Economics of strategy

Brickley, Smith, and Zimmerman,
Managerial Economics and
Organizational Architecture, 4th ed.
Chapter 9: Economics of Strategy:
Game theory
Game theory
learning objectives
• Structure a simple game in both matrix
and tree formats
• Specify a simple game
• Identify Nash equilibria
• Identify dominant strategies
Game theory overview
• General analysis of strategic interaction
• Optimal decision making when
– all decision agents are presumed rational
– each attempts to anticipate actions of rivals
non-repeated interaction
• Simultaneous?
– Rivals must make decisions with no
knowledge of each other’s decisions
• Nonrepeated?
– The interaction occurs only once
• Boeing and Airbus individually choose
and simultaneously submit a bid price
(high or low) for 10 planes
• Each cell entry represents the payoffs
• A dominant strategy is one the firm
chooses no matter what its rival does
Strategic form
dominant strategy
Nash equilibrium
• In the absence of a dominant strategy,
Nash equilibrium may predict outcome
• Nash equilibrium is set of strategies
where firm does its best given rival’s
• Use arrow technique to identify Nash
Nash equilibrium
Competition versus cooperation
• Boeing and Airbus make simultaneous
choices of new communications
– two technologies: Alpha & Beta
– both benefit with same choice
• Results in two Nash equilibria
– benefits from pre-commitment
Coordination game
two Nash equilibria
Coordination/competition game
Mixed strategies
• Mixed strategy offers an element of
• Boeing and Airbus must simultaneously
commit to an advertising campaign
– Boeing benefits most from same strategy
– Airbus benefits most from differentiation
• Randomization with p=.5 is Nash
equilibrium for both
Mixed strategy
Sequential interactions
• Boeing & Airbus communications
technology choice
– Boeing chooses first
• Analyze with backward induction
– Boeing must take Airbus’s best response
into account in making its choice
– Boeing has first mover advantage
• Credible commitment by second mover
can alter first mover choice
Extensive form
sequential game
Repeated strategic interaction
• Boeing and Airbus compete often
• Strategic choices can come to
incorporate more than short-term
Strategic interaction and
organizational architecture
• Kiana manages Lenin
• Len must choose between working and
• Kiana must choose whether to incur
monitoring costs
• No pure strategy equilibrium exists
Interactive game
no pure strategy equilibrium

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