(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 514
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CHAPTER 13 • Game Theory and Competitive Strategy 489
setting their prices. Each firm knows that by undercutting its competitor, it can
capture more market share. But it also knows that in doing so, it risks setting
off a price war. Another noncooperative game is the auction mentioned above:
Each bidder must take the likely behavior of the other bidders into account
when determining an optimal bidding strategy.
Note that the fundamental difference between cooperative and noncooperative games lies in the contracting possibilities. In cooperative games, binding
contracts are possible; in noncooperative games, they are not.
We will be concerned mostly with noncooperative games. Whatever the
game, however, keep in mind the following key point about strategic decision
making:
It is essential to understand your opponent’s point of view and to deduce his or her
likely responses to your actions.
This point may seem obvious—of course, one must understand an opponent’s
point of view. Yet even in simple gaming situations, people often ignore or
misjudge opponents’ positions and the rational responses that those positions
imply.
HOW TO BUY A DOLLAR BILL Consider the following game devised by
Martin Shubik.3 A dollar bill is auctioned, but in an unusual way. The highest
bidder receives the dollar in return for the amount bid. However, the secondhighest bidder must also hand over the amount that he or she bid—and get
nothing in return. If you were playing this game, how much would you bid for the
dollar bill?
Classroom experience shows that students often end up bidding more than a
dollar for the dollar. In a typical scenario, one player bids 20 cents and another
30 cents. The lower bidder now stands to lose 20 cents but figures he can earn a
dollar by raising his bid, and so bids 40 cents. The escalation continues until two
players carry the bidding to a dollar against 90 cents. Now the 90-cent bidder has
to choose between bidding $1.10 for the dollar or paying 90 cents to get nothing.
Most often, he raises his bid, and the bidding escalates further. In some experiments, the “winning” bidder has ended up paying more than $3 for the dollar!
How could intelligent students put themselves in this position? By failing
to think through the likely response of the other players and the sequence of
events it implies.
In the rest of this chapter, we will examine simple games that involve
pricing, advertising, and investment decisions. The games are simple in
that, given some behavioral assumptions, we can determine the best strategy
for each firm. But even for these simple games, we will find that the correct behavioral assumptions are not always easy to make. Often they will
depend on how the game is played (e.g., how long the firms stay in business,
their reputations, etc.). Therefore, when reading this chapter, you should
try to understand the basic issues involved in making strategic decisions.
You should also keep in mind the importance of carefully assessing your
opponent’s position and rational response to your actions, as Example 13.1
illustrates.
3
Martin Shubik, Game Theory in the Social Sciences (Cambridge, MA: MIT Press, 1982).
