Oligopolies - Game Theory Flashcards
What is the problem in terms of game theory?
There is a prisoners dilemma
Explain the prisoners dilemma.
It essentially shows us interdependence, where one firms action, dictates the decision of another firm.
At the end, they will end up with the same outcome known as the nash equilibrium. This is the most rational position that can last in the long run.
Theres also a dominant strategy for firms to set a specific price, where they will always benefit.
What are the conclusions we reach from game theory?
Price rigidity.
At the nash equilibrium it makes no sense for that position to change, so there will be price rigidity here. Therefore firms will have to compete on non-price factors.
Temptation to collude.
The nash equilibrium is not the best outcome. If they both charged a high price they could make a lot more. Due to interdependence this outcome is not achieved. So firms are tempted to collude to make higher profits.
Incentive to cheat agreement.
Even if theres collusion and an agreement to fix prices, firms will always be incentivised to cheat because they can undercut this and make much more profits. Although its not good in the LR, it will always be an incentive.
Also, if theres fears of regulation, some firms may cheat as a result.
