Key Diagrams - Game Theory Examples

In this video we walk through two examples of game theory pay-off matrices that might be applied in exam questions on oligopoly, price & non-price competition and collusion.

“Game theory” is a technique used by economists to help them analyse how different people or groups will behave in a given situation, assuming that they are rational. Game theory techniques really started to be developed and used by economists in the 1940s and 1950s.

A game theory pay-off matrix is a way of applying the concept of interdependent decision making between businesses in an oligopoly or duopoly. For example, you can use it to help analyse and evaluate the benefits and risks of price collusion and also spending on non-price competition such as expensive advertising campaigns.

Interdependence means that the behaviour of one firm depends on the choices and behaviour of other firms; in other words, individual firms do not make decisions independently of each other. For example, if a supermarket such as Tesco decides to cut prices on BBQ food and sauces just after the summer holidays then other dominant supermarkets such as Sainsbury’s and Asda might base their pricing strategy on Tesco’s behaviour, and therefore also decide to cut the prices of their BBQ food and sauces.

For your exam, have one worked example in your revision notes of a pricing game payoff matrix and also one that focuses more on non-price competition between businesses.

Persistently high levels of advertising & marketing spending by businesses within an oligopoly can often be explained with reference to game theory ideas. If one firm decides to go heavy on marketing spend, other may follow suit for fear of losing market share and supernormal profits. The Nash Equilibrium might be high advertising spending for all firms which may have little impact on revenues and profits.