CHAPTER 13
Game Theory and
CHAPTER OUTLINE
Competitive Strategy 13.1 Gaming and Strategic
Decisions
13.2 Dominant Strategies
13.3 The Nash
Equilibrium
Revisited
13.4 Repeated Games
13.5 Sequential Games
13.6 Threats, Commitments
and Credibility
Prepared by:
Fernando Quijano, Illustrator
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13.3 The Nash Equilibrium Revisited
Dominant Strategies: I’m doing the best I can no matter what you do.
You’re doing the best you can no matter what I do.
Nash Equilibrium: I’m doing the best I can given what you are doing.
You’re doing the best you can given what I am doing.
THE PRODUCT CHOICE PROBLEM
Two new variations of cereal can be successfully introduced—provided that
each variation is introduced by only one firm.
TABLE 13.3 PRODUCT CHOICE PROBLEM
Firm 2
Crispy Sweet
Crispy –5, –5 10, 10
Firm 1
Sweet 10, 10 –5, –5
In this game, each firm is indifferent about which product it produces—so long as it does
not introduce the same product as its competitor. The strategy set given by the bottom left-
hand corner of the payoff matrix is stable and constitutes a Nash equilibrium: Given the
strategy of its opponent, each firm is doing the best it can and has no incentive to deviate.
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THE BEACH LOCATION GAME
FIGURE 13.1
BEACH LOCATION GAME
You (Y) and a competitor (C) plan to sell soft drinks on a beach.
If sunbathers are spread evenly across the beach and will walk to the closest vendor, the
two of you will locate next to each other at the center of the beach. This is the only
Nash equilibrium.
If your competitor located at point A, you would want to move until you were just to the
left, where you could capture three-fourths of all sales.
But your competitor would then want to move back to the center, and you would do the
same.
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Maximin Strategies
TABLE 13.4 MAXIMIN STRATEGY
Firm 2
Don’t invest Invest
Don’t invest 0, 0 –10, 10
Firm 1
Invest –100, 0 20, 10
In this game, the outcome (invest, invest) is a Nash equilibrium. But if
you are concerned that the managers of Firm 2 might not be fully informed or
rational—you might choose to play “don’t invest.” In that case, the worst that
can happen is that you will lose $10 million; you no longer have a chance of
losing $100 million.
● maximin strategy Strategy that maximizes the minimum gain that can
be earned.
MAXIMIZING THE EXPECTED PAYOFF – Not examinable
If Firm 1 is unsure about what Firm 2 will do but can assign probabilities to each
feasible action for Firm 2, it could instead use a strategy that maximizes its
expected payoff.
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THE PRISONERS’ DILEMMA
TABLE 13.5 PRISONERS’ DILEMMA
Prisoner B
Confess Don’t confess
Confess –5, –5 –1, –10
Prisoner A
Don’t confess –10, –1 –2, –2
The ideal outcome is one in which neither prisoner confesses, so that both
get two years in prison. Confessing, however, is a dominant strategy for
each prisoner—it yields a higher payoff regardless of the strategy of the other
prisoner.
Dominant strategies are also maximin strategies. The outcome in which both
prisoners confess is both a Nash equilibrium and a maximin solution.
Thus, in a very strong sense, it is rational for each prisoner to confess.
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Mixed Strategies
● pure strategy Strategy in which a player makes a specific choice
or takes a specific action.
MATCHING PENNIES
TABLE 13.6 MATCHING PENNIES
Player B
Heads Tails
Heads 1, –1 –1, 1
Player A
Tails –1, 1 1, –1
In this game, each player chooses heads or tails and the two players reveal
their coins at the same time. If the coins match Player A wins and receives a
dollar from Player B. If the coins do not match, Player B wins and receives a
dollar from Player A.
Note that there is no Nash equilibrium in pure strategies for this game. No
combination of heads or tails leaves both players satisfied—one player or the
other will always want to change strategies.
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● mixed strategyStrategy in which a player makes a random
choice among two or more possible actions, based on a set of
chosen probabilities..
Although there is no Nash equilibrium in pure strategies, there is a Nash
equilibrium in mixed strategies.
In the matching pennies game, for example, Player A might simply flip the
coin, thereby playing heads with probability 1/2 and playing tails with
probability 1/2. In fact, if Player A follows this strategy and Player B does
the same, we will have a Nash equilibrium: Both players will be doing the
best they can given what the opponent is doing. Note that although the
outcome is random, the expected payoff is 0 for each player.
It may seem strange to play a game by choosing actions randomly. But put
yourself in the position of Player A and think what would happen if you followed
a strategy other than just flipping the coin. Suppose you decided to play heads.
If Player B knows this, she would play tails and you would lose. Even if Player
B didn’t know your strategy, if the game were played repeatedly, she could
eventually discern your pattern of play and choose a strategy that countered it.
Once we allow for mixed strategies, every game has at least one Nash
equilibrium.
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THE BATTLE OF THE SEXES
TABLE 13.7 THE BATTLE OF THE SEXES
Jim
Wrestling Opera
Wrestling 2, 1 0, 0
Joan
Opera 0, 0 1, 2
There are two Nash equilibria in pure strategies for this game—the one in
which Jim and Joan both watch mud wrestling, and the one in which they both
go to the opera. This game also has an equilibrium in mixed strategies: Joan
chooses wrestling with probability 2/3 and opera with probability 1/3, and Jim
chooses wrestling with probability 1/3 and opera with probability 2/3.
Should we expect Jim and Joan to use these mixed strategies? Unless they’re
very risk loving or in some other way a strange couple, probably not. By
agreeing to either form of entertainment, each will have a payoff of at
least 1, which exceeds the expected payoff of 2/3 from randomizing.
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