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**Unformatted text preview: **1 Oligopoly and Game Theory (TF Chapter 11 pp. 241-250) 2 Today’s Agenda Characteristics of an oligopoly Game theory Applications of game theory to oligopolies 3 Oligopoly • An Oligopoly has the following basic characteristics – A small number of firms – The firms produce identical or differentiated products – There are barriers to entry 4 Oligopoly • Because there are only a small number of firms, firms recognise that – Actions of rival firms can have a large impact on profits – A firm’s own actions can influence the profits and actions of rivals – For example, the quantity sold by any one producer depends on the prices charged and quantities sold by other producers 5 Game Theory • How firms interact strategically is very sensitive to particular contexts → There are many models of oligopoly behaviour • Game theory is a tool used to analyse the strategic interaction of agents (firms or people) 6 Game Theory • What is a game? – Games have these components: • Rules • Actions • Strategies • Payoffs 7 Dominant strategy • A dominant strategy – A strategy that is optimal for every possible strategy of your rival – A weakly dominant strategy gives a payoff that is greater than or equal to other strategy payoffs for every possible rival strategy – A strictly dominant strategy gives a strictly larger payoff for every possible rival strategy 8 • In a Nash equilibrium , each player takes their best possible action given the action of their opponent . Nash Equilibrium 9 An example: The Prisoners’ Dilemma • The setting: • Two bank robbers (Timmy and Jimmy) have been captured by the police • There is no physical evidence so without a confession, the police cannot convict them of a robbery • Without a confession they can only convict them for a minor crime: possession of unlicensed weapons • The police have a cunning plan… 10 10 • Rules of the game – Prisoners are put in separate rooms and cannot communicate with each other. – They are told • If one of the prisoners confesses, he can go free • The partner will then be convicted and face a heavy sentence for uncooperative behaviour • If both prisoners confess, they will be convicted and face a moderate sentence • If neither confesses they will each be convicted for the minor crime An example: The Prisoners’ Dilemma 11...

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