ECON 251 Module 13: Game Theory

Game theory

study of strategic interactions

Strategic interaction

when your best choice depends on what others choose and their best choice depends on what you choose

Elements of strategic interaction

simultaneous, non cooperative, 2 players, 2 strategies

Players

economic agents who are thinking strategically, player one goes to the left, player two goes on the top

Choices

decisions each player have to make, choices don’t have to be identical but can be

Outcomes

end result of each player making a decision

Payoffs

what each player “gets” in each outcome, strategy≠payoffs

Key steps

set up game, consider player 1’s best response to each of player 2’s strategies, consider player 2’s best response to each of player 1’s strategies, if all players are playing their best response then we get an outcome that we would expect to see when both entries in a cell are underlined (Nash Equilibrium)

Nash Equilibrium

the choice that each player makes is a best response to the choices other players are making, can have 0, 1, or many; reported in terms of strategies

Conflict in oligopoly

firms would like to collude or join a cartel, and jointly act as a monopoly; collusion tends to be unstable

Coordination games

best response is the same choice as the other player

Anti-coordination games

best response is to take a different action than the other player

Problems of coordination

difficulty in coordinating, may coordinate into the wrong equilibrium

Cournot duopoly

good that is completely costless to produce, two people, homogeneous product, non-cooperation, each firm has some market power, competition based on quantities chosen simultaneously, economically rational

Oligopoly strategy

Pm>Po>Ppc, Qpc,Qo,Qm

Typical cournot outcome

each firm better off than they were in PC but worse than they were in monopoly, both better off if they acted as a cartel, best option is defect