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Chapter 10: Games and Strategic Behavior. Game theory attempts to mathematically capture behavior in strategic situations , in which an individual\'s success in making choices depends on the choices of others. (Wikipedia)

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chapter 10 games and strategic behavior
Chapter 10: Games and Strategic Behavior
  • Game theory attempts to mathematically capture behavior in strategic situations, in which an individual\'s success in making choices depends on the choices of others. (Wikipedia)
  • The actions taken by monopolistic competitors or oligopolies are interdependent, so are their payoffs.
game theory
Game Theory
  • Basic elements of a game
    • The players
    • Their available strategies, actions, or decisions
    • The payoff to each player for each possible action
  • A dominant strategy is one that yields a higher payoff no matter what the other player does
    • Dominated strategy is any other strategy available to a player who has a dominant strategy
example american and united scenario 1
Example: American and United – Scenario 1
  • Players: United and American Airlines supplying service between Chicago and St. Louis
    • No other carriers
  • Strategies: Increase advertising by $1,000 or not
  • Assumption
    • All payoffs are known to all parties
payoff matrix
Payoff Matrix
  • Payoff is symmetric
  • Dominant strategy is raise advertising spending
    • Both companies are worse off
  • Payoff is symmetric
  • Dominant strategy is raise advertising spending
    • Both companies are worse off
equilibrium in a game
Equilibrium in a Game
  • In an equilibrium, each player of the game has adopted a strategy that they are unlikely to change.
  • Nash equilibrium is any combination of strategies in which each player’s strategy is her or his best choice, given the other player’s strategies
    • Equilibrium occurs when each player follows his dominant strategy, if it exists
    • Equilibrium does not require a dominant strategy
american and united scenario 2
American and United – Scenario 2

Lower-Left cell is a Nash equilibrium

  • Same situation
    • Different payoffs; non-symmetric
  • America raises spending
    • United anticipates American action; does not raise
prisoner s dilemma
Prisoner\'s Dilemma

Dominant strategy

Optimal strategy

  • The prisoner\'s dilemma has a dominant strategy
  • The resulting payoffs are smaller than if each had stayed silent
cartels
Cartels
  • A cartel is a coalition of firms that agree to restrict output to increase economic profit
    • Restrict total output
      • Allocate quotas to each player
cartel in action an example
Cartel in Action: An Example
  • Two suppliers of bottled water agree to split the market equally
    • Price is set at monopoly level
      • If one party charges less, he gets all of the market
    • Marginal cost is zero
    • Agreement is not legally enforceable
bottled water cartel
Bottled Water Cartel
  • Each party has an incentive to lower the price a little to increase its economic profits
  • Successive reductions result in price equal to marginal cost
repeated prisoner s dilemma
Repeated Prisoner\'s Dilemma
  • Two players with repeated interactions
    • Each has a stake in the future outcomes
  • Both players benefit from collaboration
    • Tit-for-tat strategy limits defections
  • Tit-for-tat strategy says my move in this round is whatever your move was in the last round
    • If you defected, I defect
  • Tit-for-tat is rarely observed in the market
    • This strategy breaks down with more than two players or potential players
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