Eslsca 2017

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Eslsca 2017

© All Rights Reserved

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Game Theory

Game theory is a tool for studying strategic behavior,

which is behavior that takes into account the expected

behavior of others and the mutual recognition of

interdependence.

What Is a Game?

Rules

Strategies

Payoffs

Outcome.

Game Theory

The Prisoners Dilemma

The prisoners dilemma game illustrates the four features

of a game.

The rules describe the setting of the game, the actions the

players may take, and the consequences of those actions.

In the prisoners dilemma game, two prisoners (Art and

Bob) have been caught committing a petty crime.

Each is held in a separate cell and cannot communicate

with each other.

Game Theory

Each is told that both are suspected of committing a more

serious crime.

If one of them confesses, he will get a 1-year sentence for

cooperating while his accomplice get a 10-year sentence for

both crimes.

If both confess to the more serious crime, each receives 3

years in jail for both crimes.

If neither confesses, each receives a 2-year sentence for the

minor crime only.

Game Theory

In game theory, strategies are all the possible actions of

each player.

Art and Bob each have two possible actions:

Confess to the larger crime

Deny having committed the larger crime.

Because there are two players and two actions for each

player, there are four possible outcomes:

Both confess

Both deny

Art confesses and Bob denies

Bob confesses and Art denies

Game Theory

Each prisoner can work out what happens to himcan work

out his payoffin each of the four possible outcomes.

We can tabulate these outcomes in a payoff matrix.

A payoff matrix is a table that shows the payoffs for every

possible action by each player for every possible action by

the other player.

The next slide shows the payoff matrix for this prisoners

dilemma game.

Game Theory

Game Theory

If a player makes a rational choice in pursuit of his own best

interest, he chooses the action that is best for him, given any

action taken by the other player.

way, the outcome is an equilibrium called Nash

equilibriumfirst proposed by John Nash.

The following slides show how to find the Nash equilibrium.

Bobs

view

of the

world

Bobs

view

of the

world

Arts

view

of the

world

Arts

view

of the

world

Equilibrium

Oligopoly Games

An Oligopoly Price-Fixing Game

A game like the prisoners dilemma is played in duopoly.

A duopoly is a market in which there are only two

producers that compete.

Duopoly captures the essence of oligopoly.

The figure on the next slide describes the demand and

cost situation in a natural duopoly.

Oligopoly Games

Part (a) shows each firms cost curves.

Part (b) shows the market demand curve.

Oligopoly Games

This industry is a natural duopoly.

Two firms can meet the market demand at the least cost.

Oligopoly Games

How does this market work?

What is the price and quantity produced in equilibrium?

Oligopoly Games

Suppose that the two firms enter into a collusive

agreement.

A collusive agreement is an agreement between two (or

more) firms to restrict output, raise price, and increase

profits.

Such agreements are illegal in the United States and are

undertaken in secret.

Firms in a collusive agreement operate a cartel.

Oligopoly Games

The possible strategies are:

Comply

Cheat

Because each firm has two strategies, there are four

possible outcomes:

Both comply

Both cheat

Trick complies and Gear cheats

Gear complies and Trick cheats

Oligopoly Games

The first possible outcomeboth complyearns the

maximum economic profit, which is the same as a monopoly

would earn.

Oligopoly Games

To find that profit, we set marginal cost for the cartel equal to

marginal revenue for the cartel.

Oligopoly Games

The cartels marginal cost curve is the horizontal sum of the

MC curves of the two firms and the marginal revenue curve

is like that of a monopoly.

Oligopoly Games

The firms maximize economic profit by producing the

quantity at which MCI = MR.

Oligopoly Games

Each firm agrees to produce 2,000 units and each firm

shares the maximum economic profit.

Oligopoly Games

When each firm produces 2,000 units, the price is greater

than the firms marginal cost, so if one firm increased

output, its profit would increase.

Oligopoly Games

Thee figure below shows what happens when one firm

cheats and increases its output to 3,000 units. Industry

output rises to 5,000 and the price falls.

Oligopoly Games

For the complier, ATC now exceeds price.

For the cheat, price exceeds ATC.

Oligopoly Games

For the complier incurs an economic loss.

The cheat earns an increased economic profit.

Oligopoly Games

Either firm could cheat, so this figure shows two of the

possible outcomes.

Next, lets see the effects of both firms cheating.

Oligopoly Games

The figure below shows the outcome if both firms cheat

and increase their output to 3,000 units.

Oligopoly Games

Industry output is 6,000 units, the price falls, and both

firms earn zero economic profitthe same as in perfect

competition.

Oligopoly Games

Youve now seen the four possible outcomes:

If both comply, they make $2 million a week each.

If both cheat, they earn zero economic profit.

If Trick complies and Gear cheats, Trick incurs an

economic loss of $1 million and Gear makes an economic

profit of $4.5 million.

If Gear complies and Trick cheats, Gear incurs an

economic loss of $1 million and Trick makes an economic

profit of $4.5 million.

The next slide shows the payoff matrix for the duopoly

game.

Payoff

Matrix

Tricks

view

of the

world

Tricks

view

of the

world

Gears

view

of the

world

Gears

view

of the

world

Equilibrium

Oligopoly Games

The Nash equilibrium is where both firms cheat.

The quantity and price are those of a competitive market,

and the firms earn normal profit!!!

THE END

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