A key aspect of company strategy concerns the interactions between two or more firms. When a new market segment emerges, should a firm strive for a first-mover advantage, or wait to see how the market takes shape? Diversified firms compete against one another in multiple market segments and must often consider how actions in one market might be subject to retaliation by a competitor in another segment. Similarly, when a competitor initiates a price war, a firm must decide whether it should respond in kind.

Game theory is helpful for understanding the strategic interaction between firms. Game theory uses assumptions about the behavior of rivals to help a company choose a specific strategy that maximizes its return. In this exercise, you will use game theory to help analyze business decisions.

Individual

One of the classic illustrations of game theory can be found in the prisoner’s dilemma. Two criminals have been apprehended by the police for suspicion of a robbery. The police separate the thieves and offer them the same deal: Inform on your peer and receive a lesser sentence. Let your peer inform on you and receive a harsher sentence. What should you tell the police? Visit http://www.gametheory.net where you can play the prisoner’s dilemma against a computer. Play the dilemma using different parameters, and make notes of your experience.

Groups

Many examples of game theory can be found in popular culture, from the reality show Survivor to episodes of The Simpsons. Revisit http://www.gametheory.net and select either a TV or movie illustration. Discuss the applications of game theory with your team.

As a group, prepare a one-page summary of how game theory can be applied to competitive interactions between firms.