Game Theory Business Strategy by myf17521


									Owen Graduate School of Management
Vanderbilt University
Spring 2003, Module III

                    Game Theory & Business Strategy
                                        MGT 425

      Professor:    Mike Shor
      Office:       Management Hall 352
      Phone:        343-4334
      Office Hours: by appointment


People rarely make decisions in a vacuum. The choices we make affect the profitability
and happiness of others, and their choices impact us. Game Theory offers a systematic
way of analyzing strategic decision-making in interactive situations. This course develops
a conceptual framework that can be applied to understanding business strategy. Some
tools we will use include

   •   decision tree analysis
   •   looking forward and reasoning back
   •   anticipating rivals' moves
   •   equilibrium analysis

These will then be applied to some general topics

   •   inducing cooperation
   •   the use of credible threats and promises
   •   deterrence and preemption
   •   the role of reputation

Lastly, we will analyze some particular types of games, including negotiation games and
auctions. The ultimate goal of this course is to enhance the student's ability to think
strategically in complex, interactive situations.

This course is designed to provide you with a framework for thinking about interactive
strategic settings.

Game theory presents general principles of strategic interaction. In order to gain a
broader understanding, it is necessary to realize the similarities between many strategic
settings, both in business as well as in life. The examples presented in class are intended
to isolate and illuminate (in the simplest framework possible) particular aspects that do
arise in real situations.

For example, students will participate in games online, prior to each lecture. For some
games, you will be randomly matched against a classmate to determine your payoffs, or
profits, from the game. Both fun and simple, the games illustrate general principles of

Often, course readings will demonstrate the application of principles to sports, movies,
popular culture, nature, etc. While perhaps serving as a nice break from the theory, these
applications have a broader goal: many game theoretic concepts appear counterintuitive
at first. Having a toolbox of simple analogies and explanations will empower you to
convince others of your decisions. After all, you never truly understand the material until
you are able to communicate it to others.

The text for this course is

    Games of Strategy. Avinash Dixit and Susan Skeath. New York: WW Norton, 1998.

Additional readings are available online on the course web site. All readings are required.
These additional readings range from the whimsical to the serious. Occasionally, the
additional readings will allow you to look deeper at the material, or will present concepts
that will not be covered in class directly.

Read the assigned chapter(s) in the text prior to each lecture.
Do not worry if you do not understand the technical or graphical analysis on the first try.
The lectures will help you master these concepts. However, it is important to grasp the
intuition behind the principles suggested. You are also required to read any
supplementary handouts distributed in class or available on the course web site. At least
one final exam question will be based on these readings.

You will also be required to participate in an experimental game prior to most lectures in
some classes. These are not graded, but participation is mandatory.

Your grade will depend on three group deliverables, three individual assignments, class
participation, participation in experimental games, and a final exam.

      •    Group Memo #1                              10%
      •    Group Memos #2,3                           15% each
      •    Individual Assignments                     25% total
      •    Class Participation                        10%
           Occasionally, a student may be swamped with work and unprepared for a class
           meeting. This is understandable. If you do not wish to be called on, simply do not
           use your name tent. Otherwise, name tents should be brought to every class.

      •    Final Exam                                 25%
           The final exam will serve two purposes. Most of the exam will be a
           straightforward review of the material and analytical technique, closely
           paralleling the sample problems provided on the web site. A part of the exam,
           however, will test your critical understanding of the material - questions unlike
           those you have seen previously in the examples and exercises.

      •    Participation in Experimental Games        0 to —10%
           The games are not graded, but participation is required, and failure to participate
           reduces the total grade.

  •       EXPERIMENTAL GAMES: The value of the experimental games is diminished with
          prior knowledge of the game. Therefore, it is a breach of the honor code to discuss
          the content of an experimental game with another student in the course who has not
          yet participated, or to gain information about an experimental game in which one
          has not yet participated. Further, as some of these games will be used in future
          mods, one may not discuss the content of the experimental games or their reward
          structure with other students who may take this course in the future.
  •       INDIVIDUAL ASSIGNMENTS are not a group effort. Work turned in must be entirely
          yours. Any discussion of approach, technique, or conclusions is a violation of the
          honor code.
  •       GROUP ASSIGNMENTS must consist of the work of the group, the whole group, and
          nothing but the group.
  •       Further, the standard caution about properly attributing cited or paraphrased
          material and not giving or receiving assistance on the final exam apply.

                                 GROUP DELIVERABLES

Groups must consist of between four and five students. Groups are self-selected.
However, students are strongly cautioned to form groups carefully, ensuring that the
members complement each other in analytical, writing, and mathematical skills. Note
below that the grading policy places heavy emphasis on good writing, originality, and
strong analysis.
        You must notify me of your group members by email by Tuesday, January 14th.

These deliverables are designed to give you a chance to apply the concepts developed in
class to help formulate business strategy. Each deliverable is of the same form:
       Apply the ideas from Chapter X to a real world example. The example can be
       taken from your own experience in business or from the popular press.
Be sure to define the strategic setting. Be precise, and use diagrams where appropriate.
Use the tools developed in class to predict the logical outcome of the game. From this
analysis, develop strategy advice for one of the participants in the game or for a party
interested in the outcome, such as an investor trying to predict how the situation will
unfold. The assignment must be in the form of a memo to a player or an interested party.

You should turn in a memo of under 750 words and an executive summary no longer than
100 words. Charts, tables, or figures do not count into these limits. You must also include
three to four PowerPoint slides containing both exhibits and relevant introductory &
concluding remarks suitable for a brief presentation. I may call on groups to discuss their
memos (with prior warning).

Four category grades each account for 25% of the memo's grade:
   •   Novelty & Relevance
       (relevance of the topic, difficulty of the undertaking)
   •   Sophistication of analysis
       (Comprehensiveness of the analysis)
   •   Intuition
       (how valuable and applicable is this memo to the recipient?)
   •   Professionalism
       (grammar & diction, clarity & organization)
Each of these categories is described in detail below. Note that high grades are rare and
reserved for superior, well-supported, concise memos with thoughtful argument, perfect
diction, and depth of analysis.
Assignments must be submitted at the beginning of the class in which they are due. Late
assignments will not be accepted.

                               INDIVIDUAL DELIVERABLES

   You have been promoted to chief strategist of your division. Thus, the corporate
   strategy office relies on you for fast, comprehensive analysis. The individual
   assignments will ask you to analyze a specific situation within a corporation and
   provide advice.

These memos will require analysis of data and modeling decisions about the approach
you wish to take. Write a short, concise memo. The memos must fit on a single page
(approximately 500 words), not including exhibits. You should briefly describe your
methodology, any assumptions that you have made, and specifically address the
questions asked. Supporting tables and figures should be enclosed, but the “upshot”
should be in the body of the memo.

No drafts of these individual assignments will be accepted.


Individual assignments are graded on a “check,” “check-plus,” “check-minus” system. A
correct, well-written, well-justified analysis receives a check-plus. Substantial substantive
errors (though nevertheless obvious effort) receive a check minus.

                                 EXPERIMENTAL GAMES

Prior to most lectures, students will find a link to an online game from the course web
site. Participation in these games is mandatory, though performance in the games does
not impact the grade. Games will become available by 5:00 PM the day of the lecture
(Tuesday or Thursday) and must be played by midnight the day prior to the next lecture
(Monday or Wednesday). No studying or preparation is required, and most games will
not require more than ten or fifteen minutes to complete.

                                  GROUP DELIVERABLES
                                  GRADING CATEGORIES

        Novelty & Relevance
First and foremost, the memo must be relevant to the course material and must analyze
the type of game called for in the assignment. Further, the memo topic must be rich
enough to allow you to demonstrate your analytical ability.

Most topics require careful consideration of subtleties. Careful consideration of payoffs,
examination of non-obvious strategies, analysis of multiple equilibria, and consideration
of risk and uncertainty are examples of factors which can make for sophisticated analysis.

The analysis should be purposeful. No amount of analytical heavy-lifting can replace
clear recommendations that can be implemented by the reader. Your careful analysis
must clearly motivate and convey your recommendation.

As professionals, you are all aware of the importance of strong writing skills. Letters,
reports, and even short e-mail notes all indicate to others our ability to communicate.
People develop opinions about our ability and work ethic based upon our written
correspondence. Typographical errors, grammatical errors, misspelled words, or poor
diction and writing style dramatically reduce the impact of our work no matter how
excellent the content. Thus your ability as a writer, as well as the content of your papers,
plays a significant role in the grading process.
An “A” in professionalism implies a memo with impeccable grammar and spelling. The
argument proceeds in a clear manner, is free of jargon, and is accompanied by a clear and
clean physical layout and ease of reading. Write in fully formed sentences and carefully
proof read the document to ensure proper grammar and diction. There is absolutely no
excuse for grammar, spelling, or diction errors.
Regarding style, write simply, formally and clearly. Do not use jargon! Write the memo
in plain English, and consider that it may be read both by people unfamiliar with game
theory and by game-theorists unfamiliar with your industry. Define all technical terms
and acronyms. When using diagrams to aid communication, make sure that their
meanings are clear, and do not simply rely on game-theoretic conventions.

                           GROUP DELIVERABLES (CONTINUED)

Simultaneous Move Games
Apply one of the games of Chapter 4 to a real-world example.
Give an example of a simultaneous game-like situation in a business setting. Be sure to
identify the players, the nature of the interaction, the strategies available, and the payoffs
to each player. Explain why this situation classifies as a game. Use the tools developed in
class to predict the logical outcome of the game. From this analysis, develop strategy
advice for one of the players in the game or for a party interested in the outcome.
Mixed Strategies
Apply one of the games of Chapter 5 to a real-world example.
Choose a game without an equilibrium in pure strategies and derive the mixed strategy
equilibrium. From this analysis, develop strategy advice for one of the players in the
game or for a party interested in the outcome.
Sequential / Repeated Games
Apply one of the games of Chapter 3 or Chapter 8 to a real-world example.
The game should have a temporal element. That is, it should either be a sequential game
or a repeated game. Make sure to identify the length of the game as well as the players,
strategies, and payoffs. From this analysis, develop strategy advice for one of the players
in the game or for a party interested in the outcome.
Commitment & Threats
Apply one of the games in Chapter 9 to a real-world example.
Discuss how the parties might benefit from commitment, the role of credibility, and how
commitment may be achieved.
Describe an asymmetric information problem facing your company.
Identify the source of the asymmetry and the information possessed by each party. How
could signaling or screening help resolve this uncertainty? Is this a profitable strategy?
Why or why not?
Bargaining, Auctions, or Strategic Voting. Your memo may be written to any player in
the game. For example, if writing on auctions, you may recommend a bidding strategy or
an auction design.

                                  COURSE CALENDAR

Class     Date                       Topic                       Text       Deliverables
        Tue., Jan.
 1                          What is Game Theory?               Chapter 1

        Thu., Jan.
 2                          Understanding the rules            Chapter 2

        Tue., Jan.     Being dominant / Being dominated                       Groups
 3                                                             Chapter 4
           14          Anticipating your rival's responses                    Formed

        Thu., Jan.     Looking forward - Reasoning back                     Individual
 4                                                             Chapter 3
           16         Putting yourself in your rival's shoes                Assign. #1

        Tue., Jan.   The Sensibility of being unpredictable
 5                                                             Chapter 5
           21          Understanding mixed strategies

        Thu., Jan.             Agreeing to agree                            Group Memo
 6                                                             Chapter 8
           23                Inducing cooperation                               #1

        Tue., Jan.
                       Commitment and strategic moves
                                                               Chapter 9
                       Credibility, threats, and promises
        Thu., Jan.                                                           Individual
           30                                                                Assign. #2

         Feb. 4
                           Knowing what you know
                                                               Chapter 12
                          Strategic use of information
         Thu.,                                                              Group Memo
         Feb. 6                                                                 #2

         Feb. 11
                            Buying, selling, bidding
                                                               Chapter 15
                     Designing and participating in auctions
          Thu.,                                                              Individual
         Feb. 13                                                             Assign. #3

          Tue.,          Getting what the other guy has
 13                                                            Chapter 16
         Feb. 18          Bargaining and Negotiation

          Thu.,       What good is all this stuff anyway?                   Group Memo
         Feb. 20           Is game theory useful?                               #3


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