Table of ContentsSummaryIntroduction:Key Assumptions:The Reality of the Assumptions:Model Predictions and Its AccuracyThe Prisoner's DilemmaCournot Duopoly ModelNormative ConclusionsModel ImprovementsPractical ImplicationsConclusionExecutive SummaryGame Theory Examines Decision Making behavior of individuals in situations where they are against an adversary. Cooperative game theory involves forming groups to compete against other groups. Non-cooperative game theory occurs when the player has no incentive to change strategy, even though they know the choices available to their opponent. The model assumes that players are rational and that there are only a certain number of predetermined outcomes. However, these assumptions do not always hold true in real life, as individuals make impulsive and emotional decisions. Changing circumstances due to unexpected events may also alter results. The Prisoner's Dilemma showed that strategic behavior between competitors always ends up deteriorating due to their incentive to cheat through collusion and create a win-win situation between them. This concludes that price competition between oligopolistic firms should be avoided. The Cornet Duopoly model shows that competitors can maximize their market share and profits by finding optimal prices. However, this model is not perfect and can be improved. This considers that players should always act strategically and think about their competitors' response, which is not always the case as not all managers think with this mindset. This model can only be effective when managers can make sense of the positive and negative outcomes expected from their actions. In reality, this is difficult because many companies tend not only to be unaware of their competitors' earnings, but also of their own. Say no to plagiarism. Get a tailor-made essay on “Why Violent Video Games Should Not Be Banned”?Get the original essayIntroduction:In this report, we will take an in-depth look at an economic model known as game theory. This theory analyzes your opponent's reactions to help you make the decision that will give you the most favorable outcome. Decisions made by other players in the game can change the outcome for everyone involved and thus affect the player's outcome. There are two different types of game theory, non-cooperative and cooperative. An example of non-cooperative game theory is the Nash equilibrium, where no player has an incentive to change strategy, even if they know all of their opponent's choices. We will explore several examples of the Nash equilibrium known as the Prisoner's Dilemma and the Cournot approach, as well as its implications for the study of economics. Cooperative game theory is where players form groups and compete against other groups. This can be compared to cartels such as OPEC, in that this organization works together to keep the supply of oil low among member states and therefore keep prices high to maximize profits. In this report, we will discuss the fundamental elements of this theory and its real-world applications as well as its flaws. Key Assumptions: The key assumption of game theory is that all players are rational in the sense that they all strive to maximize their efficiency. their winnings in the game. Although this assumption may confine the model to the real world, it is crucial to justify why players make the decisions they do. The following hypothesisis that there are a finite number of competitors and a finite number of predetermined outcomes. It is important that all outcomes can be predicted before the game begins. Players will do their best to maximize their victory and will only make concessions when it increases their risk of winning. Finally, all players can adopt multiple strategies and everyone is aware of the different rules of the game. The reality of assumptions: The assumption that all players act rationally does not hold in real life as individuals can make decisions based on impulses or emotions. For example, an individual might refuse to invest in a soccer team that has a higher chance of winning a competition and would essentially offer the highest return with lower risk in exchange for a team they have supported since childhood. In the case of oligopolistic firms, managers may choose to neglect profit maximization and base their decisions on other factors such as maximizing growth, revenue, and corporate social responsibility. Second, the assumption that all outcomes can be predicted before the game begins is unrealistic. for multiple reasons. First, in real life, unexpected events can always occur and change the outcome of the game. Second, “most companies will not have sufficient knowledge of their own profits, let alone those of their competitors; therefore, in cases like this, leaders cannot make strategic decisions. Moreover, it is difficult to obtain complete information in real life, where "each player is aware of his opponent's winnings." One player may have more information than another, and may therefore be in a more favorable position than his opponent to make a strategic decision. The assumption that players will only make concessions when it increases their risk of winning is true in real life. The game show “Golden Balls” is an example: in the final round, players have the option to share or steal the money. In many cases, participants are happy to share the prize because they would feel bad about themselves if they made fun of the other player and took all the money. Finally, the assumption that players would be able to adopt multiple strategies and change their prices in response to their competitors may be more difficult to achieve in real life. This could be due to any legislation within the industry, such as price caps, that could prevent companies from raising their prices above a certain point. Model Predictions and Its Accuracy The Prisoner's Dilemma The model aims to predict the outcome of a game in which players are affected by the decisions of their opponents. An example of this is the Prisoner's Dilemma. This model predicts that “two rational decision-makers who try to improve their situation by adopting strategic behavior always end up in a worse situation.” Figure 1.1: Prisoner's Dilemma Looking at Figure 1.1, initially, both companies adopt a low price strategy where they earn profits of $20 million. They eventually realize that by getting along and adopting a high-price strategy together, they can make $50 million in profits. However, each company now faces a dilemma: the incentive to cheat the deal and adopt a low-price strategy in order to capture their opponent's market share and increase their profits to $70 million. Every company also thinks that if they don't do it infirst, her opponent will get ahead of her. They both slashed their prices and their profits were reduced to $20 million. Game theory predicts that two companies that behave strategically will always end up worse off because of their incentive to cheat. She therefore concludes that price competition between oligopolistic companies should be strongly avoided. This model also reveals the strategic interdependence that exists between oligopolies and their conflicting incentives to cheat or collude. Unfortunately, this prediction is not easily testable due to the inherent shortcomings of the game theory discussed previously. However, some cases indicate that the conclusions of the Prisoner's Dilemma were accurate. In the 1950s, GM, Ford and Chrysler dominated the American automobile market and agreed to release their own versions of small cars. During the 1970s, Chrysler continually raised the price of its small cars, destined to be followed by GM and Ford. However, in an effort to capture some of Chrysler's market share, GM raised prices to a lesser extent than Chrysler. They were successful until Chrysler reduced their price to its original price. This shows how the conflicting incentives for cheating and collusion due to strategic interdependence between oligopolistic firms will always leave them worse off. Cournot Duopoly ModelThe Cournot duopoly model also uses game theory to predict that firms within a duopoly market structure are more beneficial to society. compared to monopolies, because they produce larger quantities at lower prices. Suppose that within an industry there are two companies that produce a homogeneous product, act strategically, do not collude, and are completely rational. If any of these companies want to increase their profits, they can do so by increasing prices. However, increasing profitability through higher prices results in a loss of market share. This is why “Cournot’s approach attempts to maximize both market share and profits by setting optimal prices.” This price would be accepted by both companies, making it a Nash equilibrium. Since this approach assumes that firms compete through changes in quantities, it predicts that this market structure is better able to produce socially optimal quantities of goods than monopolies. Although this model is not easily testable, its predictions are considered accurate because it is generally accepted by economists that, from society's perspective, monopolies are the worst market structure. However, in real life, monopolies are either illegal or regulated by the government, so they may produce more favorable market outcomes than those of companies within a duopoly. Normative Conclusions The word normative means following a set of rules in the context of your behavior. The model generates some normative conclusions. The player must follow the option most likely to give them the best outcome, even if it means getting a lower reward but with lower risk. Additionally, by forming groups and applying cooperative game theory, you should have a better chance of achieving a good result because you will turn potential enemies into allies. Improvements to the model Improving game theory would allow it to transcend some of the current challenges. faces. In doing so, it can reach or produce conclusions that would be more useful to the different stakeholders of the..