3_4_4_Oligopoly_Game-Theory.pptx_Document

Econ Oligopoly

1. WHAT IS GAME THEORY? TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY Game theory is a branch of mathematics that studies strategic decision-making. It's often used to analyze the behaviour of businesses in oligopolies and other market structures, as well as in other fields like politics and biology. Game theory involves modelling strategic interactions as a game, where each player has a set of strategies and potential payoffs based on the actions of the other players. Using game theory, economists can try to predict how firms will behave in an oligopoly, and what the outcome of a given scenario might be.

2. SOME KEY CONCEPTS USED IN GAME THEORY TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY Cooperative outcome An equilibrium in a game where the players agree to cooperate when making decisions Dominant strategy A dominant strategy is one where a single strategy is best for a player regardless of what strategy other players in the game decide to use Nash equilibrium Any situation where all participants in a game are pursuing their best possible strategy given the strategies of all the other participants Tacit collusion Where firms undertake actions that are likely to minimize a competitive response , such as avoiding price-cutting or not attacking each other’s market Whistle blowing When one or more agents in a collusive agreement report it to the authorities perhaps in hope of lenient treatment Zero sum game An economic transaction in which whatever is gained by one party must be lost by the other. Net gains are zero .

3. WHAT IS THE PRISONERS’ DILEMMA? TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY The prisoners' dilemma is one of the most famous examples of game theory. It's a game that involves two prisoners who are each given the choice to cooperate or betray the other prisoner. If they both cooperate, they'll both get a light sentence. If one betrays the other, they'll go free while the other gets a long sentence. But if both betray, they'll both get a moderate sentence. The prisoners' dilemma demonstrates the conflict between self-interest and cooperation. It shows how rational actors might not act in the most socially optimal way.

4. WHAT IS THE PRISONERS’ DILEMMA? TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY Note: The pay-off in this table is measured in months (M) or years (Y) in prison from each of the choices made by each prisoner. Prisoner B Stay silent Betray Prisoner A Stay silent (6M, 6M) (10Y, 0) Betray (0, 10Y) (5Y, 5Y) The prisoner’s dilemma is a game that illustrates why it is difficult to cooperate , even when in the best interest of both parties . Both players are assumed to select their own dominant strategies for personal gain. Eventually, they reach an equilibrium in which they are both worse off than they would have been, if they could both agree to select an alternative ( non-dominant ) strategy.

5. WHAT IS A NASH EQUILIBRIUM? TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY The Nash equilibrium is a solution concept in game theory that describes the optimal outcome for all players in a game, given their opponents' strategies. In the case of the prisoners' dilemma, the Nash equilibrium occurs when both prisoners choose to betray each other, since this results in the best outcome for both given the other's choices. In game theory, the Nash equilibrium is one of the most important concepts, as it helps to explain how rational actors behave in situations of conflict or cooperation. Essentially, it helps us to understand the logic behind seemingly irrational decisions.

6. JOHN NASH – A BEAUTIFUL MIND TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY John Nash is a fascinating figure in the world of mathematics and economics. He's best known for his work on game theory, which is a way of modeling strategic interactions between rational decision-makers. Nash made many important contributions to game theory, including the Nash equilibrium, which is a concept that describes the optimal outcome of a game when all players act rationally. Nash also had a very interesting personal life - he struggled with mental health issues throughout his life, but he was able to overcome them and continue to make significant contributions to his field.

7. A SIMPLE PRICING GAME: SET HIGH OR LOW PRICES? TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY Firm B (right hand figures below) Payoff = Expected Profit ($bn) High Prices Low Prices Firm A High Prices $3bn, $3bn $0bn, $5bn Low Prices $5bn, $0bn $1bn, $1bn In this two-firm game , they both have to decide whether to set high or low prices The table shows the dollar profits (pay-offs) that results from each set of choices

8. A SIMPLE PRICING GAME: SET HIGH OR LOW PRICES? TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY Firm B (right hand figures below) Payoff = Expected Profit ($bn) High Prices Low Prices Firm A High Prices $3bn, $3bn $0bn, $5bn Low Prices $5bn, $0bn $1bn, $1bn In this game, regardless of what the other firm decides to do, the best response of the other firm is to charge a lower price – they may settle at this low price If these firms decided to collude by both setting a high price , then both would earn higher total profits – this would be pareto optimal in the sense that both firms benefit .

9. NON-PRICE COMPETITION – GAME THEORY EXAMPLE TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY Firm B Advertise Don’t Advertise Firm A Advertise (£6m, £6m) (£8m, £3m) Don’t Advertise (£3m, £8m) (£5m, £5m) The grid shows a simple game between two firms competing for the same customers who must decide whether to launch an expensive advertising campaign

10. NON-PRICE COMPETITION – GAME THEORY EXAMPLE TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY Firm B Advertise Don’t Advertise Firm A Advertise (£6m, £6m) (£8m, £3m) Don’t Advertise (£3m, £8m) (£5m, £5m) In this case, the dominant strategy is to advertise, and this would be a Nash equilibrium.

11. SIMPLE GAME THEORY EXAM GOLD TUTOR2U.NET/ECONOMICS It is difficult for firms to know what the payoffs might be – it is hard in an oligopoly to make accurate business predictions. Agents do not behave rationally, but game theoretical approaches assume that they do – entrepreneurs might be strong risk-takers. Conversely, firms might adopt a risk-averse position during a recession.

12. APPLICATIONS OF GAME THEORY TUTOR2U.NET/ECONOMICS SIMPLE GAME THEORY One particularly well-known application is in the field of auctions. Many online auctions, like eBay, use game theory models to design their auction formats and rules. This helps to ensure that the auction reaches a fair outcome and that bidders behave rationally. Game theory can help to model the bargaining process between a firm and a union. The firm might use game theory to understand the union's demands and priorities, and then use that information to make a counter-offer. In this way, game theory can be a powerful tool for helping to reach a mutually beneficial agreement between the two parties. Game theory can be used to model the interaction between countries that are negotiating trade deals, as well as to understand the impact of tariffs and other trade policies. For example, the threat of retaliation if a tariff or import quota is imposed is using game theory ideas.