Game Theory, Strategic Behaviour & Oligopoly (Chapter 11)

The author begins the chapter with the mention of a quote by Eugene Wigner, a Nobel Prize winning Physicist, that There are two kinds of people in the world: Johnny Von Neumann and the rest of us. Indirectly he tries to take the attention of the reader towards Neumann whose work in the field of Game Theory & strategic behaviour is way above his predecessors. The Author describes economy as an interdependent system in which the net outcome of any decision is not based on what choices you take but on the choices your competitor has made. He also talks about how individual either consumer or producer behave in the market and how they are affected by prices. Strategic behaviour involves many aspects of human nature like bargaining, threats, bluffs etc. What economics does here is it presents such behaviours as solitary/isolated individuals which in turn are small group of producers who quietly are focussed towards profit maximisation against essential nonhuman environment. The entire chapter is divided into two parts, in part one the author cites games from Neumann and their solutions while in part two the more detailed analysis of the games are given. Part two also deals with how these games would be used to different scenario in business. Part 1 begins with one of the most interesting games which is Scissors, Paper, Stone. Designed in a 3x3 payoff matrix, the reason behind mentioning this game by the author is each player makes one move and the moves are revealed simultaneously, it is easily represented by a matrix. with one player choosing a row, the other choosing a column, and the outcome determined by their intersection. We will see later that this turns out to be a way in which any two-person game can be represented, even a complicated one such as chess. The second reason is that although this is a simple game, it is far from clear what its solution is--or even what it means to solve it. After your paper has been cut by your friend's scissors, it is easy enough to say that you should have chosen stone, but that provides no guide for the next move. Some quite complicated games have a winning strategy for one of the players. But there is no such strategy for Scissors, Paper, Stone. Whatever you choose is right or wrong only in relation to what the other player chooses. While it may be hard to say what the correct strategy is, one can say with some confidence that a player who always chooses stone is making a mistake; he will soon find that his stone is always covered. One feature of a successful strategy is unpredictability. That insight suggests the possibility of a deliberately randomized strategy. The next game discussed by the author is that of bilateral monopoly, nuclear doom and barroom brawls. The game is called bilateral monopoly because it corresponds to a market with one buyer and one seller, as the author describes this situation as follows I have the world's only apple and you are the only person in the world not allergic to apples. The apple is worth nothing to me and one dollar to you. If I sell it to you for a dollar, I am better off by a dollar and you, having paid exactly what the apple is worth, are just as well off as if you had not bought it. If I give it to you, I gain nothing and you gain a dollar. Any price between one and zero represents some division of the dollar gain between us. If we cannot agree on a price I keep the apple and the potential gain from the trade is lost. Bilateral monopoly is not a zero-sum game. If we reach agreement, our gains sum to $1; if we fail to reach agreement, they sum to zero. That makes it fundamentally different from Scissors, Paper, Stone; it permits threats, bargains, negotiation, and bluff. One way to win such a game is to find some way to commit oneself, to make it impossible to back down.

There are many examples of the same logic on a smaller scale. Consider a barroom quarrel that starts with two customers arguing about baseball teams and ends with one dead and the other standing there with a knife in his hand and a dazed expression on his face. Seen from one standpoint, this is a clear example of irrational and therefore uneconomic behavior; the killer regrets what he has done as soon as he does it, so he obviously cannot have acted to maximize his own welfare. Seen from another standpoint, it is the working out of a rational commitment to irrational action--the equivalent, on a small scale, of a doomsday machine going off. Suppose I am strong, fierce, and known to have a short temper with people who do not do what I want. I benefit from that reputation; people are careful not to do things that offend me. Actually beating someone up is expensive; he may fight back, and I may get arrested for assault. But if my reputation is bad enough, I may not have to beat anyone up. To maintain that reputation, I train myself to be short-tempered. I tell myself, and others, that I am a real he-man, and he-men don't let other people push them around. I gradually expand my definition of "push me around" until it is equivalent to "don't do what I want." We usually describe this as an aggressive personality, but it may make just as much sense to think of it as a deliberate strategy rationally adopted. Next in line is the famous game of Prisoner`s dilemma and its payoff matrix. The game has two interesting features. Firstly it introduces a new concept to reach to the solution, i.e. both the criminal confess because each calculates that confession is better than being silent no matter what the other criminal does. Secondly it also makes the criminal act rationally. Now what happens is that by confessing both get two years of imprisonment, but if they would have kept quiet they would have ended up with only six months. Hence rationality in individual ends up with both being worse off. The author goes on to explain many such games which align and contradict decision making between individuals and firms controlled by individuals. Part 3 of the chapter deals with Monopolistic competition and Oligopoly. Monopolistic competition is the one in which Profit (P)= Marginal Cost (MC) does not hold true, but the zero-profit situation does. It typically occurs where different firms produce products that are close but not perfect substitutes. Author gives an example of the case of identical services produced in different places. With the help of examples author illustrates about how to calculate the profit maximising price in different situations. Moving on the author discusses about the cooperative behaviour and the Cartel (OPEC). How such phenomenon effect / prevent the entry and exit of firms. How the gains are divide and how they are maximised.