06. Game Theory and Business Strategy

Question 1

When is a game cooperative?

Answer 1

if the players can communicate and arrange binding contracts

Question 2

When is a game non-cooperative?

Answer 2

if players cannot communicate; here, it is essential to understand your opponent´s point of view and to deduce his or her likely responses to your actions

-> awareness of anothers existence, and typically know the payoffs, but they act independently

Question 3

Nash Equilibrium | Definition

Answer 3

an outcome where both players correctly believe that they are doing the best they can, given the action of the other player

in an equilibrium, no player has an incentive to change their choice, unless there is a change by another player

Question 4

Bargaining Problem | Definition

1.
2.
3.

Answer 4

non-trivial bargaining situations have multiple mutually acceptable settlements

basically, negotiating over the terms of an agreement

can be explicit and enforceable, or it can be tacit and formally unenforceable

Question 5

Maximin stragety | Definition

Answer 5

a player determines the worst outcome that can occur for each of the possible actions; then he chooses the action that maximizes the minimum gain that can be earned

Question 6

Pure strategy | Definition

Answer 6

a player makes a specific choice or takes a specfic action

Question 7

Mixed strategy | Definition

Answer 7

a player makes random choice among two or more possible actions, based on a set of chosen probabilities

Question 8

Repeated Games | Definition

1.
2.
3.
4.

Answer 8

• a static game played multiple times over different periods
• firms can here adopt strategies based on past interactions
• actions in one period can affect competitors future actions
• possibility to cooperate to maintain higher prices

Question 9

Sequential Games | Definition

Answer 9

if firms acts before rival, it may gain advantage by converting what would be an empty threat to its rival ino credible, observable action

Question 10

Deterring entry | Definition

1.
2.

Answer 10

• strategies to prevent new competitors from entering a market
• but the first firms action must be credible and irreversible

Question 11

What are the three types of Nash equilibrium?

1.
2.
3.

Answer 11

1. unique N.E.: only one combination of strategies is each firms strategy a best response to its rival strategy (e.g. bertrand and cournot)
2. multiple N.E.:
3. mixed strategy N.E.: when players are not certain which strategy to take and dont know others strategy

Question 12

What are the three steps to find a nash bargaining solution?

Answer 12

1. find the profit at the disagreements point (outcome if no agreement is reached, call it d): dA = dU = 4
2. if a proposed agreement is reached, the firm earns a profit of π and a net surplus, π – d.
3. the Nash bargaining solution is the outcome in which each firm receives a non-negative surplus and in
   which the product of the net surplus of the two firms (called the Nash product, NP) is maximized.

Question 13

What are reasons for the Nash bargaining solutions being inefficient in real life?

1.
2.

Answer 13

• bargaining process takes time, which delays the start of benefit flow and thus reduced value of benefits overall (eg strike)
• negotiators failing to quickly reach an agreement due to bounded rationality or incomplete information about the other side´s profits

Question 14

What is the key feature that distinguishes a Nash equilibrium from an equilibrium in dominant strategies?

Answer 14

the dependence on the opponent’s behavior

Question 15

Does the prisoners’ dilemma doom oligopolistic firms to aggressive competition and low profits?

Answer 15

Not necessarily. Although our imaginary prisoners have only one opportunity to confess, most firms
set output and price over and over again, continually observing their competitors’ behavior and
adjusting their own accordingly. This allows firms to develop reputations from which trust can arise.

Question 16

Implicit collusion | Definition

Answer 16

Firms may be able to engage in such implicit collusion or tacit collusion using
trigger, tit-for-tat, or similar strategies, as long as firms do not explicitly communicate each other

Question 17

Repeated games | Cartel is much like a…..

Answer 17

prisoners dilemma

need to easily observe each others plays and react quickly to undesired behavior

Question 18

Grim Trigger strategy | Definition

Answer 18

(within repeated prisoners dilemma)
if anyone has defected at any point, defect forever. otherwise, cooperate

at start no one did anything before, so acc to this strategy, you cooperate

Question 19

What are the two conditions to check in a grim trigger strategy?

Answer 19

1. if defection has been triggered, is it an equilibrium to continue defection forever?
2. in no one has defected previously, would anyone want to?

Question 20

Whats a tit for tat strategy?

1.
2.
3.

Answer 20

A tit-for-tat strategy for repeated prisoners’ dilemma games sets cooperation in the 1st round, then
copies the rival’s previous action in each subsequent round.

it may not induce cooperation in the Airline repeated game if the extra profit in period t
is greater than the loss from the punishment in period t + 1.

However, if the tit-for-tat strategy is modified to extend the punishment for more than one period,
then it may ensure cooperation. The extension of time should be enough to more than
compensate the one time extra profit.

Question 21

Whats an implicit collusion?

Answer 21

Firms may be able to engage in such implicit collusion or tacit collusion using
trigger, tit-for-tat, or similar strategies, as long as firms do not explicitly communicate each other.

Question 22

Whats the difference between a strategy and an action?

Answer 22

Strategy: s a battle plan that specifies the full set of actions that a player will make
throughout the game.

Action: a single move that a player makes at a specified time, such as choosing an output
level or a price.

Question 23

Whats a Strategy in repeated games to Avoid a Prisoner’s Dilemma Outcome?

Answer 23

Firms can follow a trigger strategy, in which a
rival’s defection from a collusive outcome triggers a punishment.

Question 24

Sequential Game | Characteristics

Answer 24

Firms can follow a trigger strategy, in which a
rival’s defection from a collusive outcome triggers a punishment.

Question 25

How can we do a Backward induction for subgame perfect Nash-equilibrium?

1.
2.
3.

Answer 25

1. determine best response by the last player to move
2. determine best response for the player who made the next to last move
3. etc… until we reach the first move of the game

Question 26

Limit Pricing
- Stackelberg leader acts first and produces a (1: large/small?) quantity so that the follower produces… (2)
- The leader makes limit pricing credible by…(3)

Answer 26

1. large
2. a smaller quantity with no profit.
3. committing to provide a very large output level

Question 27

Moving First | What can we say about a firm moving first with regards to…

1. Moving first and its own MC?
2. Moving first and its rivals MC?

Answer 27

1. moving first to gain MC advantage over its rivals; it can lower its MC by using a capital investment or increasing the rate of learning by doing
2. a firms moves first to increase the rivals MC by more than its own

Question 28

What are some disadvantages of entering a market first?

1.
2.
3.

Answer 28

• costs of entering quickly is higher
• odds of misclalculating demand are greater
• later rivals may build on the pioneers research to produce superior product

Question 29

What is an example of first mover advantage?

1.
2.
3.
4.

Answer 29

• acting first can lead to lower production costs or innovation benefits
• early investment in technology or processes reduced MC
• learning by doing
• raising rivals costs -> should hurt rival more than oneself

Question 30

1. A current account deficit requires a net capital….
2. A current account surplus requires a net capital…..

Answer 30

1. inflow
2. outflow (e.g. investing abroad)