Game theory was developed in 1940 by John Neumann and Oskar Morgenstern to analyse strategic behaviour, Sayre and Morris Principles of Microeconomics. It is the situation where a firm analyses other firms to figure out the best possible outcome for a situation.
From the following video, game theory, we learn that game theory was first introduced because of the game of poker. Economists would play poker and would mathematically analyse the game and other players to put together the best move that they should play by figuring out what others will do. Game theory is for personal advantage and personal gain.
I came across a website that presents the Game Theory in a different way by actually using such games that present the theory as the main objective to the game. Click here to visit the site. .
The outcomes are presented in a payoff matrix, which is a matrix to show the different payoffs for each situation. The payoff will be the outcome of that the firm will receive depending on the way they choose to go. There are 4 different types of payoffs which I have presented in a diagram below using an example to help illustrate them (similar to the examples found in Principles of Microeconomics).
Don't Cheat/ Collusion
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Cheat
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Don't Cheat/ Collusion
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200/200
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50/100
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Cheat
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100/50
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125/125
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In this example we can see that is the firms both don't cheat that will get the bigger payoff, this is also called collusion which is when firms have an agreement where they set a price or quantity limit on the products(Sayre and Morris 2009). We can also see that if one of the firms cheats they will have a lower payoff then if no one cheats but a higher payoff then if they didn't cheat but the other did. And finally we see the outcome if both firms cheat.
Collusive is when firms have an agreement that they will not compete and instead they will somehow divide the market. They are cooperating with one another so that both firms will benefit. Sayre and Morris describe the formal agreement for collusion as a cartel, which is literally the sellers coming together to form an agreement.
A recent example of an illegal cartel was in 2011 between Unilever and Proctor and Gamble when they were caught fixing prices in the UK on laundry soap. They were found guilty and had to pay $457 million (combined amount) in fines.
Unilver and P&G cartel
Unilver and P&G cartel
