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# Topic12 - Game theory and oligopoly 12 Game theory and...

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1 12. Game theory and oligopoly Game theory and oligopoly Game theory is the study of how people behave in strategic situations. Strategic decisions are those in which each person (firm), in deciding what actions to take, must consider how other people (firms) might respond to that action. Because the number of firms in an oligopolistic market is small, each firm must act strategically. Game theory: key Concepts Basic elements of a game The players Their strategies The payoffs Example Suppose that Virgin Blue and Qantas are the only airlines that serve the Adelaide to Alice Springs market. Should Virgin Blue spend more money on advertising? The outcome of each strategy by these two airlines can be represented in the form of a payoff matrix. The payoff matrix for an advertising game Raise spending Leave spending the same Raise spending Leave spending the same Qantas gets \$5500 Qantas gets \$3500 Qantas gets \$8000 Qantas gets \$6000 Virgin Blue gets \$5500 Virgin Blue gets \$8000 Virgin Blue gets \$6000 Virgin Blue gets \$3500 Qantas’s choice Virgin Blue’s choice Game theory: key concepts Key assumption: players are NOT allowed to cooperate but instead must make independent decisions about what strategy they will choose. A dominant strategy exists if there is a best strategy for a player to follow, regardless of the strategies pursued by other players. A dominated strategy is any other strategy available to a player who has a dominant strategy. A Nash equilibrium is a non-cooperative outcome. Game theory: key concepts A dominant strategy equilibrium exists when all players have a dominant strategy and play that strategy. A Nash equilibrium is a situation in which every player is doing the best that they can, given the strategies that all the others have chosen.

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