Game Theory Lecture

Introduction to Game Theory

• Game Theory is a significant part of understanding imperfect competition.
• Two models of imperfect competition:
  1. Monopolistic Competition
     • Many firms, e.g., jeans companies, restaurants.
  2. Oligopoly
     • Few firms, e.g., video game manufacturers, cellphone providers.

Key Concepts in Game Theory

• Strategic Interactions
  • Firms consider competitors' reactions to their strategies.
• Example Scenarios
  • Verizon and AT&T's pricing decisions.
  • Chess and rock-paper-scissors as examples of strategic thinking.
• Soccer Penalty Kicks
  • Goalies and kickers anticipate each other's actions.
  • Study suggests more kicks should be aimed down the middle.

Economic Applications

• Advertising
  • Decisions depend on competitors' actions.
  • If both advertise, profits might not increase due to high costs.
• Pricing Strategies
  • Undercutting prices and anticipating competitor's response.
• Nuclear War
  • Arms race as a strategic interaction.

Game Theory Models

• Assumptions
  • Two players, simultaneous game, profit maximization.
• Payoff Matrix
  • Tool to summarize strategic options and outcomes.

Example: Coca-Cola vs. Pepsi

• Scenario: Both consider buying a Super Bowl ad.
• Possible outcomes and their profits are outlined in a payoff matrix.
  • Coca-Cola and Pepsi have different profits based on their advertising decisions.

Solving the Game

• Best Response
  • Determining best action based on competitor's choice.
• Dominant Strategy
  • A strategy that is always best for a player.
• Coca-Cola has a dominant strategy (always buying an ad).
• Pepsi reacts based on Coca-Cola's decision.

Nash Equilibrium

• Definition
  • A set of strategies where no player benefits from unilaterally changing their strategy.
• Finding Nash Equilibrium involves checking if any player can benefit from changing their action.

Example: Driving Game

• Players decide whether to drive on the left or right.
• Nash equilibriums are where both choose the same side to avoid crashes.

Conclusion

• Understanding strategic interactions is crucial in economics.
• Next session will focus on more specific types of games.