Strategic Behavior in
Business and Economics
UAB – Study Abroad
FALL 2010
Xavier Vilà
The Course
This course in designed as a brief introduction to individual
decision making.
Its main objective is to provide the students with Decision
Theory and Game Theory techniques that can be useful to
face and understand, using logical reasoning, strategic
situations that appear not only in business environments, but
also in everyday life.
“A theory provides a way to organize our thinking.
Theory is the science of business, not the art.”
Mike Shor
Vanderbilt University
Administrativia
• 23 regular lectures + 1 review session + 1 in-class
presentations + 1 in-class exam = 26 sessions
• Up to four Problem Sets will be distributed during the
course, collected one week later, graded, and returned back
• A Strategic Memo, that will consist of the analysis of one
real-world-case using the tools learned in class, will be
written in teams (of up to 5 members) and submitted before
December 13th. In-class presentations will take place on
December 13th. (Length: 2 pages including figures)
Administrativia
• A Final Exam consisting of questions and exercises on the
topics covered in class and in the problem sets is scheduled
for December 15th
• Your final grade will be based on the scores of the three
activities above according to the following table
Problem Sets
45%
Strategic Memo
25%
Final Exam
30%
• WEB
http://fawlty.uab.cat/Strategic
Administrativia
• Dixit.A.K and B. J. Nalebuff (2010) The Art of Strategy:
A Game Theorist's Guide to Success in Business and Life.
W.W. Norton & Company. New York
• Dixit.A.K and B. J. Nalebuff (1991) Thinking
Strategically: The Competitive Edge in Business, Politics
and Everyday Life. W.W. Norton & Company. New York
• Gibbons R. (1992) A primer in game theory. Pearson
Higher Education
• Gardner, R. (1995) Games for Business and Economics.
New York: Wiley
What are we going to do ?
The whole picture
Multipersonal
Game
Theory
Unipersonal
Decision
Theory
Collective Decision
Decision
Problem
Individual Decision
Game and
Decision Th.
Without
Risk
With
Risk
Social Choice
Theory
Decision Th.
Under Cert.
Decision Th.
Under Uncert.
Decision Problem
The problem is to make the best choice
possible, according to our interests, from a
given set of feasible alternatives
Examples
•
How many pears and how many apples to buy ?
•
What President should we have ?
•
Should Georgia be allowed to join NATO ?
•
How much to bid in an auction ?
•
What chess move ?
•
How many lotto tickets to buy ?
Individual Decision
Problem
The decision has to be made by an individual agent (a
person, a firm, a government)
Examples of Individual Decision

How many pears and how many apples to buy ?
What President should we have ?
Should Georgia be allowed to join NATO ?

How much to bid in an auction ?

What chess move ?

How many lotto tickets to buy ?
Collective Decision
Problem
The decision has to be made by a group of agents (a
group of countries, an electoral pool, a jury, etc.)
Examples of Collective
Decisions
How many pears and how many apples to buy ?
•
What President should we have ?
•
Should Georgia be allowed to join NATO ?
How much to bid in an auction ?
What chess move ?
How many lotto tickets to buy ?
Game and Decision
Theories
They study how rational agents take individual
decisions in different scenarios
Unipersonal Scenario
The final outcome of the decision depends only on the
own decision (and maybe on chances), and not on the
decisions of others
How many pears and how many apples to buy ?
How much to bid in an auction ?
What chess move ?
– How many lotto tickets to buy ?
–
Multipersonal Scenario
The final outcome of the decision depends on the own
decision, and also on the decisions of others.
Such situations are called “Games”
How many pears and how many apples to buy ?
–
How much to bid in an auction ?
–
What chess move ?
How many lotto tickets to buy ?
Decision Theory
Studies how rational agents take individual decisions
in a unipersonal scenario. The focus is on the
expected outcome.
Game Theory
Studies how rational agents take individual decisions
in a multipersonal scenario (a Game). The focus is on
the expected outcome.
Some “game” situations
Team Projects
Dating
Tennis
Poker
Traffic
Market Entry
Patent Races
OPEC-like behavior
Procurement
Corporate Takeovers
Competition
What are we actually going to do?
Model
Outcome of the model
Compare
Real World
situation
Real Outcome
Create Models as a simplification of reality !
Models
A model is a simplified (mathematical)
representation of a real situation. Models are
constructed in such a way that the analysis of
such situation becomes easier
A good model contains only those key elements
that are necessary for the analysis and is tailored
to the situation at study
Example: A Map is a simplified representation of something real (a
city), and so is a Travel Guide
Find your way
Map
Travel Guide
Know the museums
Models
Models are based on simplifying assumptions, that are
necesary to acomplish their goals
In this course ...
Rationality: Selfish players, profit maximizers, perfect calculators
Common Knowledge: I am rational, you know that I am rational, I know
that you know that I am rational, you know that I know that you know that I am rational, I
know that you know that I know that you know that I am rational, ...
Perfect Information: All relevant information is available
ATTENTION !!
There is some
MATH !!
Models
Mathematics is a convenient language to create
models. Mathematics makes it easier to explore and
unfold all the logical consequences and implications.
The Prisoners' Dilemma
After a crime has been committed, of which the
police has no clues, two suspects are arrested and
kept in solitary confinement. In order to gather
some evidence to take them to court, the police
explains the situation to the two of them in the
following terms ...
What we are going to propose to you, we will propose to the other suspect in exactly
the same terms.
We know that one of you two is guilty, but we do not have any evidence. Your
deposition might be the only evidence we can take to court.
If in your deposition you accuse the other suspect, we can use it in court as an
evidence against him, and you will be freed right away. Nevertheless, if in his
deposition the other suspect accuses you, then the judge will find the evidence
inconclusive and both of you will be condemned to 1 year each.
If you do not agree to collaborate with us and refuse to make a deposition, then the
other suspect might do and hence all the evidence will point towards you. In such
case the judge will condemn you to 5 years.
If both of you refuse to make a deposition, then there is no way we can take you to
court without any evidence. Nevertheless, just because you did not agree to
collaborate with us, we will keep you two in jail 2 weeks.
Key information:
The “rules of the game” are clear: What the police just said
The “players” are the other suspect and myself.
My “choices” are clear: To accuse or To remain silent
Depending on my decision, and on the decision of the other
suspect, I may end up free or spend 2 weeks, or 1 year, or 5 years
in jail.
Key Information:
Payoff to
Player 1
Prisoner 2
Accuse
Payoff to
Player 2
Silent
Accuse
1,1
0,5
Silent
5,0
2 w. , 2 w.
Prisoner 1
Brief Game Theory Timeline
Late XIXth century: Mathematicians became interested in Economics
1928-1944 John Von Neumann, Oskar Morgenstern
1950-1955 John Nash
1955-1960 Links Games-Economics are stablished
1960- ....
Developement ....
1994 Nobel prize: Nash-Selten-Harsanyi
2000 First World Congress of Game Theory
2005 Nobel Prize: Robert Aumann (et al.)
2007 Nobel Prize: Roger Myerson (et al.)
Lessons and Disclaimers
Game theory does not teach you “how to win”
Framework for thinking strategically in a logical, systematic way
Helps to predict the logical outcome of a “game situation”
Helps to understand and use the “rules of the game”
Helps to organize your thinking
The course is an introduction to the field