CHAPTER 13 • Game Theory and Competitive Strategy 489 setting their prices Each firm knows that by undercutting its competitor, it can capture more market share But it also knows that in doing so, it risks setting off a price war Another noncooperative game is the auction mentioned above: Each bidder must take the likely behavior of the other bidders into account when determining an optimal bidding strategy Note that the fundamental difference between cooperative and noncooperative games lies in the contracting possibilities In cooperative games, binding contracts are possible; in noncooperative games, they are not We will be concerned mostly with noncooperative games Whatever the game, however, keep in mind the following key point about strategic decision making: It is essential to understand your opponent’s point of view and to deduce his or her likely responses to your actions This point may seem obvious—of course, one must understand an opponent’s point of view Yet even in simple gaming situations, people often ignore or misjudge opponents’ positions and the rational responses that those positions imply HOW TO BUY A DOLLAR BILL Consider the following game devised by Martin Shubik.3 A dollar bill is auctioned, but in an unusual way The highest bidder receives the dollar in return for the amount bid However, the secondhighest bidder must also hand over the amount that he or she bid—and get nothing in return If you were playing this game, how much would you bid for the dollar bill? Classroom experience shows that students often end up bidding more than a dollar for the dollar In a typical scenario, one player bids 20 cents and another 30 cents The lower bidder now stands to lose 20 cents but figures he can earn a dollar by raising his bid, and so bids 40 cents The escalation continues until two players carry the bidding to a dollar against 90 cents Now the 90-cent bidder has to choose between bidding $1.10 for the dollar or paying 90 cents to get nothing Most often, he raises his bid, and the bidding escalates further In some experiments, the “winning” bidder has ended up paying more than $3 for the dollar! How could intelligent students put themselves in this position? By failing to think through the likely response of the other players and the sequence of events it implies In the rest of this chapter, we will examine simple games that involve pricing, advertising, and investment decisions The games are simple in that, given some behavioral assumptions, we can determine the best strategy for each firm But even for these simple games, we will find that the correct behavioral assumptions are not always easy to make Often they will depend on how the game is played (e.g., how long the firms stay in business, their reputations, etc.) Therefore, when reading this chapter, you should try to understand the basic issues involved in making strategic decisions You should also keep in mind the importance of carefully assessing your opponent’s position and rational response to your actions, as Example 13.1 illustrates Martin Shubik, Game Theory in the Social Sciences (Cambridge, MA: MIT Press, 1982)