Monday, January 31, 2011

Class # 3: Key Takeaways

Trees and Shadows
The Long shadow of the Endgame?

Class #3 concluded our unit on look forward, reason back. There were three key observations to come out of this unit.

1. The long shadow of the endgame--the end of the game casts a "shadow" over the entire strategic interaction.
In the NBA case, that shadow was the competitive threat of the rival team. The right of first refusal nullified this competition and let the incumbent capture the bulk of the surplus. Absent this clause, competition allowed the player to capture the bulk of the surplus.

2. The value of an option - the game theory value of an option depends on how it affects others behavior. It is often most valuable when it is not exercised since this means the competitive threat of the rival has been thwarted.

3. Irrationality - We typically use the term rational to be synonymous with profit maximizing. But non-pecuniary factors drive payoffs too. Game theory is flexible enough to handle these aspects in the analysis. A key part of developing a good model of the rival is assessing payoffs accurately--fairness, reciprocity, and other ego factors are important to account for.

No comments: