Game Theory in Supply Chain Analysis

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Game Theory in Supply Chain Analysis∗ G´rard P. Cachon† and Serguei Netessine‡ e The Wharton School University of Pennsylvania Philadelphia, PA 19104-6366 February 2003 Abstract Game theory has become an essential tool in the analysis of supply chains with multiple agents, often with conflicting objectives. This chapter surveys the applications of game theory to supply chain analysis and outlines game-theoretic concepts that have potential for future application. We discuss both non-cooperative and cooperative game theory in static and dynamic settings. Careful attention is given to techniques for demonstrating the existence and uniqueness of equilibrium in non-cooperative games. A newsvendor game is employed throughout to demonstrate the application of various tools. ∗ This is an invited chapter for the book “Supply Chain Analysis in the eBusiness Era” edited by David and˜cachon and Levi, S. David Wu and Zuo-Jun (Max) Shen, to be published by Kluwer. † ‡ 1 1 Introduction Game theory (hereafter GT) is a powerful tool for analyzing situations in which the decisions of multiple agents affect each agent’s payoff. As such, GT deals with interactive optimization problems. While many economists in the past few centuries have worked on what can be considered game-theoretic (hereafter G-T) models, John von Neumann and Oskar Morgenstern are formally credited as the fathers of modern game theory. Their classic book “Theory of Games and Economic Behavior” (von Neumann and Morgenstern 1944) summarizes the basic concepts existing at that time. GT has since enjoyed an explosion of developments, including the concept of equilibrium (Nash 1950), games with imperfect information (Kuhn 1953), cooperative games

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