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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 l.jpg

Game Theory

“Only the Paranoid Survive”

- Andy Grove, Intel Co-founder

Mike Shor

Lecture 1


What is game theory l.jpg
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


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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


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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


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Why Study Game Theory?

Because the press tells us to…

“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


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Why Study Game Theory?

  • Because we can formulate effective strategy…

  • Because we can predict the outcome of strategic situations…

  • Because we can select or design the best game for us to be playing…

Game Theory - Mike Shor


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Why Study Game Theory?

McKinsey:

  • John Stuckey & David White - Sydney

    • “To help predict competitor behavior and determine optimal strategy, our consulting teams use techniques such as pay-off matrices and competitive games.”

  • Tom Copeland - Director of Corporate Finance

    • “Game theory can explain why oligopolies tend to be unprofitable, the cycle of over capacity and overbuilding, and the tendency to execute real options earlier than optimal.”

Game Theory - Mike Shor


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Understanding Incentives

  • Do safer cars cause more accidents?

  • Does Canadian football have less punting than the NFL?

  • Are you getting a good deal if the store matches competitors’ prices?

  • What is the optimal time to execute an option (or sell stock during a bubble)?

Game Theory - Mike Shor


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Game Theory

Administratrivia


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Course Information

  • Course web site

    • Check after each lecture

  • Course discussion

    • Questions, comments

  • Instructor

    • Office hours - none

    • Appointment

    • Drop by

  • Game Theory - Mike Shor


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    Course Outline Concepts

    • Recognizing the game

      • Rules of the game

      • Simultaneous games

        Anticipating rival’s moves

      • Sequential games

        Looking forward – reasoning back

      • Mixed strategies

        Sensibility of being unpredictable

      • Repeated games

        Cooperation and agreeing to agree

    Game Theory - Mike Shor



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    Course Outline Applications

    • Winning the game

      • Commitment

        Credibility, threats, and promises

      • Information

        Strategic use of information

      • Bargaining

        Gaining the upper hand in negotiation

      • Auctions

        Design and Participation

    Game Theory - Mike Shor


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    Disclaimer # 2

    Game Theory - Mike Shor


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    Group Deliverables

    • Self selected – four to five students

    • A word of caution

    • Length: about 750 words

    • Exhibits: three or four slides

  • Content

    • Make a proposal

    • Explain it in plain English

  • Grading

    • Relevance, difficulty of undertaking

    • Depth of analysis, value of advice

    • Professionalism, clarity of writing

  • Game Theory - Mike Shor


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    Individual Assignments

    • Apply game theory to real scenarios

    • Real:

      • messy, unclear, undirected

    • Short, concise (about 500 words)

    • There are wrong answers!

    Game Theory - Mike Shor


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    Experiments

    • Participate by midnight day prior to next lecture

    • Timed – no research required

    • Scores are known

    • Opponents are not

    • Honor code

    • Not graded (but required)

    Game Theory - Mike Shor


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    Grading

    • Group Homework #1 10%

    • Group Homework #2 15%

    • Group Homework #3 15%

    • Individual Assignments 25%

    • Class Participation 10%

    • Final Exam 25%

    • Games (participation) –10 to 0

    Game Theory - Mike Shor


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    Keys to Success

    • Before each lecture:

      • Review text

  • After each lecture:

    • Visit course web site

    • Do sample problems

  • Ask questions

  • Submit drafts (3 days prior)

  • Don’t fall behind

  • Game Theory - Mike Shor


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    Policies

    They have a lovely

    “No cell phone”

    policy here…

    Game Theory - Mike Shor


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    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


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    The Golden Rule

    COMMANDMENT

    Never assume that your opponents’ behavior is fixed.

    Predict their reaction to your behavior.

    Game Theory - Mike Shor


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    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


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    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


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    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


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    Issues

    • Are the threats by the parties credible?

    • Can cooperation be sustained?

    • Are there informational advantages?

    Game Theory - Mike Shor


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    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


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    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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