GAME THEORY, STRATEGIC DECISION MAKING, AND BEHAVIORAL ECONOMICS. Chapter 14. Today’s lecture will:. Explain why game theory is more flexible than standard models of market behavior. Provide an example of prisoner’s dilemma game. Explain what is meant by Nash equilibrium.
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GAME THEORY, STRATEGIC DECISION MAKING, AND BEHAVIORAL ECONOMICS
B Does Not Confess
A Goes Free
A 5 years
B 5 years
B 10 years
A 10 years
A 6 months
A Does Not
B 6 months
B Goes Free
Ford has a rebate
Ford has no rebate
Chevy has a rebate
Chevy has no rebate
F $3 million
Suppose that Ford and Chevrolet are each considering offering a $1000 rebate
on their cars. Currently, without a rebate, they split the market evenly, and each earns profits of
$2 million per week. However, if Ford offers a rebate and Chevy doesn’t, they will win Chevy customers,
and their profits will increase to $3 million and Chevy’s will fall to $1 million. Conversely, if Chevy offers
the rebate and Ford doesn’t, Chevy profits increase to $3 million and Ford’s will fall to $1 million. If both
companies offer a rebate, neither will win new customers and profits for each will fall to $1.5 million.
Review Question 14-1: Construct a payoff matrix showing Ford (F) and Chevrolet’s strategies and
all of the outcomes.
Review Question 14-2: What is the dominant strategy?
The dominant strategy is for each firm to offer a rebate.