Comments on: The “delicate balance of terror”: How game theory can be used to predict firm behavior (oh, and save the human race from utter annihilation) http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/ for students and teachers of Economics Thu, 09 Feb 2012 09:13:55 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Markus von der Marwi http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7572 Markus von der Marwi Thu, 12 Mar 2009 02:02:54 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7572 Game theory shows how interdependant firms in an oligopoly are. Their actions completely depend on the moves of their competitors. For example should they advertise or should they not. This is true in other situations as well. The decisions made are often not the ones that are best for both firms. If there was a way for each firm to collaborate then the outcome might be very different. However firms and people always assume the other firm or person is going to cheat. This is why in the example both firms choose to advertise, instead of neither firm advertising, which would have left both firms in a better position. Game theory shows how interdependant firms in an oligopoly are. Their actions completely depend on the moves of their competitors. For example should they advertise or should they not. This is true in other situations as well. The decisions made are often not the ones that are best for both firms. If there was a way for each firm to collaborate then the outcome might be very different. However firms and people always assume the other firm or person is going to cheat. This is why in the example both firms choose to advertise, instead of neither firm advertising, which would have left both firms in a better position.

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]]> By: Matt Coucher http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7530 Matt Coucher Thu, 05 Mar 2009 18:00:13 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7530 It is interesting to see that not only does "game theory" apply to the analyzing of oligopolies but many other topics that are come across through out the world. A major example that has been brought up was the Cold War between the USA and the Soviet Union. The options were to build more nuclear weapons or to not build any for each nation. With the arms race between the two nations, one could observe that there is no dominant strategy unlike the prisoners example that we were shown in class as the obvious dominant strategy was to confess. It is interesting to see that not only does "game theory" apply to the analyzing of oligopolies but many other topics that are come across through out the world. A major example that has been brought up was the Cold War between the USA and the Soviet Union. The options were to build more nuclear weapons or to not build any for each nation. With the arms race between the two nations, one could observe that there is no dominant strategy unlike the prisoners example that we were shown in class as the obvious dominant strategy was to confess.

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]]> By: Zac Query http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7521 Zac Query Thu, 05 Mar 2009 06:15:17 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7521 This idea, Game Theory, is effective in attempting to analyze oligopoly behavior. It can only apply, however, to non-collusive oligopolies because cooperation would disturb the basic premise behind game theory, self-interest. Theoretically, if each "player" in the "game" acts accordingly to their own self-interest, they will play their dominant strategy. When both "players" play their dominant strategy an equilibrium is reached known as the Nash Equilibrium. As the video proves, the applications of Game Theory extend beyond the realm of economics. John Nash aided the US government during the Cold War and also believed he could use Game Theory to explain and justify all human interactions. Ok, well I just got back from a basketball game against a club team, the Zurich Wildcats, and I think I may have stumbled into a situation involving Game Theory. Before the game, our team and the Wildcats both had to use the same locker room. After changing, players from both teams had to make the decision of leaving their bags in the locker room or taking them out onto the court. Each team, though, was worried about the opposing team stealing their belongings. Therefore, each team had two options. Using Game Theory, I knew exactly what the outcome would be. Each team would play their dominant strategy (taking their bags with them) and therefore each team wouldn't have to worry about the other team stealing their valuables. This is not EXACTLY the kind of example we would use in class, but you can see the application. This idea, Game Theory, is effective in attempting to analyze oligopoly behavior. It can only apply, however, to non-collusive oligopolies because cooperation would disturb the basic premise behind game theory, self-interest. Theoretically, if each "player" in the "game" acts accordingly to their own self-interest, they will play their dominant strategy. When both "players" play their dominant strategy an equilibrium is reached known as the Nash Equilibrium. As the video proves, the applications of Game Theory extend beyond the realm of economics. John Nash aided the US government during the Cold War and also believed he could use Game Theory to explain and justify all human interactions.

Ok, well I just got back from a basketball game against a club team, the Zurich Wildcats, and I think I may have stumbled into a situation involving Game Theory. Before the game, our team and the Wildcats both had to use the same locker room. After changing, players from both teams had to make the decision of leaving their bags in the locker room or taking them out onto the court. Each team, though, was worried about the opposing team stealing their belongings. Therefore, each team had two options. Using Game Theory, I knew exactly what the outcome would be. Each team would play their dominant strategy (taking their bags with them) and therefore each team wouldn't have to worry about the other team stealing their valuables. This is not EXACTLY the kind of example we would use in class, but you can see the application.

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]]> By: Dimitri Da Ponte http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7516 Dimitri Da Ponte Thu, 05 Mar 2009 04:43:42 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7516 Nash’s equation would mean an absolute rule of complete distrust between human beings. If people were so definable, life would be much easier as everyone reaction to a certain situation could be known. Unfortunately the grey areas of the human condition make us unpredictable and irrational. One may say that Nash’s assumptions are like perfect competition or a monopoly, two extremes which are possible in only rare occasions. Yet as we are all different, with different presumptions and different moral values, we will collaborate to a certain point. When talking about oligopolies, I have always wondered why they simply did not talk to each other. It is obvious that the will both have higher profits by colluding. Firms will reach a second, yet less profitable, equilibrium by being completely selfish. Oligopolistic firms, though, go half way; sometimes they talk, sometimes they collude, sometimes they act independently, resulting in lower profits. This just goes to show that most of the times humans are very unreasonable beings. Nash’s equation would mean an absolute rule of complete distrust between human beings. If people were so definable, life would be much easier as everyone reaction to a certain situation could be known. Unfortunately the grey areas of the human condition make us unpredictable and irrational. One may say that Nash’s assumptions are like perfect competition or a monopoly, two extremes which are possible in only rare occasions. Yet as we are all different, with different presumptions and different moral values, we will collaborate to a certain point. When talking about oligopolies, I have always wondered why they simply did not talk to each other. It is obvious that the will both have higher profits by colluding. Firms will reach a second, yet less profitable, equilibrium by being completely selfish. Oligopolistic firms, though, go half way; sometimes they talk, sometimes they collude, sometimes they act independently, resulting in lower profits. This just goes to show that most of the times humans are very unreasonable beings.

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]]> By: sabrina walsh http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7510 sabrina walsh Thu, 05 Mar 2009 03:04:47 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7510 I find it interesting as well that we are able to apply the economic concept of "game theory" in instances not related profit oriented. for example the USSR vs. USA cold war arms race, and the prisoners plea bargain example. Today in class we learned about dominant strategies which refers to the point at which Firm A (starbucks) maximizes its profit regardless of what firm B (San Fran coffee) chooses to do. In this case how ever, both firms share the same dominant strategy which is to advertise. This is not always the case, we learned today that is also possible to not have a set dominant strategy if the firm has knowledge of the pay off matrix. I find it interesting as well that we are able to apply the economic concept of "game theory" in instances not related profit oriented. for example the USSR vs. USA cold war arms race, and the prisoners plea bargain example. Today in class we learned about dominant strategies which refers to the point at which Firm A (starbucks) maximizes its profit regardless of what firm B (San Fran coffee) chooses to do. In this case how ever, both firms share the same dominant strategy which is to advertise. This is not always the case, we learned today that is also possible to not have a set dominant strategy if the firm has knowledge of the pay off matrix.

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]]> By: Justus http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7509 Justus Thu, 05 Mar 2009 02:47:36 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7509 I think it is fascinating this technique. In the game series "Total War" this technique springs up as well. You are one of several large nations and your are competing for the best economically rhich nations on the globe. As in this gaming theory you are interdependent from one another and must always guess what his next move will be. It is interesting that a technique like a game is being used today in real life situations. The technique also makes perfect sense, because Oligopolies are interdependant from each other and always have to make their next move in response of what their opponent did. In this case the two firms STarbucks and SCoffee have the choice of advertising, or not to advertise. The best choice is for both of them not to advertise, however due to the fact that neither trust each other and think that at least one of them will advertise and gain more profit, both of them will always advertise. The result will be that both will make a profit of $12 rather than $15. The Nash Equilibrium will be at $12, because both of them have their dominant strategy to advertise. In all a really interesting technique. I think it is fascinating this technique. In the game series "Total War" this technique springs up as well. You are one of several large nations and your are competing for the best economically rhich nations on the globe. As in this gaming theory you are interdependent from one another and must always guess what his next move will be. It is interesting that a technique like a game is being used today in real life situations. The technique also makes perfect sense, because Oligopolies are interdependant from each other and always have to make their next move in response of what their opponent did. In this case the two firms STarbucks and SCoffee have the choice of advertising, or not to advertise. The best choice is for both of them not to advertise, however due to the fact that neither trust each other and think that at least one of them will advertise and gain more profit, both of them will always advertise. The result will be that both will make a profit of $12 rather than $15. The Nash Equilibrium will be at $12, because both of them have their dominant strategy to advertise. In all a really interesting technique.

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]]> By: Basti http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7475 Basti Tue, 03 Mar 2009 17:11:33 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7475 I agree with Bjoern that the game theory is important in an oligopoly. It allows a firm to analyze what opposing firms are going to do and how they can use that to their advantage. The game theory is a bit like a goalie before a penalty, if hes left footed the goalie knows a bit about where hes going to shoot. If he knows the player he can predict which way he is going to go. It is similar with firms, in the coffee example we see how Starbucks reacts to SF coffee and therefore makes more of a profit. If SF coffee advertises Starbucks must advertise to mke a profit, because STarbucks thought SCoffee would advertise and they didint so Starbucks will make a profit. I agree with Bjoern that the game theory is important in an oligopoly. It allows a firm to analyze what opposing firms are going to do and how they can use that to their advantage. The game theory is a bit like a goalie before a penalty, if hes left footed the goalie knows a bit about where hes going to shoot. If he knows the player he can predict which way he is going to go. It is similar with firms, in the coffee example we see how Starbucks reacts to SF coffee and therefore makes more of a profit. If SF coffee advertises Starbucks must advertise to mke a profit, because STarbucks thought SCoffee would advertise and they didint so Starbucks will make a profit.

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]]> By: Benji Rosen http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7424 Benji Rosen Mon, 02 Mar 2009 03:08:56 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7424 Since game theory has been explained twice now in the above responses I wont regurgitate any more informatoin. The video did not link economics to game theory, but indirectly it was very on topic in the selfish aims of the people involved which are similair to the profit maximising aims of the firms. However both firms are making selfish decisions, for example not to change the price since they have analyzed the other companies and beleive they would loose money since the other firms would lower their prices too. This though is descreet Colluding!!! They are working together, they just dont know it. Their selfish driven stratedgy combined with their use of gametheory has resulted in them deciding it is more profitable to collude and keep the prices high/costs low (when investing in advertisement) and work together. That said, there are occations where oligopolistic firms will engage in price or non price competition tactics in the hope that the other firms are not paying attention/cannot afford to do the same. This selflish black mail technique described by a paranoid schizophrenic is not far from the truth, though it doesent account for human error nor for the fact that often firms will choose to collude for those selfish reasons. Since game theory has been explained twice now in the above responses I wont regurgitate any more informatoin. The video did not link economics to game theory, but indirectly it was very on topic in the selfish aims of the people involved which are similair to the profit maximising aims of the firms. However both firms are making selfish decisions, for example not to change the price since they have analyzed the other companies and beleive they would loose money since the other firms would lower their prices too. This though is descreet Colluding!!! They are working together, they just dont know it. Their selfish driven stratedgy combined with their use of gametheory has resulted in them deciding it is more profitable to collude and keep the prices high/costs low (when investing in advertisement) and work together. That said, there are occations where oligopolistic firms will engage in price or non price competition tactics in the hope that the other firms are not paying attention/cannot afford to do the same. This selflish black mail technique described by a paranoid schizophrenic is not far from the truth, though it doesent account for human error nor for the fact that often firms will choose to collude for those selfish reasons.

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]]> By: Yael Burla http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7423 Yael Burla Mon, 02 Mar 2009 01:31:42 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7423 Two firms in an oligopolistic market do not increase their profits by selling what they feel is best; they must decipher what move the other firm will make in order to portray the same effect. These firms are very interdependent; one firm's decisions highly influcence that of the other firm. For example, if firm A chooses to advertise, even though this will increase the firm's costs it will definitiely increase their profits since consumers are attracted to innovations through such advertising. However, firm B, a firm in a similar market, is forced to advertise bevause otherwise firm B will not be as successful as firm A. If both firms choose to not advertise, they will both earn satisfactory economic profits which are not as big as those if the firm does decide to advertise. Howvevr, when both firms choose to advertise, they are actually worse off than they would have been if they had never advertised from the start. This is called the game theory; each firm has to predict the other firm's future moves and act accordingly. To make matters much simpler, the firms should collude or merge to discuss what is best the best outcome for BOTH of them. They would soon come to realize that, in this case, this would mean neither of them advertising. The downside is that one firm, firm A, could always cheat and be selfish in picking the advertising option while firm B stuck to the deal by not advertising, resulting in higher profits for firm A. Two firms in an oligopolistic market do not increase their profits by selling what they feel is best; they must decipher what move the other firm will make in order to portray the same effect. These firms are very interdependent; one firm's decisions highly influcence that of the other firm. For example, if firm A chooses to advertise, even though this will increase the firm's costs it will definitiely increase their profits since consumers are attracted to innovations through such advertising. However, firm B, a firm in a similar market, is forced to advertise bevause otherwise firm B will not be as successful as firm A. If both firms choose to not advertise, they will both earn satisfactory economic profits which are not as big as those if the firm does decide to advertise. Howvevr, when both firms choose to advertise, they are actually worse off than they would have been if they had never advertised from the start. This is called the game theory; each firm has to predict the other firm's future moves and act accordingly. To make matters much simpler, the firms should collude or merge to discuss what is best the best outcome for BOTH of them. They would soon come to realize that, in this case, this would mean neither of them advertising. The downside is that one firm, firm A, could always cheat and be selfish in picking the advertising option while firm B stuck to the deal by not advertising, resulting in higher profits for firm A.

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]]> By: Alexandria http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7419 Alexandria Sun, 01 Mar 2009 21:01:53 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7419 The video didn't work for me but I think I understand the point. The Soviet Union and US both armed themselves with nuclear missiles. By doing this, they were at an equilibrium point. Of course, it probably would have been better if they were at the other equilibrium point (with no nuclear missiles). Had only the Soviet Union armed themselves, then the US would be weak and at constant risk, the same goes if it had been the other way around. By both arming themselves, they both put themselves at risk but encountered a standstill, where no one would make the first move. This resulted in the missiles not being launched. The video didn't work for me but I think I understand the point. The Soviet Union and US both armed themselves with nuclear missiles. By doing this, they were at an equilibrium point. Of course, it probably would have been better if they were at the other equilibrium point (with no nuclear missiles). Had only the Soviet Union armed themselves, then the US would be weak and at constant risk, the same goes if it had been the other way around. By both arming themselves, they both put themselves at risk but encountered a standstill, where no one would make the first move. This resulted in the missiles not being launched.

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]]> By: Bjorn Kvaale http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/comment-page-1/#comment-7414 Bjorn Kvaale Sun, 01 Mar 2009 03:52:12 +0000 http://welkerswikinomics.com/blog/2009/02/27/the-delicate-balance-of-terror-how-game-theory-can-be-used-to-predict-firm-behavior-oh-and-save-the-human-race-from-utter-annihilation/#comment-7414 The game theory is a very important part of economics because it is used in many oligopolists firms to predict a company's moves in the future. A company must always predict that a competitor will cheat on them. In the coffee example given above, we can see that both would competitors would be earning good economic profits if they didn't advertise, but since Starbucks thinks SF Coffee will advertise, Starbucks must advertise also. With both companies advertising, a Nash equilibrium is met. Yet if Starbucks advertised and SF Coffee didn't advertise, Starbucks Coffee would be better off because they would make $20 profits instead of 15$ profits. The best way to go is for oligopolists to collude or to employ there best move possible, which is to advertise in this case. An even better tactic is to buy up the other firm, which Starbucks did with many other coffee firms. The game theory is a very important part of economics because it is used in many oligopolists firms to predict a company's moves in the future. A company must always predict that a competitor will cheat on them. In the coffee example given above, we can see that both would competitors would be earning good economic profits if they didn't advertise, but since Starbucks thinks SF Coffee will advertise, Starbucks must advertise also. With both companies advertising, a Nash equilibrium is met. Yet if Starbucks advertised and SF Coffee didn't advertise, Starbucks Coffee would be better off because they would make $20 profits instead of 15$ profits. The best way to go is for oligopolists to collude or to employ there best move possible, which is to advertise in this case. An even better tactic is to buy up the other firm, which Starbucks did with many other coffee firms.

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