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Strategic Moves: Side Payments
Side payments are a strategic move in sequential games where one player offers a benefit to another to encourage cooperation. This tactic adjusts the…
Side payments are a strategy where one player offers something to the opponent to persuade them to act in a way that benefits the first player.
Let's consider two competing pharmaceutical companies: Nova and Erks.
Nova starts by deciding whether to engage in the price war or to collude.
In the original sequential game, Nova indulges in a price war and receives a payoff of 100 dollars, while Erks gets 300 dollars.
If Nova plans to offer a side payment to Erks.
If Nova chooses to collude and Erks also promises to collude, Nova will pay Erks 200 dollars.
That way, Erks will earn a payoff of 700 dollars at node B, 500 dollars earned initially, and 200 dollars given by Nova.
This way, both earn higher payoffs; Nova gets a payoff of 300 dollars, and Erks receives a payoff of 700 dollars more than they would have earned without the side payment.
Incorporating strategic moves and side payments allows for more complex and realistic scenarios in sequential games. These moves enable players to change the game's dynamics, sometimes securing a more favorable and mutually beneficial outcome than is possible without such tactics.
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Q1: What is a side payment in game theory?
A side payment is a strategic move where one player offers a benefit to another player to encourage cooperation. This tactic adjusts payoffs for both players, making it more appealing for the opponent to choose an action beneficial to both. Side payments help shift game dynamics, leading to outcomes more favorable than those achieved through competition alone.
Q2: How do side payments change payoffs in sequential games?
Side payments modify the payoff structure by allowing one player to share gains from cooperation. In sequential games, this reshapes incentives facing other players' decisions. For example, Nova offers Erks $200 to collude, increasing Erks's payoff from 500 to 700 dollars while Nova earns 300 dollars, creating a mutually beneficial outcome compared to competing.
Q3: Why would a company offer a side payment instead of competing?
Companies offer side payments to create stable, profitable outcomes. Direct competition often yields lower payoffs due to high costs. By offering a side payment, a company can incentivize cooperation, ensuring both parties earn higher payoffs. This approach minimizes risks and avoids the reduced earnings associated with aggressive price wars or market competition.
Q4: How do side payments create a Nash equilibrium?
Side payments realign incentives so that cooperation becomes the most advantageous option for both players, creating a nash equilibrium in one period games where neither player benefits from changing their decision. This stable state results from one player sharing cooperative gains with the other, making mutual cooperation the rational choice for all parties involved.
Q5: What is the difference between outcomes with and without side payments?
Without side payments, competing players earn lower payoffs due to price wars and market competition. With side payments, both players receive higher payoffs through cooperation. For instance, TelNet's $300 side payment increases SignalMax's payoff from $500 to $800, while both avoid earning only $50 and $350 respectively through aggressive competition.
Q6: Can side payments be used in cooperative vs non cooperative games?
Side payments are most effective in cooperative vs non cooperative games where players can negotiate and agree to share benefits. They transform non-cooperative scenarios into cooperative arrangements by making mutual agreement rational for both parties. This strategic tool enables players to move from competitive outcomes to mutually beneficial agreements through explicit benefit-sharing arrangements.
Q7: What real-world industries use side payments as a strategic move?
Telecommunications and pharmaceutical companies commonly use side payments to encourage partnerships and collusion. TelNet and SignalMax used side payments to establish regional partnerships, while Nova and Erks employed them to avoid price wars. These industries benefit from cooperation because it reduces marketing expenses and increases overall profitability for all participating firms.