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# Chapter 10: Games and Strategic Behavior - PowerPoint PPT Presentation

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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Presentation Transcript

• 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.

• 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

• 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 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

• 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

Lower-Left cell is a Nash equilibrium

• Same situation

• Different payoffs; non-symmetric

• America raises spending

• United anticipates American action; does not raise

Dominant strategy

Optimal strategy

• The prisoner's dilemma has a dominant strategy

• The resulting payoffs are smaller than if each had stayed silent

• A cartel is a coalition of firms that agree to restrict output to increase economic profit

• Restrict total output

• Allocate quotas to each player

• 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

• 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

• 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