Each firm has an incentive to moderately lower its price and thus increase its sales at its competitors' expense. each firm knows that its rivals would promptly discover such deviation and follow suit shortly  The problem of interdependence has thwarted economists' attempts to develop a good theory of oligopoly. each recognizes that his decisions affect others who may react to what he does.Oligopoly pricing resembles a repeated prisoners' dilemma game.  .  However. When there are only a few sellers.

dealing with a multitude of individual consumers.The Oligopolist is big enough to affect the market in some way.  His decision can hugely impact sales  .

then each will receive a five-year jail term. If neither prisoner confesses. The police have placed Dave and Henry in jail. in separate cells. while the one who remains silent will go to jail for 20 years. which is a branch of applied mathematics and economics dealing with choices made under conflict and uncertainty. The police need the confession of at least one of the prisoners in order to get a conviction. Each prisoner is offered the following deal: if one testifies against the other while the other remains the silent.   The"prisoners' dilemma" was first described in the field of "game theory". then the police can only convict them on a minor charge with a three-month prison term. the one who testifies will not be convicted of anything. If both confess. . Suppose that the police believe Dave and Henry have committed a crime but the evidence is weak.

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20 years. then they can theoretically maximize industry profits by setting a monopolistic price. each prisoner does not have knowledge of what the other prisoner will do. The most rational response from the individual is to confess.   The optimum result for the two together is to stay silent. Firms would then have to figure out how to fairly divide up the Profits. If the other prisoner stays silent. due to a lack of cooperation and trust. If firms within an oligopolistic industry have cooperation and trust with each other. . in which Dave and Henry will each get only three months prison time. then that person gets off free. However. then the prison term will be less (five years vs. if the other prisoner confesses. A similar situation occurs with oligopolies. The prisoners' dilemma illustrates a situation in which individuals arrive at a non-optimal solution.

-5 -10. -3 (montths) . -10 Deny -3.Confess Confess Deny -5. 0 0.

. The Prisoners’ Dilemma is a good example of a static game of complete information. This is probably the simplest form of a game that involves the interaction of multiple individuals in a decision making process.

it seems that both players are better off cooperating every turn. he can expect his partner to treat him similarly next time. . but it is not clear if it is righte. resume their profession. Both Convicts will eventually get out of jail. Each knows that if he betrays his partner this time around. The victim will respond by betraying on the next turn. Many real-world situations involve repeated plays. and be caught again. but only because the game is being played only once.   One obvious response to the analysis of the prisoner's dilemma is that its result is correct. so they both refuse to confess. On net. and perhaps several more. The argument is persuasive.

A set of players 2. A set of possible strategies for each player 3. A payoff or outcome function that assigns payoffs to each player for each combination of strategies (one strategy for each player). .A Game is defined as : 1.

equilibrium means that no one wishes to change their behavior as long as nothing else changes.   Nash equilibrium concept we have to remember what an equilibrium here means. Remember that a simple demand and supply equilibrium means that consumers are purchasing their desired quantity demanded and suppliers are selling their desired quantity supplied and neither wants to change as long as the other doesn't. we also learned that a change on one side of the market (such as a change in income or a change in production costs) will lead to new desired quantities on both sides . But.

In other words. If each firm acts independently. each firm tries to maximize its profit independently. neither wishes to change strategies so long as the other player doesn't. . This approach assumes that the oligopoly firms make no attempt to work together. the result is a Nash equilibrium. In such a situation.   A Nash equilibrium exists when each player is doing the best she can given what the other player is doing. or that there are too many firms for any agreement to be reached. Perhaps they believe that agreements are not worth making because they are too hard to enforce.

In the US for . it's best to do what the other drivers are doing. in other countries they drive on the left. But.  This simple payoff matrix illustrates this. In many coutries drivers drive on the right hand side of the road. Consider the driving game to the right. no matter where you drive.

we must be careful what we define a strategy to be. . In the former case. in describing the game. as you will see. This means that. each firm decides how much to sell and lets the market determine what price it can sell it at. he holds their behavior constant and adjusts his to maximize his gains. the firm chooses its price and lets the market determine quantity.   Part of the definition of Nash equilibrium is that each player takes what the other players are doing as given when deciding what he should do. different definitions lead to different conclusions. The two obvious alternatives are to define a strategy by quantity or by price. in the latter.

Other firms are assumed to hold the quantity they produce constant. Marginal revenue is calculated from the residual demand curve (its share in the industry demand curve). . assuming that their output stays the same.   On this interpretation of Nash equilibrium. each firm observes the quantities being produced by the other firms and calculates how much it should produce to maximize its profit. One firm in an oligopoly calculates its profitmaximizing quantity of output where marginal revenue equals marginal cost.

All other firms are assumed to hold their prices constant. the lowest such price is P1. .  Each firm observes the prices that other firms are charging and picks the price that maximizes its profit on the assumption that their prices will not change. The firm maximizes its profit producing Q* and selling it for just under P1. One firm in an oligopoly chooses its profitmaximizing price.

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