Game Theory

Lorettas Driving Because Im

Drinking and Im Drinking
Because Shes Driving
- The Lockhorns
Mike Shor
Lecture 3

Review

Understand the game you are in

Note if the rules are flexible

Anticipate your opponents reactions

Understand the assumptions

Recognize that not everyone else understands them

Game Theory - Mik

Game Theory - Mik

Equilibrium

Nash Equilibrium:
A set of strategies, one for each player, such that
each players strategy is best for her given that all
other players are playing their equilibrium strategies

Best Response:
The best strategy I can play given the strategy
choices of all other players

Everybody is playing a best response

No incentive to unilaterally change my strategy

Game Theory - Mik

Cigarette Advertising on TV

1964

All US tobacco companies

heavily on TV

advertised

Surgeon General issues official warning

Cigarette smoking may be hazardous

Cigarette companies reaction

Fear of potential liability lawsuits

1970

Companies strike agreement

Carry the warning label and cease TV
advertising in exchange for immunity from
federal lawsuits.

Game Theory - Mik

Strategic Interactions

Players:
Strategies:
Payoffs:

Reynolds and Philip Morris

{ Advertise , Do Not Advertise }
Companies Profits

Each firm earns $50 million from its customers

Advertising costs a firm $20 million
Advertising captures $30 million from competitor

How to represent this game?

Game Theory - Mik

Normal (Strategic) Form

PLAYERS
Philip Morris

Reynolds

No Ad

No Ad
50 , 50

Ad
20 , 60

Ad

60 , 20

30 , 30

STRATEGIES

PAYOFFS
Game Theory - Mik

Normal Form
Philip Morris

Reynolds

No Ad

No Ad
50 , 50

Ad
20 , 60

Ad

60 , 20

30 , 30

Best reply for Reynolds:

If Philip Morris advertises:
If Philip Morris does not advertise:

advertise
advertise

Regardless of what you think Philip Morris will do

Advertise!
Game Theory - Mik

Dominant Strategy
A strategy that outperforms all other choices
no matter what opposing players do

Ad is strictly dominant for Firm 1 if:

Ad is weakly dominant for Firm 1 if:

Profit (Ad , Ad) > Profit(No , Ad)

Profit (Ad , No) > Profit(No , No)

Some inequalities are weak (),

At least one is strong(>)

By dominant we will mean strictly dominant

Game Theory - Mik

Dominance
COMMANDMENT
If you have a dominant strategy, use it.
Expect your opponent to use her
dominant strategy if she has one.

Game Theory - Mik

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Cigarette Advertising

After the 1970 agreement, cigarette

advertising decreased by $63 million
Profits rose by $91 million
Prisoners Dilemma
An equilibrium is NOT necessarily efficient
Games with dominant strategies are easy
to play (no need for what if thinking)
Game Theory - Mik

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How to Win a Bidding War

by Bidding Less?

The battle for Federated (1988)

Parent of Bloomingdales

Current share price: $60

Expected post-takeover share price: $60
Macys offers up to $70/share contingent
on receiving 50% of the shares
Do you tender your shares to Macys?
Game Theory - Mik

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How to Win a Bidding War

(continued)

Robert Campau bids $74 per share

not contingent on amount acquired

Offer Mixed Scheme:

If less than 50% tender, each receives:
$74 per share
If more than 50% tender (X%), each
receives: 50%
X % 50%

$74
$60
X%
X%

Game Theory - Mik

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The Game
Others
Macys
You

Campeau
$60

Neither
$60

Campeau

$74

$67

$74

Neither

$60

$60

$60

Each has a dominant strategy:

Macys
$70

Tender to Campeau
Resulting price: x74+ x60 = $67

BUT: Macys offered $70!

Game Theory - Mik

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Dominant Strategies

The biggest, looniest deal ever."

- Fortune Magazine, July 1988,
on Campeaus acquisition of Federated Stores.

Can we always count on

Dominant Strategies?

Game Theory - Mik

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A Strategic Situation
Two firms competing over sales

Time and The Economist must decide upon

the cover story to run some week.

The big stories of the week are:

A presidential scandal (labeled S), and
A proposal to deploy US forces to Grenada (G)

Neither knows which story the other

magazine will choose to run
Game Theory - Mik

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One Dominant Strategy

Time

The Economist
G
S
0 , 90
S 100 , 100
G 80 , 100 80 , 90

Who has a dominant strategy?

Assume it will be played!
Other player can plan accordingly.

Game Theory - Mik

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Dominated Strategies

Time

The Economist
G
S
0 , 90
S 100 , 100
G 80 , 100 80 , 90

For The Economist:

G dominant = S dominated
Dominated Strategy:
There exists another strategy which always does
better regardless of opponents actions

Game Theory - Mik

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Dominance
CAVEAT
Expect your opponent to use her
dominant strategy if she has one.
BUT
Be sure you understand your
opponents true payoffs.
(Do you know what
really motivates them?)
Game Theory - Mik

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Understanding your
Opponent (Economist)

Times finances important

Every $1 earned by Time above $80 leads
to $0.60 additional advertising revenue at
50% return to advertising, 2/3 of which is
at the expense of The Economist

Relative sales important

Every $10 advantage in a given week leads
to $3 additional profits, NPV

Too Serious reputation damaging

Running the scandal story encroaches on
traditional US news weekly market.
Expected future gain of $8, NPV.
Game Theory - Mik
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The New Game

Time

Time

S
G

The Economist
G
S
100 , 100
0 ,
80 , 100
80 ,

S
G

The Economist
G
S
100 ,
88
0 , 125
80 , 106
80 , 101
Game Theory - Mik

90
90

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Successive Deletion of
Dominated Strategies

Rational players
Should play dominant strategies
Should not play dominated strategies
Should not expect others to play
dominated strategies

Thus, dominated strategies may be

eliminated from consideration
This may be done iteratively

Game Theory - Mik

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Example: Tourists & Natives

Two bars (bar 1, bar 2) compete

Can charge price of $2, $4, or $5
6000 tourists pick a bar randomly
4000 natives select the lowest price bar

Example 1:

each gets 5,000 customers

Example 2:

Both charge $2
Bar 1 charges $4,
Bar 2 charges $5

Bar 1 gets 3000+4000=7,000 customers

Bar 2 gets 3000 customers
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Tourists & Natives

Bar 2
$2
$4
$5
$2 10 , 10 14 , 12 14 , 15
Bar 1 $4 12 , 14 20 , 20 28 , 15
$5 15 , 14 15 , 28 25 , 25
in thousands of dollars

Game Theory - Mik

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Successive Elimination of
Dominated Strategies
Does any player have a
dominant strategy?
Does any player have a
dominated strategy?

Eliminate the dominated strategies

Reduce the normal-form game
Iterate the above procedure

What is the equilibrium?

Game Theory - Mik

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Successive Elimination of
Dominated Strategies
$2

Bar 2
$4

$5

$2 10 , 10 14 , 12 14 , 15
Bar 1 $4 12 , 14 20 , 20 28 , 15
$5 15 , 14 15 , 28 25 , 25

Bar 2

$4
$5
$4 20 , 20 28 , 15
Bar 1
$5 15 , 28 25 , 25
Game Theory - Mik

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No Dominated Strategies

Often there are no dominated

strategies
Or: reducing the game is not sufficient

There may be multiple equilibria

Method:
Cell-by-cell inspection
Game Theory - Mik

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Games of Assurance

Two firms each earning $45,000

Both can invest the $45,000 into R&D
R&D successful only if both invest
If R&D successful, each nets $50,000

Invest
Firm 1
Dont

Firm 2
Invest
Dont
50 , 50 0 , 45
45 , 0 45 , 45
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Cell-by-Cell Inspection

How to Solve:
Invest
Firm 1
Dont

Firm 2
Invest
Dont
50 , 50 0 , 45
45 , 0 45 , 45

Two equilibria exist

One is better, but more risky
Game Theory - Mik

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Games of Coordination

Joint ventures and the choice of supplier

Two firms engaged in joint venture
Must use the same supplier,
but
each firm has a preferred supplier
Firm 2

A
B
0
A 100 , 50 0 ,
Firm 1
0 , 0 50 , 100
B
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Coordination Outcomes
Two equilibria exist
Firms prefer different equilibria
How to achieve the most
desirable outcome for you?

Strategic moves:
Sequential moves:

commit to choosing A
leader chooses
the equilibrium

Game Theory - Mik

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Your Value to a Game

Why do we solve games?
To know which one to play!

Solve the game

under each set of rules

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Summary

Put yourself in your rivals shoes

Recognize dominant & dominated strategies

Anticipate that your opponent will recognize

them as well

Be conscious of your value to a game.

How much is it worth to have you play?
Game Theory - Mik

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