introduction to game theory

Game Theory seeks to analyse strategic behaviour between firms Game theory is now a major research field in academic economics.

Each firm in an oligopoly recognises its interdependence - Participants must consider rules, strategies and payoffs - ie when making price and output decisions, how will other firms (players) in the market respond and react. This is the essence of Game Theory.

The classic game is the Prisoners’ Dilemma - this is shown in the tables below:

A range of oligopoly games have been developed in recent years

Game theory can be applied to both price and non-price competition within an oligopoly

Examples:

Enter a price war or keep prices constant
Engage in costly research and development or not

Consider the example shown in the tables below:

Spend huge sums on an advertising campaign against rival firms?