Game Theory

Question 1

Game Theory - Prisoner’s Dilemma

Answer 1

Each firm can either raise their price or leave it unchanged. If both firms raise prices they will make more profit, this is pareto optimal. If one raises and one keeps it low, the one that keeps it low will make profit, the one that raised will lose money.

An example of a market where both firms set high prices in the expectation that others will do the same is the petrol market.

I firms trust each other it is likely that they will both raise prices, but the safest option is always to keep prices unchanged.

Question 2

Evaluating First Mover Advantage

2 Pros & Cons

Answer 2

Pros
A business first in the market can develop a significant advantage through learning by doing e.g. Red Bull, Dyson
Can exploit Internal EoS and also brand loyalty

Cons
Second-movers can learn a lot from first-mover mistakes e.g. Apple
Failure rate of 1st Movers is very high. R&D costs are huge

Question 3

Strategic Independence

Answer 3

One firm’s output and price decisions are influenced by the likely behaviour of competitors