The Game Theory

Game theory is a process of modelling the strategic interactions between two or more players containing a set of rules and their outcome. A move by one player sparks off moves by others which ultimately communicates in strategic thinking. The firms fight for a market share and customer retention in real world. The actions performed by firms mimic the actual strategic behaviour, as modelled in the game theory. As stated in the book “Principles of Microeconomics” (Sayre & Morris), game theory is “a method of analysing firm behaviour that highlights mutual interdependence among firms”.

An article in The Economist observes “For John von Neumann and Oskar Morgenstern, the two economists who developed the idea, strategy was “a complete plan: a plan which specifies what choices [the player] will make in every possible situation”. Over the years, the idea was further developed and presented in tabular form. A payoff matrix shows the pros and cons of a decision in tabular form. The matrix highlights positive or negatives associated with the decisions under the decision makers’ controls or external conditions not under the decision makers’ control. Evidence of game theory exists in the real world; the perfect example is the nations are stockpiling nuclear weapons. Each nation is playing a strategic game with each other.

Collusion is an informal agreement between two or more parties to fix prices or output to maximise profits in order to gain a market share without the knowledge of their competitors or official bodies. By controlling prices and output, the parties create an artificial monopoly. A cartel is an association of sellers acting in unison and under a formal agreement of cooperation among firms. The association is visible to the whole market. The main difference between collusion and cartels is the legality of the agreements. Cartel is an official association whereas collusion is unofficial.

Source:
http://www.economist.com/node/12669299