Chapter 24

Chapter 24 - Chapter 24 Strategic Thinking and Game Theory...

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Unformatted text preview: Chapter 24 Strategic Thinking and Game Theory For most of the book, we have assumed that individuals are “small” — that they are unable to alter the economic environment that emerges from individual decisions in a competitive equilibrium and therefore have no reason to think about their role in the world “strategically”. 1 In Chapter 23, we began to deviate from this assumption by considering the case of “large” firms that constitute monopolies, and we found that such firms become “price setters” who deliberately manipulate the economic environment in which they operate. But the case of monopolies is just one example of a large set of possible economic settings in which such deliberate – or “strategic” – thinking becomes important, and strategic considerations can become considerably more complex than those we encountered in Chapter 23. Before we can proceed to a more general analysis of strategic behavior, we therefore have to develop some new tools. Known collectively as game theory , these tools find their roots in the pioneering work of John Nash (1928-) in the 1940’s and 1950’s and have become integrated into a variety of social sciences over the following decades. 2 For economic situations in which strategic thinking matters, the game theory approach models the most salient features of such situations as a “game” in which fictional “players” face incentives that are similar to those faced by the real-world actors in the underlying economic setting. In 1994, this approach received the full recognition of the economics community when John Nash and two succeeding game theorists, John Harsanyi (1920- 2000) and Reinhard Selten (1930-), were awarded the Nobel Prize in Economics. Nash’s compelling life story has since been immortalized in the movie “A Beautiful Mind” (which takes some artistic liberties with game theory as explored further in end-of-chapter exercise 24.1). While game theory thus opens the door to incorporating strategic thinking into economic models, the models still follow the same path that we have seen in our development of competitive markets: First, a model is defined; second, we analyze how individuals “do the best they can” within the context of the model; and finally, we investigate how an “ equilibrium” emerges – an equilibrium in which we discover the economic environment that arises when everyone is doing the best he can given what everyone else is doing. The only difference from our competitive models is that there 1 This chapter introduces a new set of tools and does not directly build on any previous material. 2 You will also find these same tools having found their way into evolutionary biology where scientists have modeled biological evolution as if it were guided by the strategic behavior of genes. 900 Chapter 24. Strategic Thinking and Game Theory is now an incentive for individuals to strategically consider how their own behavior impacts the equilibrium, a consideration that is absent when individuals are too small to have such an impact.equilibrium, a consideration that is absent when individuals are too small to have such an impact....
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This note was uploaded on 05/13/2010 for the course ECON 105D taught by Professor Cur during the Fall '09 term at Duke.

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Chapter 24 - Chapter 24 Strategic Thinking and Game Theory...

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