CHAPTER 18 Game Theory and Strategic Choices

Whatever he’s thinking, she probably already thought of it.

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Chapter Objective

Analyze the strategic decisions that you’ll make throughout your career and everyday life.

• 18.1 How to Think Strategically

  Apply the four steps for making good strategic decisions.

• 18.2 The Prisoner’s Dilemma and the Challenge of Cooperation

  Understand how the Prisoner’s Dilemma highlights the problems of getting people to cooperate.

• 18.3 Multiple Equilibria and the Problem of Coordination

  Figure out how best to coordinate with your allies to make complementary choices.

• 18.4 Advanced Strategy: First and Second Mover Advantages

  Make your move when it’s most advantageous.

• 18.5 Advanced Strategy: Repeated Games and Punishments

  Elicit cooperation by threatening punishment in repeated interactions.

Scene one: Judit Polgar surveys the men in front of her. The strongest female chess player of all time, she’s now coaching the Hungarian national men’s team. Her challenge is to teach these men what she knows instinctively: To beat your opponent you have to know them better than they know themselves.

Scene two: Soviet Leader Nikita Khrushchev has secretly shipped nuclear missiles to Cuba, just 90 miles off the coast of Florida. President Kennedy demands that Khrushchev withdraw his missiles. Khrushchev refuses. The stakes couldn’t be higher, as each country possesses enough nuclear weapons to destroy the other. With negotiations at a stalemate, President Kennedy huddles with his advisers, aware that the world is on the brink of a catastrophic nuclear war.

Scene three: Mary Barra’s agenda is packed. She runs General Motors, and she’s arranged separate meetings to evaluate whether to release an electric car, to decide what technologies to incorporate into GM cars, to plan her next negotiation with unions, and to figure out how quickly to expand into China. As she considers each alternative, she wonders how her rivals at Ford will respond.

Economics sees the same basic logic at work in all three scenes. Each strategist is trying to outfox their rivals, and each wants to stay a few moves ahead. As each ponders the next move, they all rely on the same set of ideas. These ideas come from game theory, and they provide a framework for making decisions in any strategic interaction.

We’ll start with the analytic tools you’ll need to analyze strategic interactions. Then we’ll highlight two big strategic issues: getting people to cooperate, and getting them to coordinate. For some students, that’s as far as they’ll dig with game theory. But if you want to dig into some advanced material, we’ll then evaluate how to navigate strategic interactions that play out over time.

I bet that you’ll find game theory to be incredibly useful as you navigate the strategic issues that arise in your own life. Or maybe I’m just saying this as a strategy to keep you reading. How can you tell?