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APPLIED GAMETHEORY ANDSTRATEGICBEHAVIORILHAN KUBILAY GECKILPATRICK L ANDERSONCRC PressTaylor & Francis GroupBoca Raton London New YorkCRC Press is an imprint of theTaylor & Francis Group an Informa businessA CHAPMAN & HALL BOOK

Figure ListTable ListPrefacePurpose of this BookOur ApproachOrganization of BookOur AppreciationChapter 1 A Brief History of Game TheoryWhy Study Games?Rapid Discoveries in the Twentieth CenturyKey Conceptual Developments in Early YearsPioneers of Game Theory and Advancement of the FieldGame Theory's Evolution during the Last Three DecadesRecognition122367Chapter 2 Strategy and Game Theory ConceptsGame Theory, Strategy, and Strategic BehaviorMore on Strategic Behavior and StrategyGame Theory and Strategic Behavior in BusinessConsumer Behavior, Utility Theory, and Game TheoryCardinal UtilityChoice Behavior and Game TheoryUtility Functions and Game-Theoretic ModelsUtility Theory and PayoffsGame-Theoretic Models and IllustrationThe Payoff Matrix and Tree DiagramStrategic Thinking and Simultaneous- andSequential-Move GamesRules of the GamePlayersInformationPerfect vs. Imperfect InformationComplete vs. Incomplete InformationSymmetric vs. Asymmetric InformationSet of Actions and StrategiesPayoffs'.Strategy and EquilibriumDominant and Dominated StrategiesDominated StrategiesEquilibriumNash EquilibriumNote on Dominant Strategy Equilibrium andNash 191920202223

Subgame Perfect Nash EquilibriumMixed Strategies; Repeated GamesMaximin StrategySequential Games and Problem SolvingComplex Games and Games by Categoriesn-Person GamesDifferent Categories of GamesZero-Sum Games vs. Non-Zero-Sum GamesStatic vs. Dynamic Games; Repeated GamesCooperative vs. Non-Cooperative GamesOther Key Game Theory ConceptsThreats and Rewards (Promises)CredibilitySample Game with ThreatsThe Threat as a StrategyGames of Chance: Uncertainty and Risk2323.2425272729293030313131313232Chapter 3 Modeling Games with Computer Software andExperimenting GamesPrisoner's DilemmaAnalysisNotesModeling the Game with MATLABTit for Tat and the Repeated GameFamous ExperimentAnother Prisoner's Dilemma ExperimentEven More ExperimentsBattle of the Sexes-.AnalysisMixed StrategyModeling the Original Battle of the Sexes Game with MATLABA Battle of the Sexes ExperimentAssumptions of the ResearchersAdditional ExperimentsA Sample Game of Dominated Strategies with MATLAB36363738404041424343444547485050Chapter 4 A Theory of Strategic ValueIntroduction: The Game of BusinessStrategic Value for a BusinessImportant Concepts:Advanced TopicsStrategy and ValueAccounting Net WorthCurrent Income57585859606060

Portfolio Investment61Real Options61States of Nature and Strategy61The State of Nature62A Short Revolutionary Example62A Revolutionary Game: The State of Affairs in 177563State Variables in 1775 Colonial America63State Variables for Business; Control Variables65How Many Ships in Your Navy?65The Event Tree and Dynamic Payoffs67The Event Tree67The Extensive Form and the Event Tree68State and Control Variables in the Event Tree68Encoding History in the State68Additional Examples69Payoffs and Business Value69Static "Payoffs" vs. Strategic Value69Value Changes69Dynamic Payoffs:70The Firm70Equity in a Firm71Note on Limited-Liability Companies72Markets72Real Options and Management Flexibility72The Ubiquity of Uncertainty72The Inherent Value of Management Flexibility73The Investment Decision74What is "Value" for a Firm?75Earnings and Capital Gains75Strategy and the Pursuit of "Total Return"75Available Principles of Valuation76Practical Models78Example: Strategic Valuation for the Damaged Business80Appendix 4.A Stochastic Processes, Diffusions, and Expectations.82A. Introduction82Use of Stochastic Processes in Study of Strategic Behavior82B. Brownian Motion and Random Events82The Markov Property83C. Geometric Brownian Motion and Stock Prices83D. Expected Value84Expected Value of a Strategy84Appendix 4.B Dynamic Programming85A. Optimization over Time85B. A Prototype "Bellman Equation" for a Private Firm85C. Recursive Decisions85D. Existence Theory86

Chapter 5 A Dynamic Game of Asymmetric Information in theBeer IndustryA Game between a Global Brewer and a National ImporterBackgroundMotivation and Incentives of Companies: Maximizing BusinessValueExamplesBusiness Value Depends on a Strategic Course of ActionImplications of Value, Risk, and Strategic Decisionsto the GameRegulated Alcoholic Beverages Industry and Three-TierSystem in the U.SSales Performance of Gambrinus; General Import MarketIncentives at the Time of the 1996 DecisionIncentives for Grupo ModeloObjectives of GambrinusMatching and Conflicting Objectives'Matching ObjectivesConflicting ObjectivesConcluding Remarks on IncentivesStrategic Options Available in 1996 and the GameIntroduction of Strategic OptionsStrategic Options at Two Stages'.Potential OutcomesGame-Theoretic ModelDescriptionInformationAnalysis of the Game./.Stage I (1996)Stage I (1996-2001)Stage II;Outcomes of the Game and ConclusionAppendix 9101102103104Chapter 6 Consolidation in the Wine and Spirits IndustryIntroductionEconomic Structure of the IndustryDistribution Arrangements in the IndustryThe Wine and Spirits Industry and ConsolidationConsolidation at Wholesaler LevelRecent M&As and Business Ventures in Major Marketsat Wholesaler LevelA Hypothetical Consolidation109110110Ill112113114

Description of the Consolidation GameMarket Share and PowerThe New Market and Strategic IssuesPlayers' Strategies and InformationAnalysis of the GameSimultaneous-Move Game between Wholesalers iii and ivSequential Move Game between Supplier III andWholesalers iii and ivConclusionAppendix 6.A116116117119120122122124125Chapter 7 A Regulatory Game: CAFE Standards and CompetingAutomakersIntroductionLobbying and Game TheoryLobbying as Part of the GameHistory of Corporate Average Fuel Economy (CAFE)Future Standards: Energy Independence and Security Act of2007,2011-2015 TargetsCurrent DebatesStrategic and Game Theoretical Motivation behind CAFEBuilding the Game and Players, Strategies, Payoffs,and SolutionGame Stage 1Game Stage 2Outcomes of GameStages 1 and 2Game Stage 3Solving the Problem and Nash EquilibriumConclusionAppendix apter 8 Business Strategy and Crisis: The U.S. Auto IndustryIntroduction and Cause of the 2008 Auto Industry CrisisLikely Scenarios for the Automotive IndustryEconomic and Industry ConditionsSales Trends by AutomakerCar SalesTruck SalesLong-Term Sales TrendsInvestor Confidence in Domestic Automakers and SuppliersKey Events to Date (December 2, 2008)Discussion of Potential Scenarios149150152153153154154155155158

The Most-Likely Scenario159Scenario 1: A GM-Chrysler Merger with Federal Financial Aid .159Other Likely Scenarios160Scenario 2: Federal Financial Aid and Radical Restructuringoutside of Bankruptcy160Scenario 3: Federal Financial Aid and Radical Restructuringoutside of Bankruptcy; Chrysler Assets Purchased byCompetitors160Scenario 4: Chrysler Files for Chapter 11 Bankruptcy;GM and Ford Restructure outside Bankruptcy160Scenario 5: Both GM and Chrysler File for Chapter 11Bankruptcy161Strategic Approach to a Potential Merger: Strategiesof Key Players161Players and Incentives162Incentives of the Players162Strategies163Sample Tree Diagrams Illustrating Players' Movesand Their Strategies164Strategic Analysis and Conclusion167Chapter 9 Game Theory and the LawIntroductionClassic Game Theory Applications in LitigationIncentives to SettleExample: Litigation or Settlement in a CommercialDamages Case" Optimal SanctionsExample: "Punitive" DamagesProperly Constructing the Payoff MatrixExamples: The Actual Payoff ElementsCommercial Damages:Overview of Commercial DamagesEvents in a Typical Commercial Damages Case .:Evaluating Commercial Damages Using Game TheoryThe Value of Investments under UncertaintyvGame Theory and Real 77

Extensive Form Modeling of an Investment OutcomeA Simulation Model for Real Options and Game TheoryValuationResults of Experiment Using Simulation ModelGame Theory and Antitrust LawMarket Entry and CollusionExampleAntitrust Case Study: United States of America,et al., v. Microsoft CorporationHistory of Investigations Leading up to the Antitrust SuitMarket Power: Windows and Internet ExplorerMajor CompetitorsA Game-Theoretic Model of the Microsoft Antitrust CaseKey IncentivesAnalysis of Microsoft's Decision TreeThe Trial and Conclusions of LawThe AppealThe Settlement,Appendix 185186186187188188190.193199

Zero-Sum Games vs. Non-Zero-Sum Games 29 Static vs. Dynamic Games; Repeated Games 30 Cooperative vs. Non-Cooperative Games 30 Other Key Game Theory Concepts 31 Threats and Rewards (Promises) 31 Credibility 31 Sample Game with Threats 31 The Threat as a Strategy 32 Games of Chance: Uncertainty and Risk 32 Chapter 3 Modeling Games with Computer .