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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

Game Theory

“Only the Paranoid Survive”

- Andy Grove, Intel Co-founder

Mike Shor

Lecture 1

what is game theory
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

games we play
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

games businesses play
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

why study game theory
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

why study game theory6
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

why study game theory7
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

understanding incentives
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

game theory9

Game Theory

Administratrivia

course information
Course Information
  • Course web site
      • Check after each lecture
  • Course discussion
      • Questions, comments
  • Instructor
      • Office hours - none
      • Appointment
      • Drop by

Game Theory - Mike Shor

course outline concepts
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

course outline applications
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

slide14

Disclaimer # 2

Game Theory - Mike Shor

group deliverables
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

individual assignments
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

experiments
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

grading
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

keys to success
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

policies
Policies

They have a lovely

“No cell phone”

policy here…

Game Theory - Mike Shor

interactive decision theory
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

the golden rule
The Golden Rule

COMMANDMENT

Never assume that your opponents’ behavior is fixed.

Predict their reaction to your behavior.

Game Theory - Mike Shor

toys r us
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

history
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

the game
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

issues
Issues
  • Are the threats by the parties credible?
  • Can cooperation be sustained?
  • Are there informational advantages?

Game Theory - Mike Shor

resolution
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

definition of a game
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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