GameTheory - Game Theory in Business Applications Feryal...

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Game Theory in Business Applications Feryal Erhun Management Science and Engineering Stanford University, Stanford, CA 94305-4026 Pınar Keskinocak * School of Industrial and Systems Engineering Georgia Institute of Technology, Atlanta, GA, 30332-0205 First Draft: August 2003 * Pınar Keskinocak is supported by NSF Career Award DMI-0093844. The authors would like to thank ¨ Ozgen Karaer for her valuable comments on an earlier version of this chapter. 1
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Contents 1 Another Perspective: Game Trees 6 2 Games of Strategy 8 3 Static Games of Complete Information 10 4 Dynamic Games of Complete Information 16 4.1 Repeated Games . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5 Price and Quantity Competition 27 6 Supply Chain Coordination 36 6.1 Revenue Sharing Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 6.2 Buyback Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 6.3 Two-Part Tariff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 6.4 Quantity Discount Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 7 Games of Incomplete Information 46 8 Principal-Agent Problem 51 9 Concluding Remarks 59
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What is business all about? Some will say it is all about providing a service that the customers like. Some will say it is all about innovation, developing cutting-edge technology. Some will say it is all about being first to the market. Some will say it is all about reaching the right people. Some will say it is all about building value for customers and managing risk. Some will say it is all about partnerships. Some will say it is all about being ahead of your competitors. The overarching theme in all of these statements is “interactions.” In any business, interactions with customers, suppliers, other business partners, and competitors, as well as interactions across people and different organizations within the firm, play an integral role in any decision and its consequences. Advances in information technology (IT) and e-commerce further enrich and broaden these interactions, by increasing the degree of connectivity between different parties involved in commerce. Thanks to globalization, now the entire world is the playground for many firms, increasing the complexity of these interactions. Given that each firm is part of a complex web of interactions, any business decision or action taken by a firm impacts multiple entities that interact with or within that firm, and vice versa. Ignoring these interactions could lead to unexpected and potentially very undesirable outcomes. Our goal in this chapter is to provide an introduction to game theory, which is a very useful tool for studying interactive decision-making, where the outcome for each participant or “player” depends on the actions of others. Each decision maker, such as yourself, is a player in the game of business; hence, when making a decision or choosing a strategy you must take into account the potential choices of others, keeping in mind that while making their choices, other players are likely to think about and take into account your strategy as well.
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