Econ 202 - Module 12

Four steps in making good strategic decisions

-consider all possible outcomes -play your best response -put yourself in other people's shoes -consider all possible what ifs independent from each other

second-mover advantage

The strategic advantage that can follow from taking an action that adapts to your rival's choice

Prisoner's Dilemma

a game in which pursuing dominant strategies results in noncooperation that leaves everyone worse off -yields a failure to cooperate -the temptation to take advantage undermines cooperation -the best outcome would be to cooperate, but this is not the equilibrium outcome in the dilemma, firms could do better if they both did exactly the opposite of what they ultimately choose to do

game tree

an extensive-form representation of a game shows how all possible outcomes can play out over time

an interaction between two or more persons is considered a strategic interaction when

an individual's best choice may depend on what the others choose, and the others' best choices may depend on what the individual chooses

focusing illusion

assessing payoffs a cognitive bias that occurs when people place too much importance on one aspect of an event, causing an error in accurately predicting the utility of a future outcome think about what you're not thinking about

loss aversion

assessing payoffs the tendency to care more about avoiding losses than about achieving equal-size gains don't be more sensitive to payoffs appearing as losses evaluating your payoffs as gains for losses relative to an arbitrary baseline distorts your decisions

availability bias

assessing probabilities don't be swayed by easily recalled events

anchoring bias

assessing probabilities don't get hung up on an initial estimate or starting point begin with an anchor, or starting point and insufficiently adjust from there "first impressions matter"

representativeness bias

assessing probabilities look beyond how similar things are

overconfidence

assessing probabilities your forecasts are less accurate than you think tendency to overrate the accuracy of your forecasts

in an oligopoly firms can increase their market power by

colluding to set prices

in a simultaneous move game...

each player has to make his choice without knowing their rival's choice

coordination games

everybody benefits if the problem is solved, so the trick is to get everyone common knowledge about the situation and its solution. -typically you want to make the choice that complements the choice of the other players -coordination is difficult because there's more than one equilibrium -communication, focal points, culture and norms, and laws and regulations can help solve the coordination problem

when looking at a payoff table, what does it mean to "put yourself in someone else's shoes?"

figure out what decision the other party is likely to make, given the other party's incentives

finitely repeated games

games that play out over time your what if thinking should look forward and reason backward

the difference between an extensive-form game and a simultaneous-move game is that

in extensive-form games the player can observe the other player's action before deciding, but in simultaneous-move games they can't

game theory is useful in the study of strategic interactions as many businesses' decisions are characterized by

interdependence

what problem arises in coordination games with multiple equilibria

it is difficult to achieve the commonly desired outcome

which is true of a payoff matrix?

it takes into account all relevant costs and benefits associated with each action of the players

what advantage does a game tree have over a payoff table in presenting data for players in a game that plays out over time?

the game tree allows a player to look forward and reason backward

first-mover advantage

the strategic gain from an anticipatory action that can force a rival to respond less aggressively

behavioral economics

the study of situations in which people make choices that do not appear to be economically rational explores economic decision making using findings from experimental psychology

look forward and reason backward

to anticipate the likely consequences of your choices start by analyzing the last period of the game. use this to figure out what will happen in the second-to-last period, and keep reasoning backward until you can see all the consequences that follow from today's decision

indefinitely repeated games

when you face the same strategic interaction an unknown number of times the grim trigger strategy punishes your rivals for not cooperating punishment drives cooperation. indefinitely repeated play helps solve the prisoner's dilemma

four steps for making strategic decisions

1. consider all possible outcomes 2. think about the what ifs separately 3. evaluate your best response 4. put yourself in someone else's shoes

ultimatum game

A game in which a proposer is given a sum of money and makes an offer to a responder as to how this money should be split between them. The responder must choose to accept the offer or reject it. This game has been used to study people's decision-making strategies.

when players in a game collude they

make agreements not to compete with each other and, typically, to charge high prices.

a nash equilibrium occurs when

no player has an incentive to unilaterally change strategies. no player can improve their payoff by changing their strategy once in nash equilibrium

a payoff table lists all possible _____, with a row for each _____ and a column for _____

outcomes; of one player's possible outcomes; each of the other player's possible outcomes

a first-mover advantage occurs when a player

preemptively commits to an aggressive position, and the other player's best response will be less aggressive

a dominant strategy _____

results in a higher payoff irrespective of the strategy chosen by the other player

five strategies to reduce risk

risk spreading (break up big risks into smaller-stakes risks) diversification (instead of one big risk, take many unrelated risks) insurance (buy compensation if something bad happens) hedging (find a risk to offset an existing risk) gathering info (will reduce uncertainty)

in game theory, a dominant strategy is

the best strategy to pick no matter which moves are chosen by the other player