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Economics Game Theory

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Game theory is one of those particular concepts tha pupils can find either very easy or very difficult depending on how it is taught, could be the focus needs to be on firms but a good way to start is by considering the prisoner’s dilemma. Using the prisoner’s dilemma gives people the opportunity to focus on examples that they may be used in from school, or allow them to at least understand concepts that they are able to have seen I at work or on TV programs.

That gives them a basis in a background for them to then apply the same concepts here in this example will be working through, what I have got is two firms firm X and firm Y. they have choices they can the set the price at two pounds each or one-pound eighty each. Each firm can operate its by itself individually all they could decide to collude, in this case what we are able to see is by the two firms colluding their each able to make 10 million pounds with a revenue.

If however one of the firm’s in this case firm why decides to lower that price one-pound eighty they are able to take away market share from firm X as for the firm X kept their prices two pounds, and benefit to the tune additional revenue so they gain 12 million pounds with revenue firm X sees their revenue 425 million pounds. Firm X knowing that this potentially could happen are also inclined to undercut firm Y, so walls they may well have embarked on a collusive agreement there is an incentive for both firms to break that collusive agreement and we can see here.

In this example inbox see the firm Y maintaining their high price is still pay receiving five million pounds, with revenue much like mean example we saw earlier info Inbox P with firm X is making five million pounds with was revenue, inbox C as a result of this low a price firm X is benefiting from the higher revenue. So we conceive it is a firm was seeking to maximize its potential individual welfare its individual benefit it would have an incentive to go for a lower price worst the other firm still maintains their higher price, so in other words break any collusive agreement that might exist.

This is known as the Mac c-max strategy a firm is maximizing its maximum potential individual returns, but knowing that this is the case and that both firms all likely to break this collusive agreement we end up up box D were each fun gets eight million pounds. In other words the combined welfare here the combined revenue is least overall in the other examples inbox A, we can see that the combined welfare for both firms is $20 million pounds, in boxes B&C the combined welfare is $17 million pounds, although in boxes B&C individual firms make the most amount of money depending which strategy they approach.

In box T the combined welfare is only $16 million pounds, so in other words what we are experiencing here is a combined reduced return this is therefore refer to as the maxi main both strategies, weather for mex approaches the lower price so firm Y approaches the lower price result in as ending up at the Maxi main. In other words both strategies suggests firms will end up here at what is referred to as a Nash equilibrium VC’s the dominant strategy, as a result what we can do is applying this knowledge and use it I V to illustrate Y a collusive agreement or to work earn or to stay boxe A.

Maximize their combined returns Y that collusive agreement breaks down, Y they tend to try and pursue that own individual benefits and where we end up inbox D. It is also worth remembering but this allows us to get into the mindset of competition authorities, competition authorities are able two min replicate this by considering what impact they their fines might have on firm’s executives and firms I am overall output and price.

So for halfs a competition authority might consider approaching a for and indicating to them that if they would turn state’s evidence, was they would get off scot-free in other words maximize their own personal gain and as a result insure but the other firm suffers. Now it might be as illustrated in the prisoner’s dilemma but both individuals or both firms turned state’s evidence in Monte nestle and both end up at the Maxi main position, but in reality what happened tends to happen is that one for gets wind of the government’s decision or government’s pursuit of of competition policy and therefore responds by turning state’s evidence before the other firm. And therefore maximize its own personal return at the expense of the other firm.

We can see here that if they have colluded they would have both benefited and and and maximized their combined return despite not maximizing the individual returns, and it is that important difference between maximizing the individual returns which one can you see in boxes B&C versus maximizing the combined welfare of the industry by engaging in some collusive practices.

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