game theory: the competitive dynamics of strategy
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Game Theory: The Competitive Dynamics of Strategy. MANEC 387 Economics of Strategy. David J. Bryce. The Structure of Industries. Threat of new Entrants. Competitive Rivalry. Bargaining Power of Suppliers. Bargaining Power of Customers. Threat of Substitutes. - PowerPoint PPT PresentationTRANSCRIPT
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David Bryce © 1996-2002Adapted from Baye © 2002
Game Theory: The Competitive Dynamics of Strategy
MANEC 387MANEC 387Economics of StrategyEconomics of Strategy
David J. Bryce
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David Bryce © 1996-2002Adapted from Baye © 2002
The Structure of Industries
Competitive Rivalry
Threat of newEntrants
BargainingPower of
Customers
Threat ofSubstitutes
BargainingPower of Suppliers
From M. Porter, 1979, “How Competitive Forces Shape Strategy”
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David Bryce © 1996-2002Adapted from Baye © 2002
Competitor ResponseConcepts from Game Theory
• Sequential move games in normal form– Simultaneous vs. sequential move games –
hypothetical Boeing v. McDonnell-Douglas game (bullying brothers)
• Sequential move games in extensive form– Backward induction– Subgame-perfect equilibria
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David Bryce © 1996-2002Adapted from Baye © 2002
Fundamentals of Game Theory1. Identify the players2. Identify their possible actions3. Identify their conditional payoffs from
their actions4. Determine the players’ strategies – My
strategy is my set of best responses to all possible rival actions
5. Determine the equilibrium outcome(s) – equilibrium exists when all players are playing their best response to all other players
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David Bryce © 1996-2002Adapted from Baye © 2002
Simultaneous-Move Bargaining
• Management and a union are negotiating a wage increase
• Strategies are wage offers & wage demands• Successful negotiations lead to $600 million
in surplus, which must be split among the parties
• Failure to reach an agreement results in a loss to the firm of $100 million and a union loss of $3 million
• Simultaneous moves, and time permits only one-shot at making a deal.
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David Bryce © 1996-2002Adapted from Baye © 2002
The Bargaining Game in Normal Form
UnionM
anag
emen
t 500 -3 -3 100 -100 -100
-3 300 -3-100 300 -100
-3 -3 100-100 -100 500
W=$10 W=$5 W=$1W
=$10
W=$
5W
=$1
*
*
*
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David Bryce © 1996-2002Adapted from Baye © 2002
“Fairness” – the Natural Focal Point
UnionM
anag
emen
t 500 -3 -3 100 -100 -100
-3 300 -3-100 300 -100
-3 -3 100-100 -100 500
W=$10 W=$5 W=$1W
=$10
W=$
5W
=$1
*
*
*
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David Bryce © 1996-2002Adapted from Baye © 2002
Lessons in Simultaneous-Move Bargaining
• Simultaneous-move bargaining results in a coordination problem
• Experiments suggests that, in the absence of any “history,” real players typically coordinate on the “fair outcome”
• When there is a “bargaining history,” other outcomes may prevail
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David Bryce © 1996-2002Adapted from Baye © 2002
A Sequential Game - Single Offer Bargaining
• Now suppose the game is sequential in nature, and management gets to make the union a “take-it-or-leave-it” offer
• Write the game in extensive form – Summarize the players – Their potential actions – Their information at each decision point – The sequence of moves and – Each player’s payoff
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David Bryce © 1996-2002Adapted from Baye © 2002
M
10
5
1
Step 1: Management’s Move
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David Bryce © 1996-2002Adapted from Baye © 2002
Accept
Reject
Step 2: Append the Union’s Move
M
10
5
1
Accept
Reject
U
U
Accept
RejectU
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David Bryce © 1996-2002Adapted from Baye © 2002
100, 500
-100, -3
300, 300
-100, -3
500, 100
-100, -3
Step 3: Append the PayoffsAccept
Reject
M
10
5
1
Accept
Reject
U
U
Accept
RejectU
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David Bryce © 1996-2002Adapted from Baye © 2002
100, 500
-100, -3
300, 300
-100, -3
500, 100
-100, -3
Multiple Nash EquilibriaAccept
Reject10
5
1
Accept
Reject
Accept
Reject
*
M
U
U
U
*
*
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David Bryce © 1996-2002Adapted from Baye © 2002
Step 7: Find the Subgame Perfect Nash Equilibrium Outcomes• Outcomes where no player has an incentive
to change its strategy at any stage of the game, given the strategy of the rival, and
• The outcomes are based on “credible actions;” that is, they are not the result of “empty threats” by the rival.
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David Bryce © 1996-2002Adapted from Baye © 2002
• Final player chooses the option that maximizes her payoff
• The previous player chooses the option that maximizes his payoff conditional on the expected choice of the final player, and so on
• This is backward induction – work backward from the end “sub-game,” each player makes optimal choices assuming that each subsequent rival chooses rationally
• The equilibrium is called sub-game perfect
Sequential Strategies in the Game Tree
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David Bryce © 1996-2002Adapted from Baye © 2002
Only One Subgame-Perfect Nash Equilibrium Outcome
100, 500
-100, -3
300, 300
-100, -3
500, 100
-100, -3
Accept
Reject10
5
1
Accept
Reject
Accept
Reject
M
U
U
U*
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David Bryce © 1996-2002Adapted from Baye © 2002
Re-Cap• In take-it-or-leave-it bargaining, there is a
first-mover advantage.• Management can gain by making a take-it
or leave-it offer to the union. • Management should be careful, however;
real world evidence suggests that people sometimes reject offers on the the basis of “principle” instead of cash considerations.
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David Bryce © 1996-2002Adapted from Baye © 2002
Moroni, Zarahemna and Credible Threats
MSpare
Attack
-200
-50
200
-150
MSpare 100
-100
0
-200Z
Deliver/Oath
Don’t Deliver
Payoffs
Attack
*
See Alma 44, Book of Mormon
(or Bush, Saddam and those pesky WMDs)
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David Bryce © 1996-2002Adapted from Baye © 2002
Moroni – Zarahemna and Credible Threats
MSpare
Attack
-200
-50
200
-150
MSpare 100
-100
0
-200
Z
Take Oath
Don’t Deliver
Payoffs
Attack
*Z Don’t Take
MSpare
Attack
Deliver
?100
-175 -100
See Alma 44, Book of Mormon
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David Bryce © 1996-2002Adapted from Baye © 2002
Summary and Takeaways• The reasoning of game theory supplies
a useful way to predict the outcome of competitive interactions
• By diagramming a game, players can identify their best potential strategies
• Threats of retaliation must be credible• Incumbents may be able to deter
entrants by making major strategic commitments (credible threats)