Deliverable 06 Worksheet: The Market Research Team Wo 115622

Deliverable 06 Worksheetthe Market Research Team Working On This Pro

Deliverable 06 – Worksheet The market research team working on this project creates this payoff matrix that represents the scaled values that customers give to the different levels of service and the corresponding payoffs for the telecom company: Customer Telecom Company Buy Don’t Buy Upgrade (2, , 1) Don’t Upgrade (3, , 1) You recognize that the payoff matrix is not the best way to analyze this scenario. You will construct a game tree to model the scenario and perform backwards induction to find the optimum strategy, explaining all of your reasoning along the way.

Paper For Above instruction

The scenario presented involves a strategic interaction between a telecommunications company and its customers regarding upgrade decisions, analyzed through game theory. A payoff matrix, while useful for initial insight, fails to capture the sequential nature and strategic reasoning involved. Therefore, constructing a game tree and performing backwards induction provides a more comprehensive and accurate analysis of the scenario, allowing for the identification of credible strategies.

Why a Game Tree Must Be Used Instead of a Payoff Matrix

A payoff matrix succinctly illustrates the payoffs for each player under different simultaneous strategies but does not account for the temporal sequence of decisions—who moves first and how players might react based on observed actions. In many real-world strategic interactions, decisions are made sequentially, and the later player observes the earlier player's choice before acting. This dynamic is central to this case, particularly because the telecom company's decision to upgrade or not depends on customer behavior, and vice versa.

Constructing a game tree allows modeling of such sequential decision-making, capturing the order of moves, and enabling the analysis of credible threats and commitments. It also facilitates backward induction, essential for determining subgame perfect equilibria. Without the game tree, one risks oversimplifying the interaction, potentially ignoring strategic reasoning, such as the credibility of threats or promises which might influence player decisions.

Identification of the First Player

In this scenario, the customer is typically considered to move first when deciding whether to buy or not buy, as the telecom company's payoff depends on the customer’s initial decision, which will influence the company's subsequent strategic options. Alternatively, if the telecom company set its upgrade or non-upgrade move after observing customer decisions, it would be considered the second mover. However, given the payoff structure and dynamic modeling importance, it makes sense to model the customer as the first mover, with the telecom company's decision contingent on the customer’s action.

Constructing the Initial Game Tree

Based on the payoff matrix:

- If the customer chooses to buy:

- The telecom company can choose to upgrade or not.

- If the customer chooses not to buy:

- The telecom company's payoff does not depend on upgrading, but for completeness, similar options are considered.

The initial game tree begins with the customer's decision node:

1. Customer chooses "Buy" or "Don’t Buy."

2. If "Buy," telecom then chooses "Upgrade" or "Don’t Upgrade," leading to payoffs (2,1) or (3,1).

3. If "Don’t Buy," the payoff is (0,0), assuming no further strategies.

Identifying and Explaining Non-Credible Threats

A threat is credible if the threatening party has an incentive to follow through with it. In the initial game tree, a non-credible threat might arise if the telecom company threatens not to upgrade unless the customer does not buy, despite the fact that upgrading could lead to higher payoffs if the customer in fact buys. If the threat to not upgrade is not in the company's best interest after observing the customer’s action, then it is non-credible.

For example, if the telecom company threatens to not upgrade unless the customer refrains from buying, but the company’s payoffs are higher when it upgrades, then following through on such a threat would be irrational, making the threat non-credible.

Redrawing the Game Tree with Non-Credible Threats Removed

In the revised game tree, the telecom company only makes credible threats—those aligned with its best interests given the customer’s decision. This results in eliminating branches where the company threatens to act against its own interests, such as not upgrading when it would be more profitable to upgrade, regardless of customer actions. Consequently, the game tree simplifies, focusing only on credible strategic options.

Backward Induction and Its First Step

Backward induction begins at the subgame where the telecom company makes its decision after observing the customer’s initial move. The first step involves analyzing the company's best response to each customer action:

- If the customer buys:

- The telecom company chooses the strategy with the higher payoff (either upgrade for payoff 2 or not upgrade for payoff 3).

- If the customer does not buy:

- The company's payoff is implicitly zero, and no strategic move is necessary.

This step essentially involves comparing payoffs for the telecom company conditioned on the customer’s choice, establishing what the company's optimal response will be.

Performing the First Step of Backward Induction

Given the payoffs:

- If the customer buys:

- Upgrading yields a payoff of 1 for the company.

- Not upgrading yields a payoff of 1 as well.

Since both options provide the same payoff, the company is indifferent between upgrading and not when the customer buys. However, if other considerations or probabilities favor one strategy, the company might prefer a specific one. For simplicity, assume the company chooses to upgrade when indifferent.

Redrawing the Game Tree Post-First Induction Step

Post-induction, the game tree reflects that:

- When the customer chooses to buy, the company will choose its best response, which, in this case, is to upgrade or not upgrade depending on the further detailed analysis.

- When the customer does not buy, the interaction ends with no strategic response needed.

Next Step of Backward Induction

The subsequent step involves analyzing the customer's decision, considering the company's best response:

- If the customer anticipates that the company will upgrade when they buy and the payoff for buying is (2,1), the customer weighs this against not buying (0,0). Since buying yields a higher payoff, the customer is incentivized to buy.

Performing the Final Backward Induction and Determining the Strategy

Considering the entire structure:

- The customer’s optimal strategy is to buy because it offers a higher payoff than not buying.

- The telecom company’s optimal response, given the customer’s action, is to upgrade when the customer buys, maximizing its payoff.

Thus, the subgame perfect equilibrium involves the customer choosing to buy and the telecom company choosing to upgrade, resulting in payoffs of (2, 1). This outcome is credible and stable, as both parties have incentives aligning to make this strategy rational.

Conclusion

Using a game tree and backwards induction reveals the strategic decision-making process between customer and company more effectively than a static payoff matrix. The credible strategies identified suggest that the company should alert to the best response of upgrading when customers buy, aligning incentives to maximize overall payoffs. This process underscores the importance of sequential analysis in strategic decision making, especially in dynamic interactions like telecom service upgrades.

References

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