7.12.

2022

Oligopoly: Game Theory

Firm B
High (£1) Low (90p)
Firm A High (£1) £3m, £3m £0.5m, £4m
Low (90p) £4m, £0.5m £1m, £1m
Each firms reactions depend on the other firm’s decisions.

Nash Equilibrium and Dominant Strategy with both benefiting from low prices (90p)

Conclusions:

Price Rigidity (therefore relies on Non-Price Competition)

Temptation to Collude (since both firms benefit from higher prices)

Incentive to cheat on collusive agreement (both firms are tempted to undercut other firms)

Assumptions

Only base on what is best for themselves – assumes rational agents

Examples of Matrices

Paper Rock Scissors

Paper 0, 0 5, 0 0, 1
Rock 0, 5 0, 0 10, 0
Scissors 1, 0 0, 10 0, 0
Banks, Prisoner’s Dilemma

What is Game Theory

Special case of rational choice theory. It considers small human irrationalities. The human element
has a large impact on anticipating and responding to another’s decision with each choosing that
which benefits them both.

Exercise 5

2 firms competing with identical goods – few large firms operating the route

High barriers to entry

Difference Between Dominant Strategy and Nash Equilibrium

Dominant Strategy: highest expected returns total

Nash Equilibrium: the best decision a person can make based on another person’s decision