Week 14: Strategic Thinking and Game Theory

The Five Forces Framework

Used to assess market structure and profitability potential.

Existing Competitors

Intensity increases with more firms, similar/identical products, price competition, and non-price competition.

Potential Entrants

New startups or existing firms entering the market, with barriers to entry reducing threat.

Potential Substitutes

Products from other industries that satisfy the same need; threat increases if substitutes are cheaper/better and have low switching costs.

Supplier Power

Suppliers can raise prices or reduce quality if you depend on them too much.

Buyer Power

Buyers (especially large ones) can demand lower prices, reducing profitability.

Non-Price Competition

Differentiation through features, style, reliability, location, or brand to increase market power.

Advertising

Purpose is to increase demand and/or market power, shifting the demand curve right and increasing price insensitivity.

Bargaining Power

Your ability to negotiate favorable terms, determined by your best alternative.

The Hold-Up Problem

Caused by relationship-specific investments, leading to reduced willingness to invest in efficiency-enhancing assets.

Solutions to the Hold-Up Problem

Include contract theory, reputation, repeated interaction, and vertical integration.

Game Theory Basics

Strategic interaction where decisions depend on others' actions.

Elements of a Game

Include players, strategies, payoffs, order of play, and frequency.

Simultaneous-Move Game

Players act without seeing others' moves.

Sequential-Move Game

One player moves after observing another.

Dominant Strategy

Best choice regardless of what the opponent does.

Nash Equilibrium

A situation where each player is doing the best they can given others' choices, with no incentive to deviate unilaterally.

Prisoner's Dilemma

Mutual cooperation is better, but mutual betrayal is the Nash equilibrium.

Collusion

Firms agree to charge high prices or restrict output, which is illegal and has an incentive to cheat.

Coordination Games

Goal is to match your action with others, with multiple equilibria possible.

Sequential-Move Games

Use extensive form diagrams (decision trees) to analyze.

Subgame Perfect Nash Equilibrium (SPNE)

Players' strategies form a Nash equilibrium at every point in the game, eliminating non-credible threats.