game theory

Strategic behavior

The Plan of action or behavior of an oligopolist, after taking into consideration all possible reactions of its competitors as they compete for profits or other advantages.

Game theory

-Pioneered by the mathematician John von Neuman and the economist Oskar Morgenstern in 1944.

-Concerned with the choice of the best or optimal strategy in conflict situations.

-Shows how an oligopolistic firm makes strategic decisions to gain competitive advantage over a rival or how it can minimize the potential harm from a strategic move by a rival.

Players

are the decision makers whose behavior are trying to explain and predict

Strategies

the choices to change price, develop new products, make a new advertising campaign, build new capacity, and all other actions that affect the sales and profitability of the firm and its rivals

Payoff

the outcome or consequence of each strategy or game

Payoff matrix

the table giving the payoffs from all the strategies open to the firm and the rivals’ responses.

Zero sum game

The gain of one player comes at the expense and is exactly equal to the loss of the other player.

Non-zero game

Gains or losses of one firm does not come at the expense of or provide equal benefits to the other firm.

Dominant strategy

the optimal choice of the player

Nash equilibrium

The situation where each player chooses his or her optimal strategy, given the strategy chosen by other player.

Prisoner’s dilemma

A situation in which each firm adopts its dominant strategy but each could do better (i.e., earn large profits) by cooperating.

Repeated games

-Involve many consecutive moves and countermoves by each player

-The best strategy for each player is tit-for-tat.

Tit-for-tat

Do to your opponent what he has just done to you.

Conditions for tit-for-tat

-It requires reasonably stable set of players

-There must be a small number of players

-It is assumed that each firm can quickly detect cheating by other firms

-Demand and cost condition must be relatively stable

-Assume that the game is repeated indefinitely

Decision tree

A diagram with nodes and branches

Nodes

depict points at which decisions are made

Branches

show the outcome of each decision in sequential games