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York University
ECON 2300

Intermediate Microeconomic Theory I ECON 2300 – Summer 2011 – Mark Melatos Topic 8 – Game Theory – July 7 Introduction to Games - Economic agents often have to make strategic choices: o Firms decide whether or not to enter an industry. o Firms decide how much advertising to undertake. o How much output should a firm produce and/or what price should it charge? o Governments have to determine how consumers/investors will respond to a new policy. o Countries decide what trade policy to follow. o How are these choices made? o How does an economic agent choose its optimal strategy? - An agent has to take into account how its opponents will respond to his/her action. o I.e. your opponent’s expected response determines what action you take. What Does a Game Look Like? - There are 2 types of strategic game: o Cooperative – players (agents) negotiate binding contracts that allow them to plan joint strategies. o Non-cooperative – when negotiation and enforcement of a binding contract are not possible. - Components of game o Players (only 2 for us). o A set of actions (strategies) for each player. o A way of determining the payoffs to each player from all possible outcomes of the game. How are Games Played? - We make 2 important assumptions: o Players are rational – they always seek to maximise their own playoffs. o Plays have full information about the game. Each knows what the payoff matrix looks like. - Games can be played in one of two ways: o Simultaneous movement – players move at the same time and do not observe their opponent’s action.  Players make a conjecture about what their rival will do based on the payoff matrix. o Sequential movement – one player moves first; the other player observed their choice of action and responds. The Outcome of the Game - The Nash Equilibrium (NE) o A NE is a set of strategies or actions:  Such that each player is doing the best they can, given the actions of its opponents.  From which no player has an incentive to deviate the strategies are stable. Dominant Strategies - A dominant strategy is an action that is optimal for a player, regardless what its opponent does. The Prisoners’ Dilemma - Intuition o Promising to collude is not credible. o Once one firm commits to colluding it is optimal for the other firm to ‘not collude’. - An inefficient outcome results because the players cannot trust each other, and there is no mechanism (e.g. a court of law) that can force players to keep their word. Mixed Strat
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