Good afternoon. Today, as I promised,
we're going to talk about game theory.
This is going to be one of the most interesting lectures.
You're going to learn about game theory,
how firms play their games and we're going to explore
all the foundations that are necessary for you to
understand interaction between firms and negotiations.
So let's talk about games.
Game is any situation in which the participants make a decisions which affect two things.
First, their own outcome,
how they will do in this game,
and also the outcome of the other players,
their rivals, the opponents.
Such decisions are often referred to as strategic decisions.
And we will talk about the essence of strategic decisions in a little bit.
Each participants of the game,
a player as we call them,
has well defined objectives.
So, when they play the game they know what they want to do.
So in this game of chess for example,
I want to get the other person's king.
If I play a game of poker,
I want to get the bulk of your money. All right.
So, you should have a game in which everyone has an objective.
If you do not have an objective,
then this game is not well-defined in game theory.
This is something like the games that they play with my dog that at
one moment she wants to get the ball and at the other moment he's like,
oh, I need something to eat.
So these objectives that are clear in games,
they drive the players decisions.
For example, firms competing with each other by setting prices.
So supermarkets have advertisements and they say,
come to us to shop because we have better prices. So this is a game.
This is a game that firms are setting
prices in such a way so they will attract more customers,
but also they are not going to drop the prices too much because they will lose profits.
So they have a well defined objective.
Individuals bidding against each other in an auction is another example.
Like, for example, you want to get an expensive painting,
and you bid against each other, you're like okay,
a million or a million and a half,
and in this case the person who will offer the more will end up winning the auction,
which is actually game.
Let's now talk about strategic decisions.
First of all, strategy is a word that as every word, comes from Greek.
It has to do with military.
In Greek, the word military is stratos because we
made these first decisions based on military action.
So this took the name strategy.
So strategic decisions, result in payoffs to
the players which payoffs are outcomes that they generate either rewards or penalties.
It's what you have to get from the game.
If you do some actions you may win,
if you make some other actions you may lose.
Some other actions may, you win big,
some other actions maybe you win less,
some other actions you will make you lose bad time or lose less.
So you have several outcomes which we call payoffs.
Some of them can be positive,
some of them can be negative. It doesn't matter.
In strategic interaction,
a player's payoff what you get from the game depends on two things.
First of all, your actions,
and secondly, the opponent's actions.
So you are not acting by yourself.
And this is exactly where the essence of strategy is.
For example, when you play football,
I mean the European football,
the real one, you have strategy.
It's a strategic game because,
if the other team is playing defensively,
it will be better for you to start attacking.
So what you do depends on the strategy of the other team.
If the other team is attacking and then you want to keep the score for example,
you want to keep defending because this probably will help you.
There are other games that they're not strategic.
Like for example the 100 meter race.
In the Olympic games,
when you cover the 100 meter games,
the runners very rarely care what other runners are doing.
So the other day I was watching the Olympic games,
and after the 100 meter race finished,
there was the usual winner and,
a journalist went to him and he asked him,
so great race, what was your strategy?
And the runner looked at him,
he was like, my strategy?
I was just trying to run as fast as I can.
Okay. There's no strategy there.
You just tried to do your best no matter what anyone else is doing. All right.
So this is a very important thing for you to keep in mind,
that strategic decisions require interaction, meaningful interaction.
So if you want to maximize your payoff in every game,
which should be your objective,
each player must take their opponents actions
into account when they make their own decisions.
How do you take your opponent's actions if you don't know them yet?
You have expectations, and this is very important.
Therefore, it would be very useful for the players to
understand what is the optimal response of their opponents.
This means that when you play a game and you have different strategies,
different set of actions that you can go with,
what you have to do is for each of your action,
to understand what is the best way for your opponents to react.
This would be extremely important because if you know what is
the best way for your opponents to react in each of your actions,
they will help you very much to understand what the correct action is for you.
So, I told you last time and I
hope that you actually understood that very well because it's extremely important,
that information is the single most important thing in business.
If you have the right information,
the right moment we said,
you are going to be the winner. No matter what.
So information structure of games plays a crucial role.
You have games of complete information,
and you have another category of games which we'll
call them the games of perfect information.
In games of complete information, everybody knows,
who are the opponents,
what are the rules of the game and what are the possible payoffs.
All these information is available if the game is a game of complete information.
You may ignore some past actions or the full history of actions of your opponents.
That's okay. Still game of complete information.
Now for games of perfect information,
everybody knows the full history of actions.
Everybody knows what others and themselves have done in the past but,
they may ignore the rules or who are the other players,
or what are the possible payoffs.
And you may ask me,
how can you play a game that you do not know the rules?
Let's come up with two examples to explain these with simple words.
Consider poker. When you play poker,
you sit on the table, and first of all you see around you your opponent,
you see who are the opponents are.
Secondly, you know the rules.
At least I hope you know the rules if you sit in this table because you're
going to lose a lot of money if you don't know the rules when you play poker.
And also, you know the payoffs because you see the money on
the table and you know how much each of the person has.
So you know all the possible payoffs.
So this is a game of complete information.
Now, when you are in business,
very rarely you have the luxury of knowing everything.
First of all, let's assume that you are running
one firm and you compete with other firms and what you want,
you should know what you want,
is let's say to maximize your profit,
to have as much money to make as much money as you can from this business.
How do you know what other people are trying to do?
How do you know what other firms are trying to do?
Maybe one other firm they don't look to maximize profit.
They look to maximize the market share.
Maybe another firm looks to maximize sales.
Maybe another firm, they don't care about the profits in this particular business,
they care about the profits in another adjunct business.
Like, for example, I want to sell as much merchandise as
possible so I will keep selling services on these merchandise later.
So in some cases you may not know
the rules exactly and this is a game of perfect information.
Let's stop this segment here.
We're going to talk about static and dynamic games in a little bit.
And we're going to talk about complete information. Stay with us.
