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In chapter 9 we will investigate the economic forces by which the invisible hand of the marketplace guides profit-seeking firms and satisfaction-seeking consumers in ways that, to a surprising degree, serve society’s ends. These forces encourage aggressive cost cutting by firms, even though the resulting gains will eventually take the form of lower prices rather than higher profits.
Games and Strategic Behavior Chapter McGrawHill/Irwin Copyright © 2015 by McGrawHill Education (Asia). All rights reserved 91 Learning Objectives List the three basic elements of a game Recognize and discuss the effects of dominant strategies and dominated strategies Identify and explain the prisoner's dilemma and how it applies to real-world situations Explain games in which the timing of players' choices matter Discuss strategies that enable players to reap gains through cooperation 92 Strategies and Payoffs • Actions have payoffs that depend on: – – – • The actions When they are taken The actions of others Some markets are characterized by interdependence – Apply to monopolistic competition and oligopoly 93 Game Theory • Basic elements of a game: – – – • The players Their available strategies, actions, or decisions The payoff to each player for each possible action A dominant strategy is one that yields a higher payoff no matter what the other player does – A dominated strategy is any other strategy available to a player who has a dominant strategy 94 Singapore and Thai – Scenario • Players: Singapore Airlines and Thai Airways supplying service between Singapore and Bangkok – • • • No other carriers Strategies: Increase advertising by $1,000 or not Assumption: all payoffs are know to all parties A payoff matrix is a table that describes the payoffs in a game for each possible combination of strategies 95 Payoff Matrix Thai Airways Options Singapore Airlines Options Raise Spending No Raise • • Raise Spending No Raise Singapore: $5,500 Singapore: $8,000 Thai: $5,500 Thai: $2,000 Singapore: $2,000 Singapore: $6,000 Thai: $8,000 Thai: $6,000 Payoff is symmetric Dominant strategy is raise advertising spending – Both companies are worse off 96 Equilibrium in a Game • A Nash equilibrium is any combination of strategies in which each player’s strategy is her or his best choice, given the other player’s strategies – – Equilibrium occurs when each player follows his dominant strategy, if it exists Equilibrium does not require a dominant strategy 97 Singapore and Thai – Scenario • Same situation – Different payoffs; non-symmetric Lower-Left cell is a Nash equilibrium Thai Airways Options Singapore Airlines Options Raise Spending No Raise Raise Spending No Raise Singapore: $3,000 Singapore: $8,000 Thai: $4,000 Thai: $3,000 Singapore: $4,000 Singapore: $5,000 Thai: $5,000 Thai: $2,000 98 Prisoner’s Dilemma • • • The advertising example illustrates an important class of games called the prisoner’s dilemma The prisoner’s dilemma is a game in which each player has a dominant strategy, and when each plays it, the resulting payoffs are smaller than if each had played a dominated strategy Consider another example 99 Prisoner's Dilemma – – Dominant Optimal strategy strategy Two prisoners are held in separate cells for a serious crime they did commit The prosecutor lacks sufficient evidence Kakuzu's Options Hidan's Options Confess Don't Confess Confess Don't Confess Hidan: years Hidan: Kakuzu: years Kakuzu: Hidan: Kakuzu: 20 years Hidan: years Kakuzu: years 20 years year year 910 The Remote Office • • Players: Business owner and remote office manager Options: – – Business owner can open the office or not Manager can be honest or not 922 Remote Office Pay-Off Honest manager Owner: $1,000 Manager: $1,000 A Managerial candidate promises honesty B Open remote office C Dishonest Manager Owner: -$500 Manager: $1,500 No remote office Owner: $0 Manager: $500 working elsewhere 923 Monopolistic Competition and Location • First mover advantage With Samsung and Sony, firms did better if products were different Tic-tac-toe – – • If the differentiator is time or location, the last mover may have the advantage Suppose that customers go to the nearest convenience store – • • Store A locates 1.5 km from Freeway Where will Store B locate? 924 Store B's Location • A chooses its location New business plans to enter the market – – A Location C minimizes customer's travel distance Location B maximizes customers B 500 m 800 people Freeway • 1.5 km 1,200 people 500 m 800 people C 500 m 800 people 1.5 km 1,200 people 925 Other Examples • There are a number of cases where the last mover gains an advantage – – – Times for flights Movie schedules Cola drink flavors 926 Commitment • A commitment problem arises from an inability to make credible threats or promises A commitment device changes incentives to make threats or promises credible – • Underworld code, Omerta (under which the family of anyone who provides evidence against a fellow mob member is killed) • • • Military-arms-control agreements Tips for waiters Various business problems are commitment issues 927 Restaurant Service • Restaurant wants to provide superior service Increases pay of waiters; monitoring problem – • Restaurant cannot insure good service by paying higher wages – • If waiters are not diligent, restaurant wasted money Repeat customers can ensure good service by tipping A one-time, self-interested diner will not tip – • • Tip is marginal cost Service is completed so marginal benefits are zero 928 To Tip or Not To Tip? Waiter: Diner: Diner $20 $20 Tip Provide good service Waiter Provide adequate service Don't Tip Waiter: – $5 Diner: $30 Waiter:$10 Diner: $5 929 The Strategic Role of Preferences • Game theory assumes that the goal of the players is to maximize their outcome – • In most games, players not attain the best outcomes Altering psychological incentives may also improve the outcome of a game 930 Honest Manager for Remote Office An honest manager earns more than a dishonest manager A B Managerial candidate promises honesty Open remote office No remote office C Honest Manager Owner: $1,000 Manager: $1,000 Dishonest Manager Owner: $500 Manager: – $8,500 Owner: $0 Manager: works elsewhere for $500 931 Self-Interest Evaluated • There are exceptions to outcomes based on selfinterest – – – Tips at out-of-town restaurants Revenge Passing on "unfair" opportunities 932 The Role of Preferences • Preferences are given Affect choices through – • • • • Sympathy for an adversary Generosity Honesty If preferences can be known to the other party, the commitment problem is reduced – Trustworthy employee 933 Character Judgments • If character were known perfectly, businesses could avoid the costs of dishonesty, shirking, etc Since people are victimized, make hiring mistakes, and so on, either – • • Character cannot be judged perfectly OR Character information is expensive 934 Caveat Emptor • The payoff of deceit Advantage to seeming honest while being dishonest – • • Greater opportunities Greater exploitation of opportunities 935 Games and Strategic Behavior Prisoner's Dilemma Sequential Decisions Game Theory Elements Equilibrium Commitment Problems Dominant Strategy 936 ... M § Profits are higher when each company offers a different type of smartphone 9 19 Suppose Sony Moves First Offer quad core B Don’t offer quad core Offer quad core A Sony decides Don’t offer... § Charge $1 Charge $0 .90 Charge $1 Aquapure: Mtn Spring: $500 $500 Aquapure: Mtn Spring: $0 $99 0 Charge $0 .90 Aquapure: Mtn Spring: $99 0 $0 Aquapure: Mtn Spring: $ 495 $ 495 If one firm lowers... out 9 21 The Remote Office • • Players: Business owner and remote office manager Options: – – Business owner can open the office or not Manager can be honest or not 9 22 Remote Office Pay-Off