The prosecutor informs both Suspect 1 and Suspect 2 individually that if he confesses and testifies against the other, he can go free, but if he does not cooperate and the other suspect does, he will be sentenced to three years in prison. If both confess, they will get a two-year sentence, and if neither confesses, they will be sentenced to one year in prison.
While cooperation is the best strategy for the two suspects, when confronted with such a dilemma, research shows most rational people prefer to confess and testify against the other person than stay silent and take the chance the other party confesses. It is assumed players within the game are rational and will strive to maximize their payoffs in the game. The prisoner's dilemma lays the foundation for advanced game theory strategies, of which the popular ones include:.
This is a zero-sum game that involves two players call them Player A and Player B simultaneously placing a penny on the table, with the payoff depending on whether the pennies match. In a deadlock, if Player A and Player B both cooperate, they each get a payoff of 1, and if they both defect, they each get a payoff of 2.
A dominant strategy for a player is defined as one that produces the highest payoff of any available strategy, regardless of the strategies employed by the other players. A commonly cited example of deadlock is that of two nuclear powers trying to reach an agreement to eliminate their arsenals of nuclear bombs. In this case, cooperation implies adhering to the agreement, while defection means secretly reneging on the agreement and retaining the nuclear arsenal. The best outcome for either nation, unfortunately, is to renege on the agreement and retain the nuclear option while the other nation eliminates its arsenal since this will give the former a tremendous hidden advantage over the latter if war ever breaks out between the two.
The second-best option is for both to defect or not cooperate since this retains their status as nuclear powers. The most common application of the Cournot model is in describing a duopoly or two main producers in a market.
For example, assume companies A and B produce an identical product and can produce high or low quantities. If they both cooperate and agree to produce at low levels, then limited supply will translate into a high price for the product on the market and substantial profits for both companies. On the other hand, if they defect and produce at high levels, the market will be swamped and result in a low price for the product and consequently lower profits for both.
But if one cooperates i. The payoff matrix for companies A and B is shown figures represent profit in millions of dollars. In coordination, players earn higher payoffs when they select the same course of action.
As an example, consider two technology giants who are deciding between introducing a radical new technology in memory chips that could earn them hundreds of millions in profits, or a revised version of an older technology that would earn them much less.
If only one company decides to go ahead with the new technology, rate of adoption by consumers would be significantly lower, and as a result, it would earn less than if both companies decide on the same course of action. The payoff matrix is shown below figures represent profit in millions of dollars. In this case, it makes sense for both companies to work together rather than on their own. This is an extensive-form game in which two players alternately get a chance to take the larger share of a slowly increasing money stash.
The centipede game is sequential since the players make their moves one after another rather than simultaneously; each player also knows the strategies chosen by the players who played before them. The game concludes as soon as a player takes the stash, with that player getting the larger portion and the other player getting the smaller portion. But if B passes, A now gets to decide whether to take or pass, and so on.
This is not intuitively surprising given the tiny size of the initial payout in relation to the final one. This non-zero-sum game, in which both players attempt to maximize their own payout without regard to the other, was devised by economist Kaushik Basu in If both write down the same value, the airline will reimburse each of them that amount.
The process of backward induction, for example, can help explain how two companies engaged in a cutthroat competition can steadily ratchet product prices lower in a bid to gain market share , which may result in them incurring increasingly greater losses in the process. This is another form of the coordination game described earlier, but with some payoff asymmetries.
It essentially involves a couple trying to coordinate their evening out. Where should they go? The payoff matrix is shown below with the numerals in the cells representing the relative degree of enjoyment of the event for the woman and man, respectively.
For example, cell a represents the payoff in terms of enjoyment levels for the woman and man at the play she enjoys it much more than he does. Cell d is the payoff if both make it to the ball game he enjoys it more than she does. Cell c represents the dissatisfaction if both go not only to the wrong location but also to the event they enjoy least—the woman to the ball game and the man to the play.
The dictator game is closely related to the ultimatum game, in which Player A is given a set amount of money, part of which has to be given to Player B, who can accept or reject the amount given. The catch is if the second player rejects the amount offered, both A and B get nothing. The dictator and ultimatum games hold important lessons for issues such as charitable giving and philanthropy.
If both refrain from price cutting, they enjoy relative prosperity cell a , but a price war would reduce payoffs dramatically cell d. Resource constraints are primarily financial: cash and access to capital. Capability constraints are the more serious ones. And it is fostered by a combination of leadership, routines and culture. Amazon is reaping the rewards today from developing its dynamic capabilities over 2 decades. Game Theory identifies the arsenal of tools that a company can use to relax or tighten the constraints that all players in the Value Net face.
Companies ought to reimagine the players P that can be included and excluded from the game as a way of relaxing and tightening constraints. While seeking to respect the formal rules R that govern business and society, companies ought to examine the potential for changes in informal rules to increase the value they capture.
Tactics T can be used to alter the way that other players perceive the game as well as alter the range of actions they can take. And companies can expand or contract the boundaries of contests by changing their scope S. While long-range planning of the kind that was in vogue in the s and s has been cast aside, the development of a plan that is responsive to changes in economic and market conditions and that best positions the company for growth is still the norm.
The formal strategic plan rarely explicitly identify the contingencies that call for refinement or abandonment of Plan A. But CEOs and management teams are expected to have thought through the contingencies that require plans B, C and beyond. Management scholarship on the content of the and the process of developing and evaluating the strategic plan are far from monolithic. As Walter Keichel notes in his book, Lords of Strategy, many schools and sub-schools of thought on strategy have emerged over the last six decades.
Some schools emphasize the importance of ideas while some emphasize the role of people and systems. There remains the view that the strategic plan is widely misunderstood. Every sentence in this paragraph communicates information of value to company insiders, partners, investors and competitors. The 1st sentence describes the things Apple will do and not do as well as why this approach will win.
The 2nd sentence identifies new initiatives. The 3rd sentence discusses the other players in the Apple ecosystem. And the 5th sentence describes its exploratory actions. It reminds companies that they must not play any or all of the games that are given to them. And that though changing the game requires imagination, astuteness, patience and courage, the risk-reward ratio may be favorable. Game Theory teaches companies to see the forest and the trees and to be cognizant of how other players perceive the game.
It reinforces the important lesson that games of business can be Pareto improving for all. And finally, it reminds us that games of business and life are best viewed as infinite games in which victories may be ephemeral while losses can be consequential.
Despite differences in language, methodology and emphasis, Game theory and Management have the potential to be strong complementors. Published at Berkeley Haas for more than sixty years, California Management Review seeks to share knowledge that challenges convention and shows a better way of doing business.
This is because if both of them increase the prices of their products, they would earn maximum profits. However, if only one of the organization increases the prices of its products, then it would incur losses. On the other hand, in a mixed strategy, players adopt different strategies to get the possible outcome. For example, in cricket a bowler cannot throw the same type of ball every time because it makes the batsman aware about the type of ball.
In such a case, the batsman may make more runs. However, if the bowler throws the ball differently every time, then it may make the batsman puzzled about the type of ball, he would be getting the next time. Therefore, strategies adopted by the bowler and the batsman would be mixed strategies, which are shown ion Table In case, the bowler or the batsman uses a pure strategy, then any one of them may suffer a loss.
Therefore, it is preferred that bowler or batsman should adopt a mixed strategy in this case. For example, the bowler throws a spin ball and fastball with a combination and the batsman predicts the combination of the spin and fast ball.
However, it may be possible that when the bowler is throwing a combination of spin ball and fastball, the batsman may not be able to predict the right type of ball every time.
Similarly, if the bowler throws the ball with a combination of fast and spin ball respectively, and the batsman would expect either a fastball or a spin ball randomly. This shows that the outcome does not depends on the combination of fastball and spin ball, but it depends on the prediction of the batsman that he can get any type of ball from the bowler.
A dominant strategy is the one that is best for an organization player and is not influenced by the strategies of other organizations players. Let us understand the dominant strategy with the help of the example given in Table This would results as the best strategy of XYZ. When XYZ increases its prices, it would earn Rs.
Therefore, it is better for XYZ to make its price constant so that it can earn more. The dominant strategy- for XYZ is to keep the prices of its products constant. On the other hand, the dominant strategy- of ABC would also be to keep the price constant. This is because ABC would incur losses if it increases the prices of its products. While analyzing games, the player who has adopted the dominant strategy is identified and then the strategies of other players in the game are judged on the basis of the dominant strategy.
However, the existence of the dominant strategy in every game is not possible. On the other hand, a dominated strategy is the one that provides players the least payoff as compared to other strategies in a game. In the analysis of the game theory, dominated strategies are identified so that they can be eliminated from the game.
Let us understand the dominated strategy with the help of an example. Now, assume that there are only two plays left and the ball is with the offense team. In this case, the offense team would adopt two strategies; one is to run and another is to pass.
On the other hand, the defense team would have three strategies; one is to defend against running, defend against pass through line-backers and defend against pass through quarterback blitz. In Table-4, the numerical value represents the goals made by the offense team. In this case, neither offense nor defense team have a dominant strategy.
However, the defense team does have one dominated strategy that is quarterback blitz. Either in case of defending run or pass, quarterback blitz strategy would yield more goals to the offense team.
Therefore, the defense team should avoid quarterback blitz strategy. Dominated strategy helps in making the analysis of game easier by reducing the number of options. As we know, the main aim of every organization is to earn maximum profit. However, in the highly competitive market, such as oligopoly, organizations strive to reduce the risk factor.
This is done by adopting the strategy that increases the probability of minimum outcome. Such a strategy is termed as maximin strategy.
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