Game Theory Flashcards
What is game theory?
A method of studying strategic situations. (Strategic situation = where the outcomes that affect one firm depend not only on his decisions, but the decisions of his rivals.
What are the two game theory models?
- Simultaneous games (also NORMAL / STRATEGIC FORM)
- Sequential games (also EXTENSIVE FORM)
What is a simultaneous game?
Not just that players make decisions at the same time. Also, the decision of one firm is made without knowing what decisions have been made by rivals.
What is a sequential game?
Where moves are made sequentially, so that players can clearly see what decisions have been made by other players.
What is a dominant strategy?
A dominant strategy exists where it is optimal for a player to pick a certain strategy regardless of what strategies are being played by it’s rivals.
What is a dominant strategy equilibrium?
Simply, a situation where both players are playing their dominant strategy.
What is a Nash equilibrium?
A situation where both players are acting according to their best response analysis. When this happens, no player can be made better off by changing his individual strategy, given the strategies of others.
Why do we use the concept of Nash equilibrium?
Sometimes, no dominant strategies exist. Also, Nash equilibriums are stable and self-enforcing.
Why is collusion not stable in a prisoners dilemma?
Because a firm would gain if it cheated on the agreement. This fear that rivals will cheat means the equilibrium will be the Nash equilibrium.
When is coordination between firms possible?
When it is beneficial for both firms to pick the same strategy (ie. when it is beneficial for both firms to adopt the same technology). Note: This is only possible if firms are able to communicate about their decision.
Why do we discount future profits when considering infinitely repeated games?
Because a pound earned in the first period is worth more than pounds earned in the future.
Because of this, the present value of profits = [(1+i)/i] * profit earned in each period.
What is a trigger strategy?
A strategy that is contingent on the past actions of the players in the game. Player initially cooperates, but will punish it’s rival if they renege on the agreement.
What is a grim trigger strategy?
Where firms agree to collude, but also agree that if their rival cheats on the agreement, they will charge a low price in every consequent period. If both firms agree to this, then collusion can be sustained.
When is there an incentive for a firm to cheat on an agreement?
Simply, when the profits of cheating are greater than the present value of profits gained from cooperating. (This will depend on the interest rate)
What conditions make collusion more sustainable?
- When firms know who their rivals are.
- When a firm is able to see when a rival has cheated.
- When firms know who their rival’s customers are, so they can steal them if the rival cheats.
- When punishment is possible.
