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Equilibrium
90
50
Nash
Equilibrium
O
50 90 Price of B (Pi)
Stackelberg Game
A sequential move game. These types of games are
known as Follow the Leader games.
One firm chooses the output is known as the leader . The
second firm (the follower firm) observes the first firm’s
quantity and then chooses its own output.
Once the two firms choose respective quantities, prices
are determined.
This technique first considers optimal strategy of the
player and its best response which takes moves that are
last in the game.
Predicting the future action of the last player, second last
player proceeds takes best move and process continues
backwards in time determining for each player best
response, until the beginning of the game is reached.
Summary
Game theory is a mathematical tool that helps to study strategic situations in which
players optimize a certain variable not only on the basis of their own preferences, but
also on the other players’ decisions and reactions.
As per Knight’s definition of risk, game theory falls in the category of analyzing risk, as
through this method mathematical probabilities are assigned to situations.
The “payoff” of a strategy is the net utility or gain to a player for any given counter
strategy of the other player.
A pure strategy specifies one and the same particular action at each decision point in a
game; a mixed strategy would have randomness in the actions of the player at various
decision points in a game.
Dominant strategy is the optimum strategy taken by a player which maximizes its
outcomes, whatever is the strategy of its opponents. If one player has a dominant
strategy in a game, then all other strategies are dominated strategies.
Maxmin strategy maximizes among the worst case payoffs of a player. A minmax
strategy is one in which a player minimizes the best case payoff of its rival.
Nash equilibrium proposes a strategy for each player such that no player has the
incentive to change its action unilaterally, given that the other players follow the
proposed action.
Cooperative games entail cooperation among the players; in non cooperative games
there is no possibility of a tie up among the players.
Summary
Prisoner's Dilemma" talks of the importance of cooperation. Each player gains when
both cooperate, but if only one of them cooperates, the defector will gain more. If both
defect, both lose but less than the "cheated" cooperator.
The normal form game systematically lists each player’s strategies and the possible
outcome from each strategy; an extensive form game (or a game tree) gives the
complete plan of action of the players over a period of time.
In a simultaneous game, both players act at the same time; in a sequential game one
player acts, followed by the other.
In constant sum games, the total benefit of the players, given each strategy, is a
constant and the players have to share the profit; in zero sum games, the total benefit
of the players, given each strategy, is equal to zero.
The Cournot game is a simultaneous move game where the firms strategically choose
outputs such as to maximize profits.
The Bertrand model is a simultaneous move game where the firms choose prices
simultaneously. There is exactly a single Nash equilibrium, where both the firms set
their price at marginal cost.
The Stackelberg game is a sequential move game different from the Cournot or the
Bertrand game. Equilibrium determined in this model is known as backward induction
in the game theory.