Managerial Theories of Firm: Game Theory -II

Dr Suneel Gupta
 Sequential Decisions

• One firm makes its decision first, then a rival firm, knowing the action
of the first firm, makes its decision
• The best decision a manager makes today depends on how rivals respond
tomorrow
 First-Mover & Second-Mover Advantages

• First-mover advantage
• If letting rivals know what you are doing by going first
in a sequential decision increases your payoff
• Second-mover advantage
• If reacting to a decision already made by a rival
increases your payoff
• Determine whether the order of decision making
can be confer an advantage
• Apply roll-back method to game trees for each
possible sequence of decisions
 First-Mover Advantage in Technology Choice
(Figure 13.4)

Motorola’s technology
Analog Digital
A SM B
Analog $10, $13.75 $8, $9
Sony’s
technology C D SM
Digital $9.50, $11 $11.875, $11.25

Panel A – Simultaneous technology decision

 Strategic Moves & Commitments
• Actions used to put rivals at a disadvantage
• Three types
• Commitments
• Threats
• Promises
• Only credible strategic moves matter
• Managers announce or demonstrate to rivals that
they will bind themselves to take a particular action
or make a specific decision
• No matter what action is taken by rivals
 Cooperation in Repeated Strategic Decisions

• Cooperation occurs when oligopoly firms make individual

decisions that make every firm better off than they would be in a
(noncooperative) Nash equilibrium
 Price Leadership
• Price leader sets its price at a level it believes will
maximize total industry profit
• Rest of firms cooperate by setting same price
• Does not require explicit agreement
• Generally lawful means of facilitating cooperative
pricing
 Cartels
•Most extreme form of cooperative
oligopoly
•Explicit collusive agreement to drive
up prices by restricting total market
output
•Illegal in U.S., Canada, Mexico,
Germany, & European Union
 Cartels
• Pricing schemes usually strategically unstable & difficult to
maintain
• Strong incentive to cheat by lowering price
• When undetected, price cuts occur along very elastic single-
firm demand curve
• Lure of much greater revenues for any one firm that cuts
price
• Cartel members secretly cut prices causing price to fall
sharply along a much steeper demand curve
 Tacit Collusion
• Far less extreme form of cooperation among oligopoly firms
• Cooperation occurs without any explicit agreement or any other
facilitating practices
 Strategic Entry Deterrence
•Established firm(s) makes strategic moves
designed to discourage or prevent entry of
new firm(s) into a market
•Two types of strategic moves
•Limit pricing
•Capacity expansion
 Limit Pricing
• Established firm(s) commits to setting price below
profit-maximizing level to prevent entry
• Under certain circumstances, an oligopolist (or
monopolist), may make a credible commitment to
charge a lower price forever
Game Theory in Indian e-commerce.
Really?
• What will the endgame look like? This question
is probably keeping Flipkart, Snapdeal, and
Amazon awake.
• There is little differentiation or customer loyalty,
only one thing matters—discounts. “who has
more money to give away”
• In the past, Flipkart and Snapdeal were able to raise huge
sums of money, presumably promising investors that Nirvana
(aka breakeven) was just around the corner
• All that changed with Amazon’s entry. It is not just that
Amazon has access to large amounts of capital, which it
certainly does. What changed is that the parent (Amazon.com
Inc.) is willing to back its Indian entity till it wins.
• News of a potential investment by Wal-Mart
Stores Inc. in Flipkart so interesting
• Is Flipkart going to be Walmart’s horse in the
race against Amazon?
 Game theory
IPL teams are taking franchise and fan engagement to the next level

• in 2008, Indian Premier League (IPL), became the third most

expensive sports property in the world and now in its eleventh
edition, has become a case study in the world of sports.
• The franchises have become big brands in themselves, reaching a
brand value of almost $100 million.
• Starting this year, all franchises will stop paying a franchise fee, which they used
to pay over the last 10 years, but instead, start sharing 20% of their total
revenues with the BCCI as licence fee.
• Out of the eight franchise, there are only three – Mumbai Indians (MI), Chennai
Super Kings (CSK), and Kolkata Knight Riders (KKR) – that have actually become
big brands.
•CSK: M S Dhoni : ‘Whistle
Podu’,
• KKR : Gautam Gambhir:‘Korbo
Lorbo Jeetbo’
•MI: Sachin Tendulkar/Rohit
Sharma:
Two firms, small and large , compete by price. Each can choose either a low price or a high price. The following payoff table shows the profit ( in thousand of dolor's) each firm would earn in each of the four possible decision situation.

Large
Low Price High Price

Low Price
$200, $500 $600, $ 600
Small
High Price $ 400, $ 1000
$0, $1500

a. Is their dominant strategy for small ? If so, what is it ? Why

b. Is their dominant strategy for large ? If so, what is it ? Why
c. What is the likely pair of decision’s ? What pay off will each receive
a.For firm small, a low price dominates, because small makes
more profit going low for either choice made by large
b.Firm large has no dominant strategy. If small chooses
high ,large makes more with a low price. If small chooses low,
large makes more with high price.
c.Small would be expected to set a low price, which is its
dominant strategy. Large will likely set high price because
large knows small dominant strategy is a low price, and a high
price is the best decision for large given it belives is small is
very likely to choose its dominant strategy and set a low
price. Both firm end up earning $600 in profit.
Find a solution to the following advertising decision gain between coke and
Pepsi by using the method of successive elimination dominated strategies
Pepsi’s budget
Low Medium High

A B C
Low $400, $400 $320, $720 $560, $600

D E F
Coke’s Medium $500, $300 $450, $525 $540, $500
budget

G H I
$375, $420 $300, $378 $525, $750
High

Payoffs in millions of dollars of annual profit

a. Does coke have a dominated strategy in the original payoff table? If so,
what is it and why is it dominated ? If not why not
b. Does Pepsi have a dominated strategy in the original payoff table? If so,
what is it and why is it dominated ? If not why not
c. After the first round of eliminating any dominated strategies that can
be found in original pay of table, describe the strategic situation facing
Coke and Pepsi in the reduced payoff table.
d. What is the likely out come of this advertising decision problem?
e. Pepsi’s highest payoff occurs when Coke and Pepsi both choose high
end budgets. Explain why Pepsi will not likely choose high adv budget?
a. Yes, Coke dominated strategy in the original payoff table is high. Regardless of weather
Pepsi chooses low, medium or high, Coke best strategy would never be high
b. Yes, Pepsi dominated strategy in the original payoff table is low. Regardless of weather
Pepsi chooses low, medium or high, Pepsi best strategy would never be Low
c. The reduced payoff table is constructed by deleting from original payoff table the now
corresponding to Coke dominated strategy( now high ) and the column corresponding to
Pepsi’s dominated strategy ( column low ). In the reduced payoff table , only one of the firm
( Pepsi ) has dominated strategy ( medium )
d. The likely pair of decision for Coke and Pepsi is ( Medium, Medium )
e. Pepsi not likely to choose high for its advertising budget because Coke must be expected to
choose high in order for high to be Pepsi best decision. Since high is dominated strategy for
Coke. Pepsi would be foolish to believe Coke will choose high