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Managerial Economics (Chapter 10 Bis) Game Theory

This document provides an overview of game theory and strategic behavior. It defines key game theory concepts such as players, strategies, payoffs, zero-sum games, non-zero-sum games, dominant strategies, Nash equilibriums, and uses examples like pricing competitions and prisoner's dilemmas to illustrate them. The document concludes by listing two in-class problems related to these concepts.

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3K views17 pages

Managerial Economics (Chapter 10 Bis) Game Theory

This document provides an overview of game theory and strategic behavior. It defines key game theory concepts such as players, strategies, payoffs, zero-sum games, non-zero-sum games, dominant strategies, Nash equilibriums, and uses examples like pricing competitions and prisoner's dilemmas to illustrate them. The document concludes by listing two in-class problems related to these concepts.

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© Attribution Non-Commercial (BY-NC)
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Chapter 10

Game theory and strategic


behavior
Game Theory
• Game theory was pioneered by the
mathematician John Von Neumann and
the economist Oskar Morgensten in 1944.
• It is an instrument used to analyze
cooperation and conflicts between firms in
oligopolistic markets.
• In general, game theory is concerned with
the choice of the best or optimal strategy
in conflict situations.
Example
• Game theory can help a firm determine
the conditions under which lowering its
price would not trigger a ruinous price war.
• Game theory would help us understand
why cheating leads to the collapse of a
cartel.
The features of a game
• Every game theory model includes:
- The players
- Strategies
- The payoffs
The players
• There are the decision-makers.
The strategies
• These are the actions available to each
player
Payoff
• The payoff is the outcome or
consequence of each action
• We distinguish between a zero-sum
games and a nonzero-sum games
A Zero-sum games
• It is one in which the gain of one player
comes at the expense and is exactly equal
to the loss of the other player.
• Example: If firm A increases its market
share by 10% and firm B loses 10% of its
market share.
A nonzero sum game
• It is one in which the gains of one player
do not come at the expense of the other
player.
• Example: If firm A and Firm B increase
their profits as a result of one action.
Dominant Strategy
• The dominant strategy is the optimal
choice for a player no matter what the
other player does.
Payoff matrix for an advertising
game
Firm B

Advertise Don’t
advertise
Advertise (4, 3) (5, 1)
Firm A
Don’t (2, 5) (3, 2)
advertise
The Nash equilibrium
• Not all games have a dominant strategy
for each player.

• It is the situation in where each player


chooses his or her optimal strategy, given
the strategy chosen by the other player.
Payoff matrix for the advertising
game
Firm B

advertise don’t
(4, 3) (5, 1)
advertise
Firm A (2, 5) (6, 2)
don’t
The prisoner’s Dilemma
Individual B

Confess don’t
confess

Confess (5, 5) (0, 10)


Individual A

(10, 0) (1,1)
Don’t
confess
Price competition and the
prisoner’s dilemma
Firm B

Low price High price


Low price (2, 2) (5, 1)
Firm A
(1, 5) (3, 3)

High price
In-class problems
• Problem #5 page 426
• Problem #8 page 426

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