Answer 3

Game theory analyses situations involving the strategic behaviour of two or more decision makers who have conflicting objectives.

Game theory is used to analyse the behaviour of firms in an oligopoly market structure.

Oligopoly is characterised by a few (two or more) large firms which dominate the market.

The unique feature of this market is that the actions of one firm affects the behaviour of other firms and vice versa. Each firm has to consider the possible response of the other firm/s when embarking on a course of action.

For example mobile phone service providers or coffee beans producers. In this market structure game theory is useful to analyse the way in which two or more players choose actions or strategies which jointly affect each participant.

(B)

		K-Mart
		Normal Price	Lower Price
Myers	Normal price	A 20 20	B -100 -20
	Lower price	C -20 -100	D -50 -50

Explanation of the Outcome

In the above game in the first column if K-Mart maintains the normal price, then Myers will get a profit of 20 if it maintains the normal price and will have -100 if it lowers the price. Therefore Myers will choose to maintain the normal price.

On the other hand (2^nd column) if K-Mart lowers the price Myers will earn -20 if it maintains the normal price but will earn -50 if it lowers the price. Therefore Myers will maintain the normal price.

The same reasoning holds for K-Mart. If Myers maintains the normal price (1^st row), then K-Mart will get a profit of 20 if it maintains the normal price and will have -100 if it lowers the price. Therefore K-Mart will choose to maintain the normal price.

If Myers lowers the price (2^nd row), then K-Mart will get earn -20 if it maintains the normal price and will have -50 if it lowers the price. Therefore K-Mart will choose to maintain the normal price.

The best strategy for Myers no matter what strategy K-Mart follows will be to maintain the normal price. This is the dominant strategy for Myers.

The best strategy for K-Mart no matter what strategy Myers follows will be to maintain the normal price. This is the dominant strategy for K-Mart

Required (C)

How the prisoner’s dilemma game is relevant with regard to the behaviour of firms.

The prisoner’s dilemma is an example of non cooperative game where each party acts selfishly in their own interest and end up with long prison terms. However if the parties collude they will be better off.

This analysis can be applied to the behaviour of two rival firms. If the two firms collude they may be better off.

An example is price collusion under oligopolistic market conditions. However since this type of behaviour is anti competitive, there may be regulations restricting such behaviour.

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