Oligopoly and game theory

Nonetheless, even though statistical analysis is needed to analyze real-world scenarios, game theory offers insights into how oligopolistic firms price their product. A common scenario for applying game theory to decision-making is the prisoners' dilemma. Bennie and Stella were arrested for robbing banks. Each was interrogated in separate rooms, where the interrogators offered them a choice:.

The best possibility for both as a group would be if neither confessed, which would mean that they would only have to spend 2 years in prison. The worst possibility for both of them as a group is if they both confessed — then they must spend 5 years in prison. However, as individuals, they may be able to do better or worse, depending on how successfully they anticipate what the other will do.

If Stella confesses, the worst she can do is spend 5 years in prison, and the best that she can do is go free; likewise for Bennie. Micky Pautu. Lydia Dong. Joselito Rivera. Jourdanette Tarucan. More From tamim. Popular in Market Economics. Fourie Cronje. Diny Fariha Zakhir. Gabour M Gaber. Hani Berry. Shazia Tunio. Jed Fan. Fahad Tariq. Jeffrey Cheung. Kurniawan Gangga. Ashish Singh. Aakaash C. Sunpreet Singh. Sriram Venkataramani. Top clipped slide.

Download Now Download Download to read offline. BilgiEC Follow. Oligopoly Collusion and Game Theory. Facebook Business. Tagging On Flickr. What to Upload to SlideShare. A few thoughts on work life-balance. Related Books Free with a 30 day trial from Scribd. Dry: A Memoir Augusten Burroughs. Related Audiobooks Free with a 30 day trial from Scribd. Empath Up! Sapna Herekar. Rudhir Siddham. This is the same as in the Cournot example and for National the best response function is also the same.

Simplifying yields:. A few things are worth noting when comparing this outcome to the Nash Equilibrium outcome of the Cournot game in section First, the individual output level for Federal, the first mover in the Stackelberg game, the Stackleberg leader, is higher than it is in the Cournot game. Second, the individual output level for National, the second mover in the Stackelberg game, the Stackleberg follower, is lower than it is in the Cournot game.

Third, the total output is larger in the Stackelberg outcome than in the Cournot outcome. This means the price is lower because the demand curve is downward sloping. Since the Cournot outcome is one of the options for the Stackleberg leader — if it chooses the same output as in the Cournot case the follower will as well — it must be true that profits are higher for the Stackelberg leader.

And since both the quantity produced and the price received are lower for the Stackelberg follower compared to the Cournot outcome, the profits must be lower as well. So from this we see the major differences in the Stackleberg model compared to the Cournot model.

There is a considerable first-mover advantage. By being able to set its quantity first, Federal Oil is able to gain a larger share of the market for itself and even though it leads to a lower price, it makes up for that lower price with the increase in quantity to achieve higher profits.

The opposite is true for the second mover, by being forced to choose after the leader has set its output, the follower is forced to accept a lower price and lower output. In the mid two thousands banks in the United States found themselves struggling to satisfy a tremendous demand for mortgages from the market for mortgage back securities: securities that were created from bundles of residential or commercial mortgages.

This, along with the low-interest rate policy of the Federal Reserve, led to a tremendous housing boom in the United States that evolved into a speculative investment bubble. The bursting of this bubble led to the housing market crash and, in , to a banking crisis: the failure of major banking institutions and the unprecedented government bailout of banks.

These twin crises led to the worst recession since the great depression. Interestingly, this banking crisis came relatively soon after a series of reforms of banking regulations in the United States that gave banks much more freedom in their operations. Most notably was the repeal of provisions of the Glass-Steagall Act, enacted after the beginning of the great depression in , that prohibited commercial banks from engaging in investment activities. Part of the argument of the time of the repeal was that banks should be allowed to innovate and be more flexible which would benefit consumers.

The rationale was increased competition and the discipline of the market would inhibit excessive risk-taking and so stringent government regulation was no longer necessary.

But the discipline of the market assumes that rewards are absolute that returns are not based on relative performance that the environment is not strategic. Is this an accurate description of modern banking?

Probably not. We can describe this in a very simplified model where there are two banks and they can either engage in low risk or high-risk strategies. This scenario is described in Figure