GAME THEORY AND OLIGOPOLY

INTRODUCTION
John von Neumann and Oskar Morgenstern in

1950 Designed to evaluate situations where individuals and organizations can have conflicting objectives Example: 1. wage negotiations between unions and firms 2. peace talks between two nations at war

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 STRATEGY: course of action taken by one of the

participants in a game PAYOFF: result of outcome of the strategy PAYOFF MATRIX:

FIRM 2
no price change price change no price change 10,10 -20,30 100,-30 140,35

FIRM 1

price change

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What Does Zero-Sum Game Mean?

A situation in which one participant's gains result only

from another participant's equivalent losses. The net change in total wealth among participants is zero; the wealth is just shifted from one to another.
10,10 -20,30 100,-30 140,35

Options and future contracts are examples of zero-sum

games (excluding costs). For every person who gains on a contract, there is a counter-party who loses. Gambling is also an example of a zero-sum game.
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NASH EQUILIBRIUM
DEFINITION: set of strategies such that none of the participants in the game can improve their payoff, given the strategies of the other participants FIRM 2
no price change change 10,10 No price change -20,30 100,-30 140,35 price

FIRM 1
5

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Dominant strategies
When one firms best strategy may not depend on

the choice made by other participants in the game, that firm has a dominant strategy When one player has a dominant strategy, the game will always have a Nash equilibrium

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Dominated strategies
an alternative that yields a lower payoff than

some other strategy, no matter what the other players in the game do
defensive strategy
defense against run blitz linebackers back

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offensive strategy run

10

pass
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Maximin strategies
it specifies that each player in the game will select

the option that maximizes the minimum possible profit FIRM 2

firm 1 min
NO new product 4,4 3,6 new product 3

FIRM 1 no new
product new product

6,3

2,2

2
Firm 2 min
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Mixed strategies
when in a game the participants have more than

one course of action

pitcher
throws fast ball throws curve 40% 20% 40%

Hitter anticipates fastball

anticipates curve 20%

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GAME THEORY AND OLIGOPOLY Noncooperative games:

if it is not possible to negotiate with other

participants and enter into some form of binding agreement The Prisoners dilemma
suspect 2
person 1 max 0,0 5,15

dont confess 15,5

5,5

confess
15

Suspect 1 dont confess

confess
5 Person 2 max
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Cooperative games: Enforcing a cartel

it is possible to negotiate and enforce

agreements that binds the participants in the game to a particular strategy Can avoid the Prisoners Dilemma

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Repeated games: dealing with cheaters

Even if enforced agreement is not possible the

firms may escape if the game is played many times The optimal strategy for a repeated game may be different from the optimal strategy for a game that is played only once A tit-for-tat strategy of mimicking the last choice of the other player may be effective in repeated games

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Sequential games: The advantage of being first

One of the players acts first and the other

responds Example: entry into a new market

firm 2
2,2 no new product -5,10 introduce -7,-7

new product
no new product

10,-5

Firm 1 introduce new product

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Reference
Managerial economics

By: H. Craig Petersen W. Cris Lewis

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THANK YOU

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Game theory and Oligopoly

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