Profits for firms A and B at different prices

Figure 2.3

If, however, X cut its price to £1.80, the worst outcome

would again be for Y to cut its price, but this time X's profit only
falls to £8 million. In this case, then, if X is cautious, it will cut its
price to £1.80. Note that Y will argue along similar lines, and if it is
cautious, it too will cut its price to £1.80. This policy of adopting
the safer strategy is known as maximin. Following a maximin
strategy, the firm will opt for the alternative that will maximise its
minimum possible profit.

An alternative strategy is to go for the optimistic approach

and assume that your rivals react in the way most favorable to
you. Here the firm will go for the strategy that yields the highest
possible profit. In X's case this will be again to cut price, only this
time on the optimistic assumption that firm Y will leave its price
unchanged. If firm X is correct in its assumption, it will move to
box B and achieve tie maximum possible profit of £12 million. This
strategy of going for the maximum possible profit is known as
maximax. Note that again the same argument applies to Y. Its
maximax strategy will be to cut price and hopefully end up in
box C.

Given that in this 'game' both approaches, maximin and

maximax, lead to the same strategy (namely, cutting price), this is
known as a dominant strategy game. The result is that the firms
will end up in box D, earning a lower profit (£8 million each) than if
they had charged the higher price (£10 million each in box A).

The equilibrium outcome of a game where there is no

collusion between the players (box D in this game) is known as a
Nash equilibrium, after John Nash, a US mathematician (and
subject of the film A Beautiful Mind) who introduced the concept in
1951.