Game Theory

Game Theory
A2 Economics
Edexcel Unit 3…read more

What is it?
+ Game Theory is where firms (or people) make their
choices depending on the behaviour of others
+ This interdependence between firms makes strategies
very hard to predict…read more

Tacit Collusion
+ Quiet, and `behind the scenes'
+ No spoken agreement
+ Trying to limit competition and divide the market
+ Illegal in most countries
+ Always a temptation to break an agreement in order to
maximise profits
+ This can be illustrated in a simple game theory matrix…read more

Game Theory Matrix
Firm
B
High Low
price price
Firm A: £100m Firm A: £50m
High
price Profits are
Firm B: £100m Firm B: £120m
indicated
Firm next to the
A name of
Firm A: £120m Firm A: £80m each firm
Low
price Firm B: £50m Firm B: £80m…read more

Game Theory Matrix
+ We assume that there are 2 firms: Firm A and B
+ If the two firms, they will make profits of £100m each
by both setting high prices (top left box)
+ They each know they can maximise their individual
profits by lowering prices and breaking the agreement
+ One could obtain £120m while the other
has only £50m…read more

Game Theory Matrix
+ As a result of neither firm trusting the other, they will
both go for the low-price strategy and end up with
£80m each
+ This is a worse outcome than if they had colluded
+ Due to a lack of trust between firms, any collusive
agreement is likely to be broken
+ This is referred to as the maxim strategy…read more