Game Theory and Oligopolistic Behaviour

1. Game Theory
a. Definition
i. It is concerned with the choice of an optimal energy in conflict situations. It
can help an oligopolist choose the course of action that maximized its
benefits or profits after considering all possible reactions of its competitors.
Eg.
1. The condition under which lowering the price would not trigger a
ruinous price war
2. Whether the firm should build excess capacity to discourage entry
into the industry, even though this lowers the firm’s short-run
profits
3. Why cheating in a cartel is usually leads to its collapse

b. Model
i. Includes
1. Players
a. They are decision makers whose behaviour we are trying to
explain and predict
2. Strategies
a. They are the potential choices to change price, to develop
new or differentiated products, to introduce a new or a
different advertising campaign, to build excess capacity, and
all other such actions that affects the sales and profitability
of the firm and its rivals
3. Payoffs
a. This is the outcome or consequence of each combination of
strategies by two firms
b. Usually expressed in the terms of profits or losses of the
firm
c. Payoff Matrix
i. A table that gives the payoffs from all the strategies
open to the firm and the rival’s response

c. Natures
i. Zero-sum games
1. 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
ii. Nonzero-sum games
1. If the gains or losses of one firm do not come at the expense of or
provide equal benefit to the other firm
2. Classification
a. Positive nonzero-sum game
i. Where both firms benefit
b. Negative nonzero-sum game
i. Where both firms incur loss
2. Dominant Strategy
a. It is the optimal choice for a player no matter what the opponent does

b. In this example, no matter what the rival does, the firm has more profit if it
advertises, hence, here advertising is a dominant strategy for both the firms

3. Nash Equilibrium
a. It is a situation in which each player chooses an optimal strategy, given the strategy
chosen by the other player

b. Here, Firm A doesn’t have a dominant strategy, and depends on Firm B’s action

4. Prisoner’s Dilemma
a. It refers to a situation in which each firm adopts its dominant strategy but each
could do better by cooperating

b. In this negative payoff matrix, dominant strategy for both prisoners is to confess but
if both of them chose not to confess, they both only get a one-year sentence

5. Strategic Moves
a.