Microecon Chapter 18 - Game Theory and Strategic Choices

Strategic Interaction

When your best choice may depend on what others do, and vice versa.

Payoff

Value associate with a possible outcome.

Strategy

Rule or plan of action for playing a game.

Optimal Strategy

That which maximizes payoff.

Dominant Strategy

That which is optimal no matter what the opponent does.

Dominated Strategy

That which is always worse than some other strategy, no matter what other players do.

Nash Equilibrium

An equilibrium where the choice that each player makes is the best response to the choices other people are making.

Four steps for Strategic Decisions

1. Consider ALL the possible outcomes.

2. Think about the “what if” seperately.

3. Evaluate your best response.

4. Put yourself in someone else’s shoes.

Zero-Sum Game

A game in which one players gain is exactly equal to another player’s loss, resulting in a net change of 0 in the overall outcome.

→ There is no pure strategy Nash Equilibrium in this scenario.

Collusion

When competitors get together and agree to charge the same high prices

Coordination Game

When all players have a common interest in coordinating their choices.

→ May have multiple equilibria

→ The best response is the same choice as the other player

Solutions to Coordination Problems

1. Communication

2. Focal Points, Culture, and Norms

3. Laws and Regulations

Focal Point

A cue from outside a game that helps you coordinate on a specific equilibrium.

Simultaneous Game

Players make their choice without knowing what the other player has chosen, as if the decisions were being made at the same time.

Sequential Games

A player can see their rival’s action before choosing theirs, or vice versa.

First-Mover Advantage

The strategic gain from an anticipatory action that can force a rival to respond less aggressively.

Second-Mover Advantage

The strategic advantage that can follow from taking an action that adapts to your rival’s choice.

One-Shot Games

A strategic interaction that only occurs once.

Repeated Games

When a player faces the same strategic interaction with the same rivals and the same playoffs in successive periods.

Strategic Plan

A list of instructions that describes exactly how to respond in any possible situation.

Grim Trigger Strategy

1. If other players have cooperated in all previous rounds, then you will cooperate

2. If any other player has defected in any previous round, then you’ll defect forever.