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Game Theory

Game Theory. “Only the Paranoid Survive” - Andy Grove, Intel Co-founder Mike Shor Lecture 1. What is Game Theory ?. “No man is an island” Study of rational behavior in interactive or interdependent situations Bad news: Knowing game theory does not guarantee winning Good news:

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Game Theory

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  1. Game Theory “Only the Paranoid Survive” - Andy Grove, Intel Co-founder Mike Shor Lecture 1

  2. What is Game Theory? • “No man is an island” • Study of rational behavior in interactive or interdependent situations • Bad news: Knowing game theory does not guarantee winning • Good news: Framework for thinking about strategic interaction Game Theory - Mike Shor

  3. Games We Play • Group projects free-riding, reputation • Flat tire coordination • GPA trap prisoner’s dilemma • Tennis / Baseball mixed strategies • Mean professors commitment • Traffic congestion • Dating information manipulation Game Theory - Mike Shor

  4. Games Businesses Play • Patent races game of chicken • Drug testing mixed strategies • FCC spectrum auctions • Market entry commitment • OPEC output choice collusion / enforcement • Stock options compensation schemes • Internet pricing market design Game Theory - Mike Shor

  5. Why Study Game Theory? FCC Spectrum Auction “As for the firms that want to get their hands on a sliver of the airwaves, their best bet is to go out first and hire themselves a good game theorist.” The Economist, July 23,1994 p. 70 “Game Theory, long an intellectual pastime, came into its own as a business tool.” Forbes, July 3, 1995, p. 62. “Game theory is hot.” The Wall Street Journal, 13 February 1995, p. A14 Game Theory - Mike Shor

  6. Why Study Game Theory? • Strategy • Commitment vs. flexibility • Decision-making under uncertainty • Looking forward & reasoning back • Market Design • Auctions • National Resident Matching Program • Electric Power Exchanges • Internet Game Theory - Mike Shor

  7. Interactive Decision Theory • Decision theory • You are self-interested and selfish • Game theory • So is everyone else “If it’s true that we are here to help others, then what exactly are the others here for?” - George Carlin Game Theory - Mike Shor

  8. The Golden Rule COMMANDMENT Never assume that your opponents’ behavior is fixed. Predict their reaction to your behavior. Game Theory - Mike Shor

  9. Toys “R” Us • Market share: 20% nationally • Levels of toy stores: • Toy & department stores • Specialized discounter (only TRU) • General discounter (Wal-Mart,Target) • Warehouse clubs (Costco,Pace) • Mark-ups: 9% to 50% • High product differentiation Game Theory - Mike Shor

  10. History • TRU had a lot of market power • Toy stores did not compete on price • Discounters couldn’t match variety • Advent of warehouse clubs • By 1989: 200 items in competition • TRU reaction: • Statement to manufacturers: Cannot sell to warehouses without losing TRU as a customer Game Theory - Mike Shor

  11. The “Game” • Toys R Us • analyzed market potential for warehouse clubs • concluded that they will do well • Manufacturers • unaware of the future of warehouse clubs • enthusiastic about the new market • concerned that rivals who broke ranks and sold to the clubs might gain sales at their expense • Warehouse clubs • Consider not carrying a line of toys if few of the toys have any value Game Theory - Mike Shor

  12. Issues • Are the threats by the parties credible? • Can cooperation be sustained? • Are there informational advantages? Game Theory - Mike Shor

  13. Resolution • Major manufacturers agreed to TRU deal • Costco toy sales decreased • Pre-agreement growth of 51% per year • TRU brokered a cooperative agreement among the manufacturers • Served as the central clearinghouse for complaints about breaches in the agreement Game Theory - Mike Shor

  14. Definition of a Game • Must consider the strategic environment • Who are the PLAYERS? (Decision makers) • What STRATEGIES are available? (Feasible actions) • What are the PAYOFFS? (Objectives) • Rules of the game • What is the time-frame for decisions? • What is the nature of the conflict? • What is the nature of interaction? • What information is available? Game Theory - Mike Shor

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