Game Theory



Game theory is the study of behavior in strategic situations in which the outcome of an individual's actions depends on the actions of others. This is relevant in the case of an oligopoly because when a firm has competition, each firm must consider not only its own decisions but also the actions and reactions of the other firms in the market. The Prisoner's Dilemma is the most famous type of game. Here, players have dominant strategies to confess to their crimes, making them both worse off in the end. The Nash equilibrium occurs when the players confess, leading to longer sentences for both than they would have received if they had denied their crimes. Some games have no dominant strategies, and others may have no Nash equilibrium. Playing the Prisoner's Dilemma repeatedly changes the outcome. Players may not follow their dominant strategies and may be able to cooperate with each other in denying their guilt.

At A Glance

  • Game theory is the study of strategic behavior, and each game has three components: players, strategies, and payoffs.
  • The Prisoner's Dilemma is a game with two strategies available to players: cooperate or defect. Each player has a dominant strategy to defect, and the Nash equilibrium produces a worse outcome for both players than if they had cooperated with one another.
  • A game can be solved by looking for each player's best response, given the other player's choice.
  • A dominant strategy is a strategy that is the best choice regardless of the option chosen by the player's opponent.
  • A Nash equilibrium is a game outcome in which no participant can gain by a change of strategy if the strategies of others remain unchanged.
  • There are many types of games. Some have dominant strategies, and others do not. Some games may not have a Nash equilibrium.
  • In repeated Prisoner's Dilemmas, players are better off not following their dominant strategies. Instead, they minimize their prison time by following a tit-for-tat strategy.