General Remarks

This is a course on strategic thinking using as its base the models developed in the field of game theory. Applications to public policy and to business strategy will be explored. We will develop the basic tools of game theory through lectures and exercises, and we will put the tools to work by applying them to policy and business examples.

Ojective of the course:

• To teach students how to think strategically about a wide range of policy and business problems involving competition, cooperation, bargaining, negotiation etc.
• To apply strategic insight to real life problems

Downloads

• A Note on Shapley Value
• Non cooperative games
• Testing Mixed-Strategy Equilibria
• Insurance Approach: Mortality Models and Credit Risk
• Mechanism Design
• Auction Theory
• Counterspeculation, Auctions and Competitive Sealed Tenders
• Why Auction Theory
• Sample Exam
• Second Price Auctions

About Game Theory

Game theory studies competitive and cooperative behavior in strategic environments, where the fortunes of several players are intertwined. It provides methods for identifying optimal strategies and predicting the outcome of strategic interactions. The field of game theory began around 1900 when mathematicians began asking whether there are optimal strategies for parlor games such as chess and poker, and, if so, what these strategies might look like. The first comprehensive formulation of the subject came in 1944 with the publication of the book Theory of Games and Economic Behavior by famous mathematician John von Neumann and eminent economist Oskar Morgenstern. As its title indicates, this book also marked the beginning of the application of game theory to economics. Since then, game theory has been applied to many other fields, including political science, military strategy, law, computer science, and biology, among other areas. In 1994 three pioneers in game theory were awarded a Nobel Prize, marking the 'arrival' of the field. Since then a number of game theorists have been awarded the Nobel highlighting the central role the field has come to occupy in economics. Among the other applications, game theory today is finding its way into the world of business. (Pick up a business magazine or book and there is a good chance that it will use some game theory jargon: zero-sum game, Prisoner's Dilemma, win-win game, etc.) We will be learning the underlying theory in the course, and using it to understand the principles of strategic behaviour in business.

Course Content

The course is divided into two parts: game theoretic tools for analysis and application of the tools to a variety of interactive contexts drawn from business and policy making. The topics covered by the course are given below.

Co Operative Games

Assessing the value of players and coaltions ('Cooperative Games') In this module we assume that players in a game can make binding contracts and ask the basic question: given the 'value' of individuals and coalitions what is a rational way to divide the pie between the individual players and what is the likely structure of coalitions that form. To answer, we will introduce techniques for thinking about such situations and calculating the value of players under different assumptions. Topics covered in this module include definition of the coalitional form of a game, solution concepts like the core, Shapley value etc.

Cost Sharing Problems

Non Co operative Games

Thinking About What They're Thinking
In this module we begin with an overview of the basic principles of 'non-cooperative games'. With these games in mind, we then ask the basic question: How can a player choose a good strategy when the best choice depends on what strategies the other players in the game choose? To answer, we will introduce techniques for thinking through the game from the positions of the other players, and anticipating their choices. Topics covered in this module include definition of games in normal and extensive form, principle of dominant strategies and safe strategies, Nash Equilibrium, backward induction equilibrium. Well known games such as the ?The Prisoner's Dilemma, the Battle of the Sexes, the Coordination Game, chess ?will be studied.
Asymmetric Information: The Problem of Adverse selection vs Moral Hazard
Often interaction between two parties involves one party at a distinct advantage over the other in terms of access to information. Information asymmetry can arise because types are unknown (adverse selection) or the actions are unobservable (moral hazard). An averaging across differenttypes is inefficient. In this session we will discuss the problem and possible soultions to overcome it.
Mechanism Design
In this session, we look at the art of designing rules of a game to achieve a specific outcome. This is done by setting up a structure in which each player has an incentive to behave as the designer intends. After introducing the revelation principle we will apply the theory to the design of financing "public goods" using the Clark Groves mechanism.
Auctions
We will study the application of the principles taught in Mechanism Design to optimal design and bidding in auctions. We will start with an overview of the main theoretical results in auction theory like the winners curse and go on to a detailed analysis of Treasury auctions, and telecom license auctions. Finally an analysis of the Vickrey second price auction will set the stage for subsequent module on mechanism design.
Strategic Voting
In this module we introduce the issues presented by collective decision making through voting like the Condorcet Paradox, the reversal paradox, and the agenda paradox. We study the outcome of elections when we admit the possibility of voters misrepresenting their preferences to 'rig' the elections in their favor.
Collective action problems
In this module we will discuss collective action problems that arise in situations where individuals act in self interest and examine several possibilities of alleviating the problems, for example frequent repetition, changing payoffs, etc.
Designing Labor Markets
In this module we introduce the concept of stable matching and use the stable matching algorithm to suggest how college admissions, final placements and similar processes can be rationalized.
Games with strategic moves
In this module we introduce the concept of threats, promises, credible commitments and examine how players can use them to seize a first mover advantage, or shift the balance of power in a strategic situation in some other way. Methods of acquiring credibility, and countering the opponents' strategic moves are discussed.
Asymmetric Information and Designing Contracts
In this session we will focus on designing appropriate contracts that will resolve some of the problems arising due to asymmetric information. Inducing cooperation through repeated interaction In this module, we look at more complicated games in which players interact with each other repeatedly. This is where strategies of bluffing, signaling, threatening etc. come into play and outcomes can be 'cooperative' despite a strictly self interested perspective of players. We will introduce the model of repeated games, and use it to understand issues of international security, and cross border relations.

References

• Games of Strategy - Dixit & Skeath
• Fun and Games - Ken Binmore
• Games Businesses Play - Pankaj Ghemavat
• Co-opetition - Brandenburger and Nalebuff