GAME THEORY AND

COMPETITIVE STRATEGY

CHAPTER 14
Topics to be Discussed
 An Overview of Game Theory.
 Gaming and Strategic Decisions
 Dominant Strategies
 The Nash Equilibrium Revisited
 Static Games
 Dynamic Games
 Sequential Games
 Threats, Commitments, and Credibility
 Entry Deterrence
What is Game Theory?
 Game theory - a set of tools that economists,
political scientists, military analysts and others
use to analyze decision making by players who
use strategies
 Game - any competition between players (firms)
in which strategic behavior plays a major role.
 any situation in which players (the participants) make
strategic decisions
 Ex: firms competing with each other by setting
prices, group of consumers bidding against each
other in an auction
Gaming and Strategic Decisions
 Game theory tries to determine optimal strategy
for each player
 Strategy is a rule or plan of action for playing the
game
 Optimal strategy for a player is one that maximizes
the expected payoff
 We consider players who are rational – they think
through their actions
 Players take into account the possible actions of other
players.
An Overview of Game Theory (cont).

 Strategic interdependence - a player’s optimal

strategy depends on the actions of others.

 “If I believe that my competitors are rational and act

to maximize their own profits, how should I take
their behavior into account when making my own
profit-maximizing decisions?”
Definitions
 Payoffs -Strategic decisions result in payoffs to the
players: outcomes that generate rewards or
benefits
 players’ valuations of the outcome of the game, such
as profits for firms or utilities for individuals.
 Payoff function: specifies each player’s payoff as a
function of the strategies chosen by all players.
 Rules of the game - regulations that determine the
timing of players’ moves, the actions that players
can make at each move and possible outcomes.
An Overview of Game Theory (cont).
 Static game - game in which each player acts only
once and the players act simultaneously (or, at
least, each player acts without knowing rivals’
actions).

 Dynamic game - game in which players move

either sequentially or repeatedly
Predicting a Game’s Outcome
 Dominant strategy - a strategy produces a higher
payoff than any other strategy the player can use
for every possible combination of its rivals’
strategies.
Example
 Two airlines: American and United.
 Each airline can take only one of two possible
actions:
 Each can fly either 64 or 48 thousand passengers
between Chicago and Los Angeles per quarter.
 Because the firms choose their strategies
simultaneously, each firm selects a strategy that
maximizes its profit given what it believes the
other firm will do.
Profit Matrix for a Quantity-Setting Game:
Dominant Strategy
Dominant Strategies

• Equilibrium in dominant strategies:

Outcome of a game in which each firm is
doing the best it can regardless of what its
competitors are doing. Optimal strategy is
determined without worrying about the
actions of other players

 However, not every game has a dominant

strategy for each player
Predicting a Game’s Outcome
 If United chooses the high-output strategy (qU =
64), American’s high-output strategy maximizes its
profit.
 If United chooses the low-output strategy (qU =
48), American’s high-output strategy maximizes its
profit.
 Thus, the high-output strategy is American’s
dominant strategy.
 Whichever strategy United uses, American’s profit is
higher if it uses its high-output strategy.
Predicting a Game’s Outcome
 A striking feature of this game is that the players
choose strategies that do not maximize their joint
profit.

 Prisoners’ dilemma - a game in which all players

have dominant strategies that result in profits (or
other payoffs) that are inferior to what they could
achieve if they used cooperative strategies
 Classic Example: Prisoners’ Dilemma
• Two suspects held in separate cells are charged with a major
crime. However, there is not enough evidence.
• Both suspects are told the following policy:
 If neither confesses then both will be convicted of a minor
offense and sentenced to one month in jail.
 If both confess then both will be sentenced to jail for six
months.
 If one confesses but the other does not, then the confessor
will be released but the other will be sentenced to jail for
nine months. Prisoner 2
Mum Confess
Mum -1 , -1 -9 , 0
Prisoner 1
Confess 0 , -9 -6 , -6
 Classic Example: Prisoners’ Dilemma
• Even though it would be better for both prisoners to stay
mum, each prisoner gets a higher payoff from confessing:
– If the other prisoner stays mum, you get 0 instead of -1 if
you confess.
– If the other prisoner confesses, you get -6 instead of -9 if
you confess.
– Therefore, confessing is the dominant strategy.
• As a result, both prisoners confess.
• The prisoners’ dilemma has many applications: in business,
political science, etc. Prisoner 2
Mum Confess
Mum -1 , -1 -9 , 0
Prisoner 1
Confess 0 , -9 -6 , -6
Dominant Strategy
 A Dominant Strategy is one that is optimal no
matter what an opponent does
 Example: A and B sell competing products. They
are deciding whether to undertake advertising
campaigns.
Payoff Matrix for Advertising Game

Firm B, Player 2
Don’t
Advertise Advertise
Firm A, Player 1

Advertise 10, 5 15,0

Don’t
Advertise 6,8 10,2

For A: regardless of what B does, advertising is the best for A

For B: regardless of what A does, advertising is the best for B

In other words, “Advertise” is the dominant strategy for firm A.

“Advertise” is also the dominant strategy for firm B.
Profit Matrix for a Quantity-Setting Game:
Iterated Dominance
Neither firm has a strictly dominant strategy in this game. As we
showed before, if United chooses qU = 64 or 48, American’s profit is
highest if it sets qA = 64. However, if United selects qU = 96,
American’s best action is to set qA = 48.2 Thus, none of American’s
possible strategies is a dominant strategy: a single strategy that
always produces the highest profit regardless of United’s actions.
Rather, the strategy that maximizes American’s payoff depends on
United’s action.
 Games without a dominant strategy

• A dominant strategy is stable, but in many games

one or more party does not have a dominant
strategy. A more general equilibrium concept is
the Nash Equilibrium.
• A Nash Equilibrium is a set of strategies (or actions)
such that each player is doing the best it can, given
the actions of its opponents
• The optimal decision of a player without a
dominant strategy will depend on what the
other player does
Example: The Modified Advertising Game
Firm B, Player 2
Don’t
Advertise Advertise
Firm A, Player 1

Advertise 10,5 15,0

Don’t
6,8 20,2
Advertise
Example: The Modified Advertising Game
Firm B, Player 2
Don’t
Advertise Advertise
Firm A, Player 1

Advertise
10,5 15,0
Don’t
Advertise
6,8 20,2

For Firm A: No dominant strategy; depends on B’s actions. If

A thinks B will “advertise,” A’s best response is to “advertise”
and gets a payoff of 10. If A thinks B will choose “don’t
advertise,” A’s best response is to choose “don’t advertise”
and gets a payoff of 20.
Example: The Modified Advertising Game

Firm B, Player 2 Don’t

Advertise Advertise
Firm A, Player 1

Advertise 10,5 15,0

Don’t
Advertise
6,8 20,2

For firm B: B’s Dominant strategy is to advertise. Regardless of what A

does, B’s payoff is higher if it chooses “advertise.”

In this game, A knows that B will advertise, since “advertise” is B’s

dominant strategy. Taking this into account, A will also choose
“advertise.” The Nash Equilibrium is that A chooses “advertise” and B
also chooses “advertise.” A’s equilibrium payoff is 10, and B’s payoff is 5.
The Nash Equilibrium Revisited

• None of the players have incentive to deviate from

its Nash strategy, therefore it is stable
• Dominant Strategy
– “I’m doing the best I can no matter what you do.
You’re doing the best you can no matter what I do.”
• Nash Equilibrium
– “I’m doing the best I can given what you are doing.
You’re doing the best you can given what I am doing.”
• Dominant strategy is a special case of Nash
equilibrium
Multiple Nash Equilibria

 Two cereal companies face a market in which two

new types of cereal can be successfully introduced,
provided each type is introduced by only one firm
 Product Choice Problem
 Market for one producer of crispy cereal
 Market for one producer of sweet cereal
 Each firm only has the resources to introduce one cereal
 Non-cooperative
 Product Choice Problem
Firm 2
Crispy Sweet

Crispy
-5, -5 10, 10
Firm 1

Sweet 10, 10 -5, -5

For firm 1: No dominant strategy; depends on 2’s actions.

If firm 1 thinks firm 2 will choose “crispy,” firm 1’s best response is to choose
“sweet” and get a payoff of 10. (If firm 1 thinks firm 2 will choose “crispy” and
firm 1 chooses “crispy,” then firm 1 would get payoff of -5.)
 If firm 1 thinks firm 2 will choose “sweet,” 1’s best response is to choose
“crispy” and get a payoff of 10. (If firm 1 thinks firm 2 will choose “sweet” and
firm 1 chooses “sweet,” then firm 1 would get payoff of -5.)
Product Choice Problem
Firm 2
Crispy Sweet

Crispy
-5, -5 10, 10
Firm 1

Sweet 10, 10 -5, -5

For firm 2: No dominant strategy; depends on 1’s actions.

If firm 2 thinks firm 1 will choose “crispy,” firm 2’s best response is to
choose “sweet” and get a payoff of 10. (If firm 2 thinks firm 1 will choose
“crispy” and firm 2 chooses “crispy,” then firm 2 would get payoff of -5.)
 If firm 2 thinks firm 1 will choose “sweet,” 2’s best response is to choose
“crispy” and get a payoff of 10. (If firm 2 thinks firm 1 will choose “sweet”
and firm 2 chooses “sweet,” then firm 2 would get payoff of -5.)
Product Choice Problem

Firm 2
Crispy Sweet

Crispy
-5, -5 10, 10
Firm 1

Sweet 10, 10 -5, -5

There are two (pure strategy) Nash equilibria or “mutual best

responses”:
1. Firm 1 chooses “sweet” and firm 2 chooses “crispy.”
2. Firm 1 chooses “crispy” and firm 2 chooses “sweet.”
Best Response and Nash Equilibrium.

 Best response - the strategy that maximizes a

player’s payoff given its beliefs about its rivals’
strategies.

 Nash equilibrium - a set of strategies such that,

when all other players use these strategies, no
player can obtain a higher payoff by choosing a
different strategy
Question 1

Find the dominant strategies and Nash equilibrium

Question 2
Question 3

• Does either firm have a dominant strategy in the static game (i.e. if
the two firms make their decision simultaneously)? Explain
 Pure strategy - each player chooses an action with
certainty; player makes a specific choice or takes a
specific action
 assigns a probability of 1 to a single action.
Multiple Nash Equilibria, No Nash Equilibrium, and
Mixed Strategies

Mixed Strategy
• Player makes a random choice among two or more possible

actions, based on a set of chosen probabilities

– A mixed strategy of a player is a probability distribution over
the player’s strategies.
– The distributions are mutual best responses to one another in
the sense of expected payoffs
• One reason to consider mixed strategies is when there is a
game that does not have any Nash equilibrium in pure
strategy
• When allowing for mixed strategies, every game has a Nash
equilibrium
Matching Pennies
Player 2
Heads Tails

Heads -1, 1 1, -1
Player 1

Tails 1, -1 -1, 1

• Player 1 and Player 2 choose to show the other player heads or

tails.
• If the coins match (both heads or both tails), Player 2 wins $1 and
Player 1 loses $1.
• If the coins don’t match (one head and one tail), then Player 1 wins
$1 and Player 2 loses $1.
 Matching pennies
Player 2
Head Tail
Head -1 , 1 1 , -1
Player 1
Tail 1 , -1 -1 , 1

 Head is Player 1’s best response to Player 2’s strategy Tail

 Tail is Player 2’s best response to Player 1’s strategy Tail

 Tail is Player 1’s best response to Player 2’s strategy Head

 Head is Player 2’s best response to Player 1’s strategy Head

 Hence, NO Nash equilibrium in pure strategies

35
 Matching Pennies
Player 2
Heads Tails
For any fixed strategy of Player 2
such that Player 1 knows what 2
Heads -1, 1 1, -1
will play, Player 1 will play the
other side of the coin. Likewise,

Player 1
for any fixed strategy of Player 1
such that Player 2 knows what 1 Tails 1, -1 -1, 1
intends to play, Player 2 will play
the same side of the coin.

There is no “mutual best response” in pure strategies. In other words, there is

NO pure strategy Nash equilibrium. However, there is another Nash concept,
that is of “mixed strategies.” In this case, A and B will play heads with 50%
probability and tails with 50% probability. The coins will match 50% of the
time (in which case Player 2 wins) and the coins will not match 50% of the
time (Player 1 wins.)
Solving matching pennies
Player 2
Head Tail
Head -1 , 1 1 , -1 r
Player 1
Tail 1 , -1 -1 , 1
1-r
q 1-q
Randomize your strategies to surprise the rival
 Player 1 chooses Head and Tail with probabilities r and
1-r, respectively.
 Player 2 chooses Head and Tail with probabilities q and 1-q,
respectively.
Mixed Strategy:
 Specifies that an actual move be chosen randomly from the set of
pure strategies with some specific probabilities.
Solving matching pennies
Player 2 Expected
Head Tail payoffs
Head -1 , 1 1 , -1 r 1-2q
Player 1
Tail 1 , -1 -1 , 1
1-r 2q-1
q 1-q

Player 1’s expected payoffs

 If Player 1 chooses Head, -q+(1-q)=1-2q
 If Player 1 chooses Tail, q-(1-q)=2q-1
 Solving matching pennies
Player 2 Expected
Head Tail payoffs
Head -1 , 1 1 , -1 r 1-2q
Player 1
Tail 1 , -1 -1 , 1
1-r 2q-1
q 1-q

Player 1’s best response r

1
B1(q):
 For q<0.5, Head (r=1)
1/2
 For q>0.5, Tail (r=0)
 For q=0.5, indifferent (0r1)
1/2 1 q
39
Solving matching pennies
Player 2 Expected
Head Tail payoffs
Head -1 , 1 1 , -1 r 1-2q
Player 1
Tail 1 , -1 -1 , 1
1-r 2q-1
q 1-q
Expected
payoffs 2r-1 1-2r

Player 2’s expected payoffs

 If Player 2 chooses Head, r-(1-r)=2r-1
 If Player 2 chooses Tail, -r+(1-r)=1-2r
40
 Solving matching pennies
Player 2 Expected
Head Tail payoffs
Head -1 , 1 1 , -1 r 1-2q
Player 1
Tail 1 , -1 -1 , 1
1-r 2q-1
q 1-q
Expected
payoffs 2r-1 1-2r
r
Player 2’s best response 1
B2(r):
 For r<0.5, Tail (q=0) 1/2
 For r>0.5, Head (q=1)
 For r=0.5, indifferent (0q1)
1/2 1 q
41
 Solving matching pennies
Player 2
 Player 1’s best response Head Tail
B1(q): -1 , 1 1 , -1
Player Head r
 For q<0.5, Head (r=1) 1 Tail 1 , -1 -1 , 1 1-r
 For q>0.5, Tail (r=0)
q 1-q
 For q=0.5, indifferent (0r1)
 Player 2’s best response Mixed strategy
B2(r): Nash equilibrium
 For r<0.5, Tail (q=0)
r
1
 For r>0.5, Head (q=1)
 For r=0.5, indifferent (0q1)
1/2
 Check
r = 0.5  B1(0.5)
q = 0.5  B2(0.5) 1 q
1/2
42
Solving matching pennies
 Once we allow for mixed strategies, every game
has at least one Nash equilibrium
 Mixed Strategies provide solutions to games when
pure strategies fail.
 Battle of the Edward and Bella
Edward- Player 2
Football
Shopping
Match

Shopping 2,1 0,0

Bella-
Player 1

Football 0,0 1,2

Match

Edward and Bella only get a positive payoff when they’re doing the
same activity together. However, Bella prefers shopping, and
Edward prefers watching football match.
 Battle of the Edward and Bella
Edward- Player 2
Football
Shopping
Match

Shopping 2,1 0,0

Bella-
Player 1

Football 0,0 1,2

Match

Two pure strategy Nash equilibria:

1. Both choose “Shopping”
2. Both choose “Football Match”
 Battle of the Edward and Edward-
BellaPlayer 2
Football
Shopping
Match

Shopping 2,1 0,0

Bella-
Player 1

Football 0,0 1,2

Match

A mixed strategy of a player is a probability distribution over player’s

(pure) strategies.
 A mixed strategy for Bella is a probability distribution (p, 1-p), where p is the
probability of choosing Shopping, and 1-p is that probability of choosing
Football Match.
 If p=1 then Bella actually plays Shopping. If p=0 then Edward actually plays
Football Match
 Battle of the Edward and Bella
Edward- Player 2
Football
Shopping
Match

Shopping 2,1 0,0

Bella-
Player 1

Football 0,0 1,2

Match

There’s a mixed strategy equilibrium, where

Bella plays “Shopping” (the preferred activity) with probability 2/3, and
“Football Match” with probability 1/3; and Edward plays “Football Match”
(the preferred activity) with probability 2/3, and “Shopping” with
probability 1/3.
Dynamic Games
 Dynamic games - players move
 sequentially (2-staged game) or
 simultaneously repeatedly over time (multi-

period)
 a player has perfect information about other
players’ previous moves.
 Firms can signal or threaten other firms

 Action vs Strategy
 Action is a move that the player makes at a specified point, e.g. how much output firm produces during a
specific period
 A strategy is a battle of plan that specifies actions that the player will take conditional on the information
available to each player. If the other player does this we should do this.
Sequential Game
 two-stage game - is played once and hence can be
said to occur in a “single period.”
 In the first stage, Player 1 moves.
 In the second stage, Player 2 moves and the game
ends with the players’ receiving payoffs based on their
actions.
Sequential Game
 Sub game –At a given stage, a sub game consists of
all the subsequent decisions that players may
make given the actions already taken
 Subgame perfect Nash equilibrium - players’
strategies are a Nash equilibrium in every
subgame.
 Backward induction - first determine the best
response by the last player to move, next
determine the best response for the player who
made the next to-last move, then repeat the
process back to the move at the beginning of the
game
 Sequential or Dynamic Games

• Players move in turn, responding to each other’s actions and reactions

• Examples:
– Leader firms and follower firms
– Responding to a competitor’s ad campaign
– Entry decisions
• Responding to regulatory policy
• Going back to the product choice problem:
• Two new (sweet, crispy) cereals, sweet will sell better
• Successful only if each firm produces one cereal, but both still profitable with
only one producer
• What if Firm 1 sped up production and introduced new cereal first?
• Now there is a sequential game. Firm 1 will think about what Firm 2 will do.
Sequential or Dynamic Games
Crispy -5, -5
Crispy Firm 2
Sweet 10, 20
Firm 1
Crispy 20, 10
Sweet Firm 2
Sweet -5, -5

The game is solved by looking first at period 2, then making decision for period 1. This is
referred to as “backward induction.”

Firm 1 can follow this though process:

If I select “crispy”, firm 2 will definitely select “sweet”.
If I select “sweet”, firm 2 will definitely select “crispy.”

Firm 1 gets a higher payoff from sweet, so firm 1 chooses “sweet” and firm 2 chooses
“crispy.” This is the subgame perfect Nash Equilibrium.

In this game, there is a first mover advantage. The firm that gets to go first does better.
Stackelberg Game Tree
Sequential Game
 How should American, the leader, select its output
in the first stage?
 For each possible quantity it can produce, American
predicts what United will do and picks the output level
that maximizes its own profit.
 The subgame perfect Nash equilibrium requires
players to believe that their opponents will act
optimally—in their own best interests.
Credibility.
 Why doesn’t American announce that it will
produce the Stackelberg leader’s output to induce
United to produce the Stackelberg follower’s
output level?
 when the firms move simultaneously, United doesn’t
believe American’s warning that it will produce a large
quantity, because it is not in American’s best interest
to produce that large a quantity of output.
Credibility.
 Credible threat - an announcement that a firm will
use a strategy harmful to its rival and that the rival
believes because the firm’s strategy is rational in
the sense that it is in the firm’s best interest to use
it
 Identical firms that move simultaneously can’t
credibly threaten each other.
 Threats are credible is firms are different such as one
firms ability to act before the other.
Strategic Moves

 What actions can a firm take to gain advantage in

the marketplace?
 Deter entry
 Induce competitors to reduce output, leave, raise
price
 Implicit agreements that benefit one firm
 Strategic Move: Action that gives a player an
advantage by constraining his behavior
 a strategic move is one that influences the other person’s choice
in a manner favorable to one’s self, by affecting the other
person’s expectations of how one’s self will behave
 Strategic Moves
Firm 2
Crispy Sweet

Crispy -5, -5 10, 20

Firm 1

Sweet 20,10 -5, -5

• In the game as is, there are two pure strategy Nash Eq’a: Firm 1 Sweet, Firm 2
Crispy, and Firm 2 Sweet, Firm 1 Crispy
• For Firm 1 to make a “strategic move”, it must constrain its behavior to the extent
Firm 2 is convinced that he is committed to “sweet” if he is to get the payoff of 20.
– This in fact changes the game from the structure presented above, making it into a dynamic
game where the strategic move is taken in the first period, and likely changing the payoffs
from those above.
Strategic Moves
Firm 2
Crispy Sweet

Crispy -5, -5 10, 20

Firm 1

Sweet 20,10 -5, -5

How to Make the First Move: Must Demonstrate Commitment

Firm 1 must do more than announce they will produce sweet cereal
- Invest in expensive advertising campaign
-Buy large order of sugar and send invoice to Firm 2
Commitment must be enough to induce Firm 2 to choose crispy.
These strategic moves (advertising, sugar purchase) will change the payoffs from
those in the boxes above.
Strategic Moves
Firm 2
Crispy Sweet

Crispy -5, -5 -7, 20

Firm 1

Sweet 20,10 -5, -5

These strategic moves (advertising, sugar purchase) will

change the payoffs from those previously shown, so that
producing crispy is no longer a profitable option for Firm 1.
Entry Deterrence
 Barriers to entry important for monopoly power
 Economies of scale, patents and licenses, access to
critical inputs
 Firms can also deter entry: To deter entry, the
incumbent firm must convince any potential
competitor that entry will be unprofitable.
Entry Deterrence
 Example:
 If X does not enter, I makes a profit of $200 million if
they charge a high price and 130 if they charge a low
price.
 If X enters and charges a high price, I earns a profit of
$100 million and X earns $20 million
 If X enters and charges a low price, I earns a profit of
$70 million and X earns $-10 million
Entry Deterrence
Potential Entrant (X) (Firm 2)
Enter Stay out

High price
(accommodation) 100, 20 200, 0
Incumbent (I)
(Firm 1)
Low Price
(warfare)
70, -10 130, 0

Could threaten X with warfare if enters market

Not credible because once X has entered, it is in your
best interest to accommodate and maintain high price
Entry Deterrence (cont’d)

 What if firm I makes an investment before entry to

increase capacity (i.e. lower MC)?
 Irrevocable commitment
 Gives new payoff matrix since profits will be
reduced by investment
 Threat is completely credible
 Rational for Firm X to stay out of market
Entry Deterrence (cont’d)

Potential Entrant (X)

Enter Stay out

High price
(accommodation) 50, 20 150, 0

Incumbent (I)

Low price
(warfare) 70, -10 130, 0
 Entry game
Challenger
 Challenger’s strategies
 In In Out
 Out
Incumbent
 Incumbent’s strategies
 Accommodate A F 1, 2
 Fight
 Payoffs 2, 1 0, 0
 Normal-form representation

Incumbent
Accommodate Fight
In 2 , 1 0 , 0
Challenger
Out 1 , 2 1 , 2
 Nash equilibria in entry game
Challenger
• Two Nash equilibria
 ( In, Accommodate ) In Out
 ( Out, Fight ) Incumbent

A F 1, 2
• Does the second Nash
equilibrium make sense? 2, 1 0, 0
• Non-creditable threats
Incumbent
Accommodate Fight
In 2 , 1 0 , 0
Challenger
Out 1 , 2 1 , 2
 Find Subgame Perfect Nash equilibria:
Backward Induction
• Starting with those smallest subgames
• Then move backward until the root is reached
• Backward induction outcome is…
Challenger: IN, Incumbent: ACCOMODATES
Challenger

In Out
Incumbent

A F 1, 2
The first number is the payoff
of the challenger. The second
2, 1 0, 0 number is the payoff of the
incumbent.
Repeated Game
 Static games that are repeated - in each period,
there is a single stage:
 Both players move simultaneously.
 Player 1’s move in period t precedes
 Player 2’s move in period t + 1; hence, the earlier action
may affect the later one.
 The players know all the moves from previous periods,
but they do not know each other’s moves within any
one period because they all move simultaneously.
Repeated Game
 Suppose now that the airlines’ single-period
prisoners’ dilemma game is repeated quarter after
quarter.
 If they play a single-period game, each firm takes its
rival’s strategy as a given and assumes that it cannot
affect that strategy.

 In a repeated game, a firm can influence its rival’s

behavior by signaling and threatening to punish.
Beach Location Game (i.e. the Hotelling Model circa
1929)

 Scenario
 Two competitors, Y and C, selling soft drinks
 Beach is 200 yards long
 Sunbathers are spread evenly along the beach
 Price A= Price B
 Customer will buy from the closest vendor
 Where will they locate? What is the Nash
equilibrium?
Beach Location Game
100 yds

0 B? A? 200 yards

Consider this strategy:

If B locates at the 50 yard mark, it will get the customers located
between 0 and 100 yards, i.e. get 50% of customers.

If A locates at the 150 yard mark, it will get the customers

located between 100 and 200 yards, i.e. get 50% of customers.

Is this a Nash equilibrium?

NO!!!!
Beach Location Game
100 yds

0 B? A? 200 yards

Consider this profitable deviation for B: B could

move to the 149 yard mark, and get nearly 75% of
customers (those located between 0 and 149.5
yards) and A would get stuck with just over 25% of
customers (those located between 149.5 and 200
yards). (Similar arguments could be developed for a
profitable deviation for A from the 150 yard mark.)
Beach Location Game

100 yds

0 B? A? 200 yards
The Nash Equilibrium is where both A and B are located
at the 100 yard mark, where customers are divided
50/50. If they’re both at 100 yard mark, any movement
will cause the mover to lose customers—i.e. there’s no
profitable deviation. (To convince yourself, consider any
set of locations for A and B NOT at the center, and you’ll
see that there’s a profitable deviation.)
This type of model is also used for politics. Politicians
move toward the political “center” to attract the most
votes. (Downs Model c. 1957)