Presentation Transcript

1. Principles of Game Theory

   Implications
2. Administrative Midterm graded except bonus I made it too easy: low score was a B+ (no – excellent job by you guys). Mid-mini feedback Seemed to like: The book(s) New perspective on interactions/problems. Seemed to dislike: The book(s) Assignment due dates Suggestions Make the class more applied (either with games, or cases, or…)
3. Opportunity to pause What are some of the intuitions you’ve gained so far? In my opinion, there are many – but you might not realize them until later. Don’t hate the player, hate the game. Trite but true: if you don’t like the outcome of the game you’ll be playing, change the game. Assignment for next class: Take any interaction in the next two days and describe it as a game. What are the equilibria? What could you change about the interaction to change the outcome?
4. Last time If we observe stupid – or irrational – actions, ask yourself why those presumably rational actors are taking irrational action. Sustainable Cooperation? Requires sacrificing immediate profits for a future relationship The sacrifice is only made if the punishment is severe enough Punishment that is too severe is not credible
5. Commitment “The power to constrain an adversary depends upon the power to bind oneself.” Thomas Schelling Telling you I’m going to act in my best interest is notcommitting To commit to a suboptimal action, I need to: Change the game Change perceptions
6. Ways to be Credible Reduce payoffs from those strategies that may tempt Make it costly to renege Think about the lawsuit game. Publicly observed costly actions may be worthwhile investments from a strategic point of view. Remove strategies from among those that may tempt you in the future Destroy avenues of retreat Examples?
7. Removing Strategies You are not always better off with more options Several ways to strategically remove options Delegation In contract negotiation, can “squabble” over many details Instead, send an agent with power of attorney to “sign as is” or “walk away.”  credible commitment to not change the contract.
8. Delegation Examples Government Bureaucracy Suboptimal rules can often be optimal overall Credible commitments to future interactions Making exceptions can change the game (and the types of players you interact with – more on this in mechanism design) Human Resource departments Collection agencies Finance & Accounting: the role of 3rd party accountants.
9. Removing Strategies: Burning & Building Bridges Sometimes burning bridges can be a good idea. Burning Bridges Power can come from not being able to retreat Examples? Costly upfront investment Hunt for Red October Alternatively: build a bridge for your opponent. “When you surround an enemy, you must leave an outlet for him to go free.” –Sun-Tzu
10. Implications Non-intuitive implications: Reduce your strategy space and/or decrease your own payoffs to commit. Or, hurt yourself to help yourself. Increase your opponent’s strategy space to preclude your rival from committing. Or, help your rival to help yourself.
11. Rational Irrationality U.S. / U.S.S.R. nuclear deterrence Mutually Assured Destruction (MAD) like Grim Trigger Strategy Proportional Response like Tit-for-Tat Dr Strangelove.
12. Doomsday device Is it credible? Severity “Create fear in the mind of the enemy” Irreversibility “It is essential” Irrationality “Not something a sane man would do” Practicality “It wasn’t a practical deterrent” Clarity “Tell the world”
13. Back to the classic dilemma Prisoners’ Dilemma Why does the dilemma occur? Interaction No fear of punishment Short term or myopic play Firms: Lack of monopoly power Homogeneity in products and costs Overcapacity Incentives for profit or market share Consumers Price sensitive Price aware Low switching costs } Last time
14. Avoid the Dilemma: Change the Game Firms: Lack of monopoly power Become a monopolist Homogeneity in products and costs Differentiate product Lower cost Not so useful…
15. Avoid the Dilemma: Change the Game Firms: Lack of monopoly power Homogeneity in products and costs Incentives for profit or market share Change incentives: cross-share holding Overcapacity Reduce capacity (but it may be a fine line…) Eliminate the urge to lower prices } Do it if you can
16. Cross-shareholding Recall from last time Suppose each firm acquires 20% of the other. What changes?
17. Commit to not lower prices “If we ever offer a lower price to any other customer, we’ll offer it to you as well” “low-price” guarantee ≈ high price guarantee Suppose payoffs from from a demand function such that: Firm 2
18. “Low-price” Guarantees Take a 2 period game: Period 1 both companies charge high, will there be an incentive in the last period (round 2) to defect and lower prices? No: in period 2, pricing low requires a $1 refund to 30 customers from the previous period Firm 1: 65 – 30 = 35
19. “Low-price” Guarantees Low price guarantee
20. Leveraging Customers Price matching guarantees and most favored customer clauses exploit: Customer price sensitivity Price awareness Low customer switching costs. Exactly the factors that make price competition “nasty” for the companies!
21. Change the Game Ways to increase search costs: Prevent price advertising Government regulation (liquor stores) Industry agreement (likely illegal) Professional trade groups (doctors) Limit store hours Closing laws Obfuscate price information Provide “one at a time” pricing (airlines) Require visit (grocery stores) Make comparison difficult (mattresses, insurance) Use multiple prices (banking, auto dealers)
22. Commitment Under Uncertainty For you seniors: An offer you can’t refuse After a seemingly successful interview, the interviewer asks where the firm ranks on your list of potential employees BUT Before answering, you are told: The firm only hires applicants who rank it first If the firm is in fact your first choice, then you must accept a job offer in advance, should one be made
23. Commitment Under Uncertainty Why make such offers? Take advantage of your uncertainty Take advantage of your risk-aversion Make you commit before they do!
24. Don’t hate the player… change the game