# GAMES THEORY - Game theory is a branch of applied mathematics that is used in the social sciences (most notably economics

), biology, engineering, political science, international relations, computer science, and philosophy. Game theory attempts to mathematically capture behavior in strategic situations, in which an individual's success in making choices depends on the choices of others. While initially developed to analyze competitions in which one individual does better at another's expense (zero sum games), it has been expanded to treat a wide class of interactions, which are classified according to several criteria. Today, "game theory is a sort of umbrella or 'unified field' theory for the rational side of social science, where 'social' is interpreted broadly, to include human as well as non-human players (computers, animals, plants)" (Aumann 1987). --- There are various types of games –zero sum, non-zero sum: The zero-sum property (if one gains, another loses) means that any result of a zero-sum situation is Pareto optimal (generally, any game where all strategies are Pareto optimal is called a conflict game). Situations where participants can all gain or suffer together are referred to as non-zero-sum. Thus, a country with an excess of bananas trading with another country for their excess of apples, where both benefit from the transaction, is in a non-zero-sum situation. Other non-zero-sum games are games in which the sum of gains and losses by the players are sometimes more or less than what they began with. --- The concept was first developed in game theory and consequently zero-sum situations are often called zero-sum games though this does not imply that the concept, or game theory itself, applies only to what are commonly referred to as games. Non Zero-Sum: Many economic situations are not zero-sum, since valuable goods and services can be created, destroyed, or badly allocated, and any of these will create a net gain or loss. Assuming the counterparties are acting rationally, any commercial exchange is a non-zero-sum activity, because each party must consider the goods it is receiving as being at least fractionally more valuable than the goods it is delivering. Economic exchanges must benefit both parties enough above the zero-sum such that each party can overcome its transaction costs. STRATEGIC BEHAVIOUR - ‘Strategic behaviour’ refers to actions which a firm takes to improve its competitive position relative to actual and potential rivals, in order to gain a permanent commercial ad-vantage, thereby increasing its long-run profits. Carlton and Perloff (1994:382) refer to actions ‘to influence the market environment and so increase profits’; while Martin (1993:46) refers to ‘investment of resources for the purpose of limiting rivals’ choices’. Strategic behaviour thus refers to conduct which is not economically inevitable, but which is the outcome of a conscious attempt to shape the firm’s market environment to its own lasting advantage and to the competitive disadvantage of rivals. There are two categories of strategic behaviour. ‘Non-cooperative behaviour’ occurs when a firm tries to improve its position relative to its rivals by seeking to prevent them from entering a market, to drive them out of business or to reduce their profits. ‘Cooperative behaviour’ occurs when firms in a market seek to coordinate their actions and therefore limit their competitive responses (this does not necessarily imply explicit agreement). Here, only non-cooperative strategic behaviour is considered. --- It is primarily under oligopolistic market conditions that a firm has an incentive to alter its relative position through strategic behaviour. The firm recognises its interdependence and the need to take into account other firms’ reactions when making its own decisions; but it also recognises that it is free to make decisions to alter its commercial environment. These strategies are revealed over time through investment and through tactical moves and countermoves. LINEAR PROGRAMMING - Linear programming (LP) is a technique for optimization of a linear objective function, subject to linear equality and linear inequality constraints. Informally, linear programming determines the way to achieve the best outcome (such as maximum profit or lowest cost) in a given mathematical model and given some list of requirements represented as linear equations. More formally, given a polytope (for example, a polygon or a polyhedron), and a realvalued affine function defined on this polytope, a linear programming method will find a point in the polytope where this function has the smallest (or largest) value. Such points may not exist, but if they do, searching through the polytope vertices is guaranteed to find at least one of them. Linear programs are problems that can be expressed in canonical form: Maximise: - Subject to: represents the vector of variables (to be determined), while and are vectors of (known) coefficients and is a (known) matrix of coefficients. The expression to be maximized or minimized is called the objective function ( in this case). The equations are the constraints which specify a convex polyhedron over which the objective function is to be optimized. Linear programming can be applied to various fields of study. Most extensively it is used in business and economic situations, but can also be utilized for some engineering problems. Some industries that use linear programming models include transportation, energy, telecommunications, and manufacturing. It has proved useful in modeling diverse types of problems in planning, routing, scheduling, assignment, and design.

PRODUCTION FUNCTION – A production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs. A meta-production function (sometimes metaproduction function) compares the practice of the existing entities converting inputs X into output y to determine the most efficient practice production function of the existing entities, whether the most efficient feasible practice production or the most efficient actual practice production. In either case, the maximum output of a technologically-determined production process is a mathematical function of input factors of production. Put another way, given the set of all technically feasible combinations of output and inputs, only the combinations encompassing a maximum output for a specified set of inputs would constitute the production function. Alternatively, a production function can be defined as the specification of the minimum input requirements needed to produce designated quantities of output, given available technology. It is usually presumed that unique production functions can be constructed for every production technology. There are several ways of specifying the production function. In a general mathematical form, a production function can be expressed as: Q = f(X1,X2,X3,...,Xn) where: Q = quantity of output - X1,X2,X3,...,Xn = factor inputs (such as capital, labour, land or raw materials). This general form does not encompass joint production, that is a production process, which has multiple co-products or outputs. Cobb-Douglas - The Cobb-Douglas functional form of production functions is widely used to represent the relationship of an output to inputs. It was proposed by Knut Wicksell (1851-1926), and tested against statistical evidence by Charles Cobb and Paul Douglas in 1900-1928. --- For production, the function is Y = ALαKβ, where: Y = total production (the monetary value of all goods produced in a year), L = labor input, K = capital input, A = total factor productivity, α and β are the output elasticities of labor and capital, respectively. These values are constants determined by available technology. Properties: 1. Constant Returns to scale: As mentioned above, the Cobb-Douglas function assumes constant returns as scale i.e., (α+β)=1. It must be noted that Cobb-Douglas function can also accommodate any degree of returns to scale. 2. Elasticity of substitution is equal to one – α = percentage change in factor quantity ratio / percentage change in factor price ratio. Importance: 1. The Cobb function is convenient in Internal and Inter Industry comparisons. Since α and β which are partial elasticity coefficients are pure numbers, they can be easily used for comparing results of different samples having varied units of measurements. 2. Another advantage is that function capture the essential non-linearities of production process and also has the benefit of the simplification of process by transforming the function into a linear form with the help of logarithms. 3. The parameters of a Cobb function in addition to being elasticises, also possess other attributes. Limitations: 1. The Cobb functions includes only two factor inputs – labour and capital, that there are equally important inputs used in the production process. 2. The production assumes constant returns to scale, which is not possible in general. Certain factors of production cannot be increased in the same proportion e.g., entrepreneurship. Even if it is possible to do so, it is not possible to have constant returns to scale in the long runs. 3. There is usual problem of measurements of capital. We know that labour is measured in terms of labour services per hour. With respect to capital, it is quite difficult to measure capital services per hour as it involves depreciation over time. 4. Since the raw material does not figure on the input side, the output side is therefore taken as the net of raw material. Once we assume a constant return to scale, we believe that there is a fixed relation of raw materials of fuel variety. DEMAND - The amount of a particular economic good or service that a consumer or group of consumers will want to purchase at a given price. The demand curve is usually downward sloping, since consumers will want to buy more as price decreases. Demand for a good or service is determined by many different factors other than price, such as the price of substitute goods and complementary goods. In extreme cases, demand may be completely unrelated to price, or nearly infinite at a given price. Along with supply, demand is one of the two key determinants of the market price. Elasticity of Demand - Price elasticity of demand (PED) is defined as the measure of responsiveness in the quantity demanded for a commodity as a result of change in price of the same commodity. It is a measure of how consumers react to a change in price. In other words, it is percentage change in quantity demanded by the percentage change in price of the same commodity. In economics and business studies, the price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in price. It is measured as elasticity that is it measures the relationship as the ratio of percentage changes between quantity demanded of a good and changes in its price. In simpler words, demand for a product can be said to be very inelastic if consumers will pay almost any price for the product, and very elastic if consumers will only pay a certain price, or a narrow range of prices, for the product. Inelastic demand means a producer can raise prices without much hurting demand for its product, and elastic demand means that consumers are sensitive to the price at which a product is sold and will not buy it if the price rises by what they consider too much.

Perfectly Inelastic Perfectly Elastic Determinants: A number of factors determine the elasticity: Substitutes: The more substitutes, the higher the elasticity, as people can easily switch from one good to another if a minor price change is made, Percentage of income: The higher the percentage that the product's price is of the consumer's income, the higher the elasticity, as people will be careful with purchasing the good because of its cost, Necessity: The more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as the case of insulin for those that need it., Duration: The longer a price change holds, the higher the elasticity, as more and more people will stop demanding the goods (i.e. if you go to the supermarket and find that blueberries have doubled in price, you'll buy it because you need it this time, but next time you won't, unless the price drops back down again). Breadth of definition: The broader the definition, the lower the elasticity.

SUPPLY FUNCTION The quantity of a product that firm is willing to offer at a particular given price in the market is termed as Supply. Supply of a product and the factor which determine it could be analysed in the firm of supply function. A manager has to analyze the factor to which supply of his product is sensitive too. Ceteris Paribus, supply of product and price of the product are directly related that supply of product is a direct function of the price of the product which gives us an upward sloping supply curve of a product. The supply curve may be linear or non linear. 2 types: Short run supply - In the short run the firm may face a fixed cost even if it produces no output, and we need to check whether it would be better off producing no output rather than y*. If it produces no output it makes a loss equal to FC. Thus the firm's optimal decision is to produce nothing if its best positive output y* yields a loss greater than FC, and otherwise to produce y*. Put differently, the optimal decision is to produce no output if the price is less than the minimum of the firm's average variable cost (in which case for every unit the firm sells it makes a loss). In summary: A firm's short run supply function is given as follows. 1. If price is less than the minimum of the firm's AVC then the optimal output is zero. 2. If the price exceeds the minimum of the firm's AVC then the optimal output y* satisfies the conditions that p = SMC(y*) and SMC is increasing at y*. Long run supply - In the long run the firm pays nothing if it does not operate. Thus its supply function is given by the part of its marginal cost function above its long run average cost function. (If its maximal profit it positive it wants to operate; if its maximal profit it negative it does not want to operate.) In summary: A firm's long run supply function is given as follows. 1. If price is less than the minimum of the firm's LAC then the optimal output is zero. 2. If the price exceeds the minimum of the firm's LAC then the optimal output y* satisfies the conditions that p = LMC(y*) and LMC is increasing at y*. Elasticity of Supply - The price elasticity of supply is defined as a numerical measure of the responsiveness of the quantity supplied of product (A) to a change in price of product (A) alone. It is the measure of the way quantity supplied reacts to a change in price. . When there is a relatively inelastic supply for the good the coefficient is low; when supply is highly elastic, the coefficient is high. Supply is normally more elastic in the long run than in the short run for produced goods. As spare capacity and more capital equipment can be utilised the supply can be increased, whereas in the short run only labor can be increased. Of course goods that have no labor component and are not produced cannot be expanded. Such goods are said to be "fixed" in supply and do not respond to price changes. The quantity of goods supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks which they can build up or run down. The determinants of the price elasticity of supply are: The existence of the naturally occurring raw materials needed for production; the length of the production process; the production spare capacity (the more spare capacity there is in an industry the easier it should be to increase output if the price goes up); the time period and the factor immobility (the ease of resources to move into the industry); the storage capacity of the merchants (if they have more goods in stock they will be able to respond to a change in price more quickly). COST - A cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In economics, a cost is an alternative that is given up as a result of a decision. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production. Costs are often further described based on their timing or their applicability. Cost Concepts: 1. Economic Costs: The economic cost of a decision depends on both the cost of the alternative chosen and the benefit that the best alternative would have provided if chosen. Economic cost differs from accounting cost because it includes opportunity cost. 2. Short Run Costs: The concept of the short-run refers to the decision-making time frame of a firm in which at least one factor of production is fixed. Costs which are fixed in the short-run have no impact on a firms decisions. For example a firm can raise output by increasing the amount of labour through overtime. A generic firm can make three changes in the short-run: Increase production, Decrease production, Shut down. In the short-run, a profit maximizing firm will: Increase production if marginal cost is less than price; Decrease production if marginal cost is greater than price; Continue producing if average variable cost is less than price, even if average total cost is greater than price; Shut down if average variable cost is greater than price. Thus, the average variable cost is the largest loss a firm can incur in the short-run. 3. Long Run Costs: he long-run time frame assumes no fixed factors of production. Firms can enter or leave the marketplace, and the cost (and availability) of land, labor, raw materials, and capital goods can be assumed to vary. In contrast, in the short-run time frame, certain factors are assumed to be fixed, because there is not sufficient time for them to change. This is related to the long run average cost (LRAC) curve, an important factor in microeconomic models. A generic firm can make these changes in the long-run: Enter an industry, Increase its plant, Decrease its plant, Leave an industry. Long run marginal cost (LRMC) refers to the cost of providing an additional unit of service or commodity under assumption that this requires investment in capacity expansion. LRMC pricing is appropriate for best resource allocation, but may lead to a mismatch between operating costs and revenues. In long run equilibrium, the LRMC=Long run average total cost (LRATC) at the minimum of LRATC. In macroeconomic models, the long run assumes full factor mobility between economic sectors, and often assumes full capital mobility between nations. The concept of long run cost is used in cost-volume-profit analysis and product mix analysis.

the sample are weighed equally. B. Exponential smoothing: uses weighted average of past data as the basis for a forecast. Yt+1 = aYt + (1-a) Yt or Y new = a Y old + (1-a) Y’ old, where, Y new = exponentially smoothed average to be used as the forecast, Y old = most recent actual data, Y’old = most recent smoothed forecast, a = smoothing constant. Smoothing constant (or weight) has a value between 0 and 1 inclusive. Popular because: simple, inexpensive, time series data often exhibit a persistent growth trend. Disadvantage: this technique yields acceptable results so long as the time series shows a persistent tendency to move in the same direction. Whenever a turning point occurs, however, the trend projection breaks down. The real challenge of forecasting is in the prediction of turning points rather than in the projection of trends. Judgemental approach - Required when: 1. Analysis of time series and trend projections is not feasible because of wide fluctuations in sales or because of anticipated changes in trends; and 2. Use of regression method is not possible because of lack of historical data or because of management’s inability to predict or even identify causal factors. ISOQUANT - An isoquant (derived from quantity and the Greek word iso, meaning equal) is a contour line drawn through the set of points at which the same quantity of output is produced while changing the quantities of two or more inputs. While an indifference curve helps to answer the utility-maximizing problem of consumers, the isoquant deals with the cost-minimization problem of producers. Isoquants are typically drawn on capital-labor graphs, showing the tradeoff between capital and labor in the production function, and the decreasing marginal returns of both inputs. Adding one input while holding the other constant eventually leads to decreasing marginal output, and this is reflected in the shape of the isoquant. A family of isoquants can be represented by an isoquant map, a graph combining a number of isoquants, each representing a different quantity of output. Shapes of Isoquant Curve: If the two inputs are perfect substitutes, the resulting isoquant map generated is represented in fig. A; with a given level of production Q3, input X is effortlessly replaced by input Y in the production function. The perfect substitute inputs do not experience decreasing marginal rates of return when they are substituted for each other in the production function. If the two inputs are perfect complements, the isoquant map takes the form of fig. B; with a level of production Q3, input X and input Y can only be combined efficiently in a certain ratio represented by the kink in the isoquant. The firm will combine the two inputs in the required ratio to maximize output and minimize cost. If the firm is not producing at this ratio, there is no rate of return for increasing the input that is already in excess. Isoquants are typically combined with isocost lines in order to provide a cost-minimization production optimization problem.

A B ISOCOST - an isocost line represents a combination of inputs which all cost the same amount. Although similar to the budget constraint in consumer theory, the use of the isocost pertains to cost-minimization in production, as opposed to utility-maximization. The typical isocost line represents the ratio of costs of labour and capital, so the formula is often written as: , Where w represents the wage of labour, and r represents the rental rate of capital. The slope is: or the negative ratio of wages divided by rental fees. The isocost line is combined with the isoquant line to determine the optimal production point (at a given level of output). The cost function for a firm with two variable inputs - Consider a firm that uses two inputs and has the production function F. This firm minimizes its cost of producing any given output y if it chooses the pair (z1, z2) of inputs to solve the problem Min z1,z2w1z1 + w2z2 subject to y = F (z1, z2), where w1 and w2 are the input prices. Note that w1, w2, and y are given in this problem---they are parameters. The variables are z1 and z2. Denote the amounts of the two inputs that solve this problem by z1*(y, w1, w2) and z2*(y, w1, w2). The functions z1* and z2* are the firm's conditional input demand functions. (They are conditional on the output y, which is taken as given.) The firm's minimal cost of producing the output y is w1z1*(y,w1, w2) + w2z2*(y,w1, w2) (the value of its total cost for the values of z1 and z2 that minimize that cost). The function TC defined by which is called the firm's (total) cost function. (Note that the hard part of the problem is finding the conditional input demands; once you have found these, then finding the cost function is simply a matter of adding the conditional input demands together with the weights w1 and w2.)