Game Theory

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Game Theory

• Oligopoly issues continued!

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Games Theory
Honestno joke! Its relevant!

• Have a game of stone, paper scissors!

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Need 2 volunteers

• to go outside!

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Game Theory The Prisoners Dilemma
You have been caught with a friend accused of
a serious crime. You could face up to 10 years
in jail. You have a choice to either Confess of
Deny the crime. Whats your choice?
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Prisoners Dilemma
What would have been your choices if youre
solicitor had briefed you better on what your
options could have been?
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Whats the best choice then??
Equilibrium occurs when each player takes the
best possible action for themselves given the
action of the other player The dominant strategy
is each prisoners unique best strategy
regardless of the other players action Best
strategy? Confess? A bad outcome (!) prisoners
could do better by both denying but once
collusion sets in, each prisoner has an incentive
to cheat!
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A Simple Game of Serendipity
Have a go once Then Ill show you the
grid Then have another 4 goes Keep a record of
your points

• Use your whiteboard work with a partner
• On the count of 3, you both have to choose to
  write down either
• the letter C or D.
• You could either win up to 4 points!

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Your choices.
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RD Game Dominant Strategy
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Research and Development Game
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Watch the video
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Decisions, Decisions.

• Game theory is the study of rational behaviour in
  situations involving interdependence
• May involve common interests coordination
• May involve competing interests rivalry
• Rational behaviour players do the best they can,
  in their eyes
• Because of interdependence, a rational decision
  must be based on a prediction of others
  responses
• Put yourself in the others shoes and predicting
  what action the other person will choose, you can
  decide your own best action.

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More examples of game theory

• Decisions taken either at the same time, or
  without knowledge of an action already taken by a
  rival / competitor
• Imperfect information or knowledge
• e.g. Choice of product design, advertising
  campaign
• e.g. Penalty shoot-out - goalie v. striker
  Tennis server v. receiver

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Basic Game Theory

• Game Theory seeks to analyse strategic behaviour
  between firms
• Now a major research field in academic economics
• Each firm in an oligopoly recognises its
  interdependence
• Participants must consider rules, strategies and
  payoffs
• Classic game is the Prisoners Dilemma
• A range of oligopoly games have been developed in
  recent years

• Game theory can be applied to both price and
  non-price competition within an oligopoly
• Examples
• Enter a price war or keep prices constant
• Engage in costly research and development or not
• Spend huge sums on an advertising campaign
  against rival firms?

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Why is Game theory relevant to Oligopoly?....Adver
tising!

• Half the money spent on advertising is wasted
  the problem is identifying which half!
• Pepsi Cola and Coca Cola must independently must
  decide how heavily to advertise.
• Advertising is expensive, but if one firms
  chooses to advertise moderately while the other
  advertises heavily, then the first loses out
  while the second does well

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Its also relevant to

• Productivity whether to expand capacity
• RD investment into innovation
• Financial investment into new technology
• HRM to rationalise or not?

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Quick revision

• Use whiteboard
• Can you draw explain the Kinky D curve of an
  oligopolist?

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Deriving the Kinked Demand Curve
Raising price above P1 Demand is relatively
elastic Firm loses market share and some total
revenue
Price
Assume we start out at P1 and Q1 Will a firm
benefit from raising price above P1? Will it
benefit from cutting price below P1?
P1
Reducing price below P1 Demand is relatively
inelastic Little gain in market share other
firms have followed suit Total revenue may still
fall
AR1
Output
Q1
MR1