Game theory
Game Theory & The Economics of Cooperation
We can now see how oligopolies relate to game theory because when two businesses are working with one another they have to think about what the other firms will do before they decide to act.
- Oligopolies sometimes find it difficult to cooperate with one another.
- To help us understand why we will briefly look at game theory.
- Game theory is how individuals behave when involved in tactical circumstances.
- Here we are introduced to two unrelated criminals (Bonnie and Clyde) who have been arrested by the police for committing a relatively petty offense.
- If convicted, they would each spend up to one year in prison.
- However, the police also have their suspicions that these two felons are tied to a more severe crime but they lack evidence to convict them and rely only on a hunch.
- Therefore, the police decide to interrogate Bonnie and Clyde in two separate rooms, resulting in the police proposing a deal to the two crooks, providing an incentive that these two criminals will hopefully snitch on each other.
- THE DEAL:
- As a result of the minor crime both will be locked up for one year.
- However if either confess to the more serious crime and lay the blame on the other then the one who confesses will walk away free, resulting in their partner getting up to 20 years.
- But if both crooks confess to the larger crime then they will both receive 8 years and avoid a trial.
- For the minor crime Bonnie is guaranteed to be locked up for one year. If she remains silent about the serious crime then she could possibly end up spending 20 years in prison if Clyde snitches on her.
- So her best tactic is to confess, as she may only spend 8 years compared to the 20 she could end up receiving if she remained silent. Bonnie could also have the possibility of walking away free if she confesses and her partner denies these accusations.
- However Bonnie still remains unsure as to Clyde's decision.
- The circumstances remain pretty the same for Clyde situation. He faces the same dilemma as Bonnie. Confessing works well in Clyde's favour as well.
- We can now see that the criminals dominant strategy ( a tactic that is in the best interests of the criminal unconcerned of what the other one decides to do) is to confess.
- However, let’s say that both criminals have already agreed to remain silent on this crime, then this would result in the two only serving up to one year in prison. (See diagram at bottom of page) (Ref. pg365 Mankiw&Taylor)
We can now see how oligopolies relate to game theory because when two businesses are working with one another they have to think about what the other firms will do before they decide to act.