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  1. 1. Extensive form games <ul><li>This lecture provides a general introduction to the course, explains the extensive form representation of games and introduces you to Comlabgames , software for designing, playing and analyzing experimental games. </li></ul>
  2. 2. Preamble <ul><li>Being “ strategic ” means intelligently seeking your own goals in situations that involve other parties who do not share your goals. </li></ul><ul><li>In this school “ corporate ” typically refers to a business entity, for example a corporation owned by shareholders whose interests in the firm are exclusively financial. </li></ul><ul><li>And “ management ” refers to the kind of job you will enter upon graduating from here. </li></ul>
  3. 3. Course objectives <ul><li>Recognize strategic situations and opportunities. </li></ul><ul><li>Summarize the essential elements in order to undertake an analysis. </li></ul><ul><li>Predict the outcomes from strategic play </li></ul><ul><li>Conduct experiments, that is “human simulations”, to verify and revise your predictions. </li></ul><ul><li>Analyze the experimental data to increase your knowledge and familiarity using simple statistics </li></ul><ul><li>Exploit such situations for your own benefit. </li></ul>
  4. 4. Methodology and tools <ul><ul><li>We will draw upon </li></ul></ul><ul><ul><ul><ul><ul><li>Cases </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Game theory </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Experimental methods </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Statistics </li></ul></ul></ul></ul></ul><ul><ul><li>The main tool we use is Comlabgames, free software you can download from: </li></ul></ul><ul><ul><ul><li>www.comlabgames.com </li></ul></ul></ul>
  5. 5. Cases <ul><li>Using a case to describe a business situation is a starting point for many of the concepts we discuss. </li></ul><ul><li>In distilling the essential features of a case our goal will be to answer four critical questions: </li></ul><ul><ul><ul><li>Who are the main players or entities? </li></ul></ul></ul><ul><ul><ul><li>What moves by the players and chance events determine the possible outcomes? </li></ul></ul></ul><ul><ul><ul><li>How well informed are the players when making their respective decisions? </li></ul></ul></ul><ul><ul><ul><li>How does each player value the consequences of any given outcome? </li></ul></ul></ul>
  6. 6. Game theory <ul><li>A strategic situation exists when the actions of one person directly affects the payoff of someone else. </li></ul><ul><li>Game theory is the study of such interactions among players. </li></ul><ul><li>A premise of game theory is that each player pursues his or her respective objectives taking that interdependence into account. </li></ul>
  7. 7. The experimental approach <ul><li>Why use an experimental approach? </li></ul><ul><li>Putting yourself in the shoes of the decision maker helps you understand his or her choices. </li></ul><ul><li>Building models for conducting experiments helps you answer the four vital questions. </li></ul><ul><li>Predicting the results of your own experiment and analyzing the data from it helps you understand how your strategic rivals might react. </li></ul>
  8. 8. Statistics <ul><li>Why bother with a statistical analysis? </li></ul><ul><li>Using statistics helps you evaluate whether your predictions were confirmed or not. </li></ul><ul><li>As more data streams become available, managers must understand and interpret statistical analysis in an increasingly sophisticated fashion. </li></ul><ul><li>Strategic consultants must know how to conduct statistical analyses that use these data streams. </li></ul>
  9. 9. Assessment <ul><li>There are 2 projects : the first project is worth 35 percent and the second project is worth 65 percent. </li></ul><ul><li>See due dates in the syllabus. Each project consists of </li></ul><ul><li>Modeling an issue in business. </li></ul><ul><li>Explaining its predictions. </li></ul><ul><li>Conducting your own experiment in class. </li></ul><ul><li>Participating in the other class projects as a subject. </li></ul><ul><li>Analyzing of the data from your own experiment. </li></ul><ul><li>Projects may undertaken individually, or in groups of two to four. Each member of a group will receive the same mark. </li></ul>
  10. 10. Introductory examples <ul><li>To introduce you to experimental methods, let us conduct some experiments designed using the extensive form game module on the comlabgames web site. </li></ul><ul><li>Next lecture we will show how translate a case into an extensive form game. </li></ul>
  11. 11. Food fight on Lake Erie <ul><li>There is a Wild Oats supermarket and a Coop organic grocery in Cleveland OH selling organic food, but only a Coop in Buffalo NY. </li></ul><ul><li>There is greater demand for organic food in Cleveland than in Buffalo, mainly attributable to differences in population. </li></ul><ul><li>Whole Foods is contemplating entry into one of those markets as it expands across the Midwest into the Northeast. </li></ul><ul><li>If Whole Foods builds a new store in either location, one or both rivals might respond by cutting prices and offering the similar product lines, or they might passively accommodate Whole Foods’ high end entry. </li></ul>
  12. 12. Whole Foods versus Wild Oats <ul><li>If Whole Foods enters Cleveland, then the Buffalo Coop retains its monopoly in organic food. </li></ul><ul><li>In this case the profits of the existing stores in Cleveland depend on their response to entry. </li></ul>
  13. 13. Soaking the rich <ul><li>The goal of the Internal Revenue Service is to maximize tax revenue given the resources at its disposal. </li></ul><ul><li>The IRS audits those reporting incomes over $200,000 far more than those reporting $50,000. Similarly full time wage earners are audited much less than self employed businessmen. </li></ul><ul><li>If the IRS audited everyone, then nobody would cheat, but the costs of a universal audit are prohibitive. </li></ul><ul><li>We ask how much auditing the IRS will conduct, and how much tax fraud will occur. </li></ul>
  14. 14. Tax Audit <ul><li>It is more costly to undertake an audit than to only check for irregularities, and if no fraud was committed the extra tax revenue and penalties garnered is the same. </li></ul><ul><li>Undetected fraud is more lucrative to the taxpayer then committing some accounting irregularities. </li></ul><ul><li>Truthful reporting and passing over use up no resources, merely redistributing wealth from the taxpayer to the IRS. </li></ul>
  15. 15. Developing a factory dump or an archeological site <ul><li>As the economy shifts from the manufacturing to the service sector, former factory sites and waste dumps are rapidly becoming prime real estate. </li></ul><ul><li>Real estate developers are more savvy about parceling up land tracts and marketing them than industrial enterprises. </li></ul><ul><li>However the original factory owners know more about the sources of contaminants and pollutants on their former factory sites. </li></ul><ul><li>The law holds the current owner of a site responsible for problems caused by hazardous waste on it. </li></ul>
  16. 16. Temporal integration <ul><li>In this game the factory owner can develop the site by itself, but then retains full liability for all the contaminants on it. </li></ul><ul><li>Selling the site divests the factory of its liabilities for any hazardous waste on the site. </li></ul><ul><li>Should the factory owners move into real estate development? </li></ul>
  17. 17. Game tree <ul><li>The games we just played were represented by their extensive forms. </li></ul><ul><li>The extensive form representation answers the four critical questions in strategy: </li></ul><ul><ul><ul><ul><ul><li>Who are the players ? </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>What are their potential moves ? </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>What is their information ? </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>How do they value the outcomes? </li></ul></ul></ul></ul></ul>
  18. 18. Who is involved? <ul><li>How many major players are there, and whose decisions we should model explicitly? </li></ul><ul><li>Can we consolidate some of the players into a team because they pool their information and have common goals? </li></ul><ul><li>Should we model the behavior of the minor players should be modeled directly as nature , using probabilities to capture their effects on the game? </li></ul><ul><li>Does nature play any other role in resolving uncertainty, for example through a new technology that has chance of working? </li></ul>
  19. 19. What can they do? <ul><li>Each node designates whose turn it is. It could be a player or nature. The initial node shows how the game starts, while terminal nodes end the game. </li></ul><ul><li>A branch join two nodes to each other. Branches display the possible choices for the player who should move, and also the possible random outcomes of nature’s moves. </li></ul><ul><li>Tracing a path from the initial node to a terminal node is called a history . A history is uniquely identified by its terminal node. </li></ul>
  20. 20. What do they know? <ul><li>Each non-terminal decision node is associated with an information set . </li></ul><ul><li>If a decision node is not connected to a dotted line , the player assigned to the node knows the partial history . </li></ul><ul><li>If two nodes are joined by a dotted line, they belong to the same information set, and the two sets of branches emanating from them, which define the player’s choice set, must be identical. </li></ul><ul><li>A player cannot distinguish between partial histories leading to nodes that belong to the same information set. </li></ul>
  21. 21. What are the payoffs? <ul><ul><ul><li>Payoffs capture the consequences of playing a game. </li></ul></ul></ul><ul><ul><ul><li>They represent the utility or net benefit to each player from a game ending at any given terminal node. </li></ul></ul></ul><ul><ul><ul><li>Payoffs show how resources are allocated to all the players contingent on a terminal node being reached. </li></ul></ul></ul>
  22. 22. Lecture summary <ul><li>We defined the four critical questions for analyzing any strategic situation. </li></ul><ul><li>We introduced the extensive form representation of a game to depict the answers to those critical questions. </li></ul><ul><li>We conducted several experiments in class to explore how players might resolve some strategic interactions. </li></ul>