advertising Game

• Observations
• A regardless of B, advertising is the best
• B regardless of A, advertising is best

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Payoff Matrix for Advertising Game

• Observations
• Dominant strategy for A and B is to advertise
• Do not worry about the other player
• Equilibrium in dominant strategy

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Modified Advertising Game
Firm B
Dont Advertise
Advertise
Advertise
Firm A
Dont Advertise
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Modified Advertising Game

• Observations
• A No dominant strategy depends on Bs actions
• B Dominant strategy is to advertise
• Firm A determines Bs dominant strategy and makes
  its decision accordingly

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Product Choice Problem
Firm 2
Crispy
Sweet
Crispy
Firm 1
Sweet
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Product Choice Problem

• If Firm 1 hears Firm 2 is introducing a new sweet
  cereal, its best action is to make crispy
• Bottom left corner is Nash equilibrium
• What is other Nash Equilibrium?

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Beach Location Game

• Where will the competitors locate (i.e., where is
  the Nash equilibrium)?
• Will want to all locate in center of beach
• Similar to groups of gas stations, car
  dealerships, etc.

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Maximin Strategy
Firm 2
Dont invest
Invest
Dont invest
Firm 1
Invest
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Maximin Strategy

• Observations
• Dominant strategy Firm 2 Invest
• Firm 1 should expect Firm 2 to invest
• Nash equilibrium
• Firm 1 invest
• Firm 2 Invest
• This assumes Firm 2 understands the game and is
  rational

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Maximin Strategy

• Observations
• If Firm 2 does not invest, Firm 1 incurs
  significant losses
• Firm 1 might play dont invest
• Minimize losses to 10 maximin strategy

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Prisoners Dilemma
Prisoner B
Confess
Dont Confess
Confess
Prisoner A
Dont Confess
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Prisoners Dilemma

• What is the
• Dominant strategy
• Nash equilibrium
• Maximin solution
• Dominant strategies are also maximin strategies
• Both confess is both Nash equilibrium and maximin
  solution

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Matching Pennies
Player B
Heads
Tails
Heads
Player A
Tails
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Matching Pennies

• Pure strategy No Nash equilibrium
• No combination of head and tails leaves both
  players better off
• Mixed strategy Random choice is a Nash
  equilibrium

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The Battle of the Sexes
Joan
Wrestling
Opera
Wrestling
Jim
Opera
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The Battle of the Sexes

• Pure Strategy
• Both watch wrestling
• Both watch opera
• Mixed Strategy
• Jim chooses wrestling
• Joan chooses wrestling

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Pricing Problem
Firm 2
Low Price
High Price
Low Price
Firm 1
High Price
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Modified Product Choice Problem
Firm 2
Crispy
Sweet
Crispy
Firm 1
Sweet
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Product Choice Game in Extensive Form
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Choosing Output
Firm 2
7.5
10
15
7.5
10
Firm 1
15
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Choosing Output

• This payoff matrix illustrates various outcomes
• Move together, both produce 10
• If Firm 1 moves first (Q15), best Firm 2 can do
  is 7.5

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Pricing of Computers and Word Processors
Firm 2
High Price
Low Price
High Price
Firm 1
Low Price
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Production Choice Problem
Race Car Motors
Small cars
Big cars
Small engines
Far Out Engines
Big engines
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Modified Production Choice Problem
Race Car Motors
Small cars
Big cars
Small engines
Far Out Engines
Big engines
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Bargaining Strategy
Firm 2
Produce A
Produce B
Produce A
Firm 1
Produce B
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Bargaining Strategy

• With collusion
• Firm 1 Produces A and Firm 2 produces B (50,50)
• Without collusion
• Firm 1 produces A and Firm 2 produces B (50,50)
• Nash equilibrium

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Bargaining Strategy
Firm 2
Work alone
Enter consortium
Work alone
Firm 1
Enter consortium
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The Discount Store Preemption Game
Company X
Enter
Dont enter
Enter
Wal-Mart
Dont enter
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The Discount Store Preemption Game

• Two Nash equilibrium
• Low left
• Upper right
• Must be preemptive to win

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Entry Possibilities
Potential Entrant (X) (80 fixed costs)
Enter
Stay out
High price (accommodation)
Incumbent (I)
Low Price (warfare)
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Entry Deterrence
Potential Entrant (X)
Enter
Stay out
High price (accommodation)
Incumbent (I)
Low price (warfare)
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Development of a New Aircraft
Airbus
Produce
Dont produce
Produce
Boeing
Dont produce
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Development of a New Aircraft

• Boeing has head start
• Boeing will produce
• Airbus will not produce

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Development of an AircraftAfter European Subsidy
Airbus
Produce
Dont produce
Produce
Boeing
Dont produce
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Development of an AircraftAfter European Subsidy

• Airbus will produce
• Boeing will not produce

Airbus
Produce
Dont produce
Produce
Boeing
Dont produce
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Competing Through R D
Kimberly-Clark
RD
No RD
RD
PG
No RD
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Competing Through R D

• Both spend on RD
• Dominant strategy
• Why not cooperate?
• Strengthening Bargaining Power
• Credibility
• Reducing flexibility