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Uorga

Game Theory

study of mathematical models of strategic interaction between rational decision-makers. Today it applies to a wide range if behavioural relations and is an umbrella term for the science of logical decision making.

Uorga

Dominated Strategy

A strategy is dominated if, regardless of any actions of other players, there is another strategy that would earn the player a higher payoff. —> a strategy is dominated if there is another strategy that is more advantageous to play, regardless of the other players

Uorga

Nash Equilibrium

Concept within game theory where the optimal outcome is where there is no incentive to deviate from the strategy for any of the parties considering the others choice.

Describes the combination of actions containing the reaction functions of all players.

Uorga

Best Response

The best response is the strategy which gives the best outcome for the player, taking the other‘s strategy as given

Uorga

Simultaneous (static) game

Game where each player chooses his action without knowledge of the other players action.

Uorga

Sequential (dynamic) game

Game where one player chooses action before other one does. The later player must have some information of the first‘s choice, otherwise the difference in time would have no strategic effect

Uorga

Cournot Competition

Economic model where companies compete through the amount of output they produce, which they decide independently of one another and at the same time. It has following features:

— there is more than one firm and the firms produce a homogeneous product

— firms do not cooperate; there is no collusion

— firms have market power —> each firms output decision affects the good‘s price

— firms compete in quantities which they choose simultaneously

— firms are rational and seek to maximise their profit given the competitor‘s decision

— quantity cournot > quantity monopoly

— price cournot < price monopoly

Uorga

Cournot duopoly

Specific case of cournot competition where the number of firms on the market is 2

Uorga

Reaction function

Locus of optimal/profit maximising actions that a firm may execute for any given action chosen by its competitor

Uorga

Pareto-efficient outcome

An outcome where no individual can be better-off without making another worse-off

Uorga

Bertrand competition

Model of competition where the firms compete by setting prices and the customers can choose which quantity they will buy for the given price. It has following features:

— At least to firms produce a homogeneous product and cannot collude

— firms compete by setting the price simultaneously, customers will buy wherever the price is lower

— if two firms set the same price, demand is evenly split between them

— it is the simplest to focus on duopoly, although a higher number of firms would be possible

Uorga

Bertrand paradox

Describes the situation of the Nash equilibrium in Bertrand competition, where **two firms** end up with **price = marginal costs**, since undercutting the price would be profitable in Bertrand competition, so they both end up at the lowest possible price, which results in **zero profit** for both firms.

Paradox:

In cournot —> few firms lead to higher price, more firms lead to price close to MC

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