Micro Review

1
Micro Review

• Game Theory and Taxation

2
Dominant Strategy

• One strategy is better for a given player,
  regardless of what his/her opponent chooses to do

3
Game Theory
Game Theory Model to Analyze Behavior

• Uptown Dominant
• Strategy Low
• Rareair Dominant
• Strategy Low

RareAirs Price Strategy

• 2 Competitors
• 2 Price Strategies
• Each Strategy Has a Payoff Matrix

High
Low
A
B
12
15
High
12
6
Uptowns Price Strategy
C
D
6
8
Low
15
8
4
Nash Equilibrium
NASH EQUILIBRIUM when each player is pursuing
their best possible strategy in the full
knowledge of the other players strategies. A
Nash equilibrium is reached when nobody has any
incentive to change their strategy.
5
An Example of a Nash Equilibrium
Column
a
b
0,1
1,2
a
Row
b
1,0
2,1
(b,a) is a Nash equilibrium. To prove this
Given that column is playing a, rows best
response is b. Given that row is playing b,
columns best response is a.
6
Tax Incidence
Efficiency Loss of a Tax
S
Tax Paid by Consumers
S
Tax 2
Efficiency Loss (or Deadweight Loss)
Tax Paid by Producers
D
7
Tax Incidence
Demand Elasticity and the Incidence of an Excise
Tax
St
St
Tax
Tax
S
S
a
Pi
a
Pe
b
P1
P1
b
De
Pb
Pa
c
c
Dt
Q2
Q1
Q2
Q1
Tax Incidence and Elastic Demand- burden on the
supplier
Tax Incidence and Inelastic Demand- burden on the
consumer