Industrial Economics, Industrial Organization How can game theory help Essay

Industrial Economics, Industrial Organization How can game theory help us to understand firm's interactions Discuss the differe - Essay Example A game theory is composed of a series of elements including: players or partners, rules which imply the possible decisions that one is capable of making given another party’s decisions, and the facts that a player could have knowledge of before moving or making a decision. Other elements include the consequences or outcomes of certain moves and the payoffs of each possible outcome. Payoffs imply the money got from a given decision (Durlauf, 2010). Game theories In arriving at the solutions given the game theories, it is important that industries understand certain tools. These tools include dominated and dominant strategies and the Nash equilibrium. A dominant strategy is a tactic that gives higher payoffs no matter what the opponent does, while a dominated strategy is an approach that is lower than another strategy; this implies that for a dominated strategy, there is a dominant strategy that is in existence over it. On the other hand, in Nash equilibrium, no industry or indi vidual is in preference of a different choice. This means that each player chooses the best strategy given the approaches taken by the other players in the market (Durlauf, 2010). In an effort to understanding how firms and industries react, it is vital that the different types of game theories are understood. Firms’ interactions are mainly guided by certain game theories. There is a myriad of game theories. Simultaneous game is one of the game theories. As the name suggests, the players in the market make decisions independent of the other player’s decisions. This means that no party is aware of the other party’s choices or decisions. This kind of scenario forms what is known as a Cournot model. In such a case, each firm or industry tries to make a forecast of what the other player in the market will be so as to arrive at a reasonable decision itself (Durlauf, 2010). In Cournot models, firms predicts the other industry’s output choice and then based on t he forecasts, each firm goes ahead to choosing a profit maximizing output for itself. In cournot, prices as at Nash equilibrium are above the perfect competitive prices. In this case it is clear that the Cournot game model influence the market price as firms try to control their levels of production. Thus, through Cournot model, it is possible for firms to come up with best reaction functions in their production in cases where the industries have completely no clue on what the other players in the market are up to achieving (Mukherjee, 2004). Sequential game is another game theory whereby an industry or firm makes a decision on price or quantity, when it already has knowledge on what another player or partner has decided on. The kind of strategic interaction depicted in such a scenario gives rise to a Stackleberg’s model. In this model, one industry makes a choice before another. It is frequently used to depict industries in which there is a dominant firm. In the Stacklebergà ¢â‚¬â„¢s model, an industry that is a leader chooses output to maximize profits depending on how a follower will react to its choice. Given the choices by a leader, a follower will try as much as possible to make profits given the quantity the leader produces. A leader makes decisions on its own production considering the