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ECON1101: Microeconomics 1

Chapter 11: Strategy


Game theory
Elements of a game
1. Players
2. Strategies available to each player
3. Payoffs each player receives for each possible combination of strategies

Payoff matrix
A payoff matrix is a table that describes the payoffs to each player in a
game for each possible combination of strategies.

Dominant strategy
A dominant strategy is a strategy that yields a player a higher payoff no
matter what the other players in a game choose.

Dominated strategy
A dominated strategy is any other strategy available to a player who
has a dominant strategy.

Nash equilibrium
A Nash equilibrium is a set of strategies, one for each player, in which
each players strategy is his or her best choice, given the other players
strategies.

Prisoners dilemma
The prisoners dilemma is a game in which each player has a dominant
strategy and, when each plays their dominant strategy, the resulting
payoffs are smaller than if each had played a dominated strategy.

Examples of the prisoners dilemma

A cartel is a group of firms that conspires to coordinate production and


pricing decisions in an industry for the purpose of earning an economic
profit. It usually breaks down like the prisoners dilemma.
People shout at parties and all go home with strained vocal cords.
People stand at concerts even though they can see just as well when
everyone sits.
Over-harvesting of unregulated fishing areas
International arms races
Interstate industry assistance bidding wars

Repeated prisoners dilemma & tit-for-tat

The repeated prisoners dilemma is a game in which the same pair of


players play out a prisoners dilemma repeatedly, observing the outcome
of each play before the next play begins.
Tit-for-tat is a strategy for playing the repeated prisoners dilemma
game, in which a player cooperates on the first move, then mimics their
partners last move on each successive move.

Games in which timing matters


Decision tree
A decision tree (or game tree) is a diagram that describes the possible
moves in a game in sequence and lists the playoffs that correspond to
each possible combination of moves.

The ultimatum bargaining game


The ultimatum bargaining game is a game in which the first player has
the power to confront the second player with a take-it-or-leave-it offer.

Credible threat
A credible threat is a threat to take an action that is in the threateners
interest to carry out.

Credible promise
A credible promise is a promise to take an action that is in the
promisers interest to keep.

Commitment problem
A commitment problem is a situation in which people cannot achieve
their goals because of an inability to make credible threats or promises.

Commitment device
A commitment device is a way of changing incentives so as to make
otherwise empty threats or promises credible. Psychological devices (e.g.
guilt, sympathy, justice, honour) are effective if peoples character can be
accurately judged.