Chapter 10: Game Theory: Inside Oligopoly
Players – individuals (also: firms) who make decisions.
Strategies – planned decisions of the players.
In the context of oligopoly games:
1. Simultaneous-move game – games in which each player makes decisions without
knowledge of the other players’ decisions.
2. Sequential-move game – game in which one player makes a move after observing the
other player’s move.
One-shot game – Players will play the game only once.
Repeated game – The game is played more than once.
The type of pricing games which the move is made simultaneously is usually called Bertrand
Duopoly Game.
Strategy – In game theory, a decision rule that describes the actions a player will take at each
decision point.
Normal-form game – A representation of a game indicating the players, their possible
strategies, and the payoffs resulting from alternative strategies.
Dominant strategy – A strategy that results in the highest payoff to a player, regardless of the
opponent’s action. When you have a dominant strategy it is best to play it.
If you do not have a dominant strategy, look at the game from your rival’s perspective. If your
rival has a dominant strategy, anticipate that he/she will play it.
It is smart to play a secure strategy if there is no dominant strategy.
Secure strategy – A strategy that guarantees the highest payoff given the worst possible
scenario.
, The secure strategy suffers from two shortcomings:
1. It is a conservative strategy and should be considered only if you have a good reason to
be extremely averse to risk.
2. It does not take into account the optimal decisions of your rival and thus may prevent you
from earning a significantly higher payoff.
Nash equilibrium – A condition describing a set of strategies in which no player can improve
her payoff by unilaterally changing her own strategy, given the other players’ strategies. Each
player is doing the best he can given what other players are doing.
Application of One-shot Games
Pricing decision - Collusion (which is illegal) is not a real option, because all parties have an
incentive to cheat.
Advertising and Quality decisions - In oligopolistic markets, firms advertise and/or increase their
product quality in an attempt to increase the demand for their products. However, there can be a
situation where each firm advertises just to cancel out the effect of other firms’ advertising,
resulting in high advertising expenditure with no change in demand and low profit.
Coordination decisions - In an environment where different appliances require different outlets,
a consumer who desires several appliances would have to spend a considerable sum wiring the
house to accommodate all of the appliances.
Monitoring employees - Game theory can also be used to analyze interactions between workers
and the manager.
Mixed (randomized) strategy – A strategy whereby a player randomizes over two or more
available actions in order to keep rivals from being able to predict his or her action.
Nash bargaining – Two players “bargain” over some object of value.
Infinitely repeated game – A game that is played over and over again forever and in which
players receive payoffs during each repetition of the game.
Players – individuals (also: firms) who make decisions.
Strategies – planned decisions of the players.
In the context of oligopoly games:
1. Simultaneous-move game – games in which each player makes decisions without
knowledge of the other players’ decisions.
2. Sequential-move game – game in which one player makes a move after observing the
other player’s move.
One-shot game – Players will play the game only once.
Repeated game – The game is played more than once.
The type of pricing games which the move is made simultaneously is usually called Bertrand
Duopoly Game.
Strategy – In game theory, a decision rule that describes the actions a player will take at each
decision point.
Normal-form game – A representation of a game indicating the players, their possible
strategies, and the payoffs resulting from alternative strategies.
Dominant strategy – A strategy that results in the highest payoff to a player, regardless of the
opponent’s action. When you have a dominant strategy it is best to play it.
If you do not have a dominant strategy, look at the game from your rival’s perspective. If your
rival has a dominant strategy, anticipate that he/she will play it.
It is smart to play a secure strategy if there is no dominant strategy.
Secure strategy – A strategy that guarantees the highest payoff given the worst possible
scenario.
, The secure strategy suffers from two shortcomings:
1. It is a conservative strategy and should be considered only if you have a good reason to
be extremely averse to risk.
2. It does not take into account the optimal decisions of your rival and thus may prevent you
from earning a significantly higher payoff.
Nash equilibrium – A condition describing a set of strategies in which no player can improve
her payoff by unilaterally changing her own strategy, given the other players’ strategies. Each
player is doing the best he can given what other players are doing.
Application of One-shot Games
Pricing decision - Collusion (which is illegal) is not a real option, because all parties have an
incentive to cheat.
Advertising and Quality decisions - In oligopolistic markets, firms advertise and/or increase their
product quality in an attempt to increase the demand for their products. However, there can be a
situation where each firm advertises just to cancel out the effect of other firms’ advertising,
resulting in high advertising expenditure with no change in demand and low profit.
Coordination decisions - In an environment where different appliances require different outlets,
a consumer who desires several appliances would have to spend a considerable sum wiring the
house to accommodate all of the appliances.
Monitoring employees - Game theory can also be used to analyze interactions between workers
and the manager.
Mixed (randomized) strategy – A strategy whereby a player randomizes over two or more
available actions in order to keep rivals from being able to predict his or her action.
Nash bargaining – Two players “bargain” over some object of value.
Infinitely repeated game – A game that is played over and over again forever and in which
players receive payoffs during each repetition of the game.
