Topic 11 - Thinking Strategically

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Thinking Strategically

The Theory of Games

The 3 Elements of a Game Include:

1. Players
2. Possible Strategies a
3. Pay-Offs

[1] Cartels are a group of firms that conspire to coordinate production and pricing in an industry for the purpose of earning an economic profit. They only exist on the basis of an expectation for repeated games, visibility to punish and the ability to punish non cooperation. Australia's whistle blower strategy attempts to reduce or eliminate cartels in the business environment.

Strategy

1. Dominant - when 1 player has a strategy that yields a higher payoff no matter what the other player does
2. Dominated - when 1 player has a strategy that yields a higher payoff no matter what the other player does

Nash Equilibrium

Nash Equilibrium occurs in a game when each players strategy is their best choice given the other player’s strategies. Essentially no player has an incentive to change strategy.

Prisoners Dilemma - A Game Theory Example

This image from wikipedia portrays the prisoners dilemma.[2]

In this example, the prisoners are unable to talk to each other in making their decision. Hence, they will both use their dominant strategy of betraying the other prisoner (confessing) as no matter what the other person chooses they will be better off by confessing. Since both confess (use their dominant strategy), they end up with 3 months jail which is the nash equilibrium.

It is important to note, that if they could cooperate with each other, potentially they would have both remained silent and both received 1 months jail time.

Another Example - Water Suppliers

This example is from the prescribed textbook. [3]

The graph on the left shows the market demand and marginal revenue for 2 suppliers of water (for simplicity, the marginal cost is assumed to be 0). The graph on the right (payoff matrix) shows the strategies each firm could choose and their respective payoffs

• If the 2 Firms agree to sell half the quantity demanded at the price a monopolist would charge - \$1 (500 quantity produced each)
• \$500 Producer Surplus each
• If one firm reduced their price to \$0.90, than:
• Their quantity supplied increases to 1100 and their profits or surplus rise to \$990 (and the other firm has 0 profits)
• Then the other firm will reduce to \$0.90, Than quantity supplied will be 550 Each and profits will be \$495 each (less than \$500 previously)

References

1. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
2. http://en.wikipedia.org/wiki/Prisoner's_dilemma
3. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.
4. Frank, Jennings, Bernanke, R, 2011. Principles of Microeconomics. 3rd ed. Australia: MCGRAW-HILL.