Prisoner A Don’t Confess Confess Don’t Confess Confess Prisoner B The Prisoner’s Dilemma Both jailed 15 years Prisoner A: ...
The Chemical Company’s Dilemma Company A Maintain Capacity Double Capacity Maintain  Capacity Double Capacity Company B Co...
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Why Not Rational?

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Game Theory Example in Chemicals

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  • What do you do with a high margin growth business that you believe is non-cyclical? You invest in it. And by the time you have the confidence to tell Wall Street the business is non-cyclical, guess what? You’ve already invested hundreds of millions of dollars in it. And so have all your competitors. While limiting capacity increases would be ideal if all the PET producers did the same thing, new competition would surely come in, attracted by the high margins. Also, what company would want to lose market share if it decided to stay static while its competitors rushed to boost capacity? That’s the dilemma chemical companies face. Either they raise capacity in good times, or lose market share to their competitors. You can equate this to what is known in game theory as “The Prisoner’s Dilemma.” In one version, it goes as follows. Two prisoners are accused of a crime. If one confesses and the other does not, the one who confesses will be freed and the other will spend 20 years in jail. If neither confesses, each will be held only a few months. If both confess, they will each be jailed 15 years. They cannot talk with one another. If each does a purely self-interested calculation, he will decide to confess. The problem is, when each pursues his own interest, both end up worse.
  • So here’s the chemical company’s dilemma—a simplified version of course! If Company A doubles capacity and its competitor does nothing, Company A will make lots of money. Company B makes less money and loses market share. If Company A and B do nothing, they both make a good amount of money. But if both Company A and Company B follow their own best interest and double capacity, they will both lose lots of money.
  • Why Not Rational?

    1. 1. Prisoner A Don’t Confess Confess Don’t Confess Confess Prisoner B The Prisoner’s Dilemma Both jailed 15 years Prisoner A: 20 years Prisoner B: Free! Prisoner A: Free! Prisoner B: 20 Years Both held for 6 months
    2. 2. The Chemical Company’s Dilemma Company A Maintain Capacity Double Capacity Maintain Capacity Double Capacity Company B Company A: Lose lots of $ Company B: Lose lots of $ Company A: Make decent $ Company B: Make decent $ Company A: Make less $, lose market share Company B: Make lots of $ Company A: Make lots of $ Company B: Make less $, lose market share

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