Game Theory: The study of behavior in situations of interdependence is known as game theory. The reward received by a player in a game, such as the profit earned by an oligopolist, is that player’s payoff. A payoff matrix shows how the
payoff to each of the participants in a two - player game depends on the actions of both. Such a matrix helps us analyze situations of interdependence. Game theory deals with any situation in which the reward to any one player—the payoff—depends not only on his or her own actions but also on those of other players in the game. In the case of oligopolistic firms, the payoff is simply the firm’s profit.
Prisoners’ dilemma is a game based on two premises:
(1) Each player has an incentive to choose an action that benefits itself at the other player’s expense
(2) When both players act in this way, both are worse off than if they had acted cooperatively.
An action is a dominant strategy when it is a player’s best action regardless of the action taken by the other player.
A Nash equilibrium, also known as a noncooperative equilibrium, results when each player in a game chooses the action that maximizes his or her payoff given the actions of other players, ignoring the effects of his or her action on the payoffs received by those other players.
A firm engages in strategic behavior when it attempts to influence the future behavior of other firms. A strategy of tit for tat involves playing cooperatively at first, then doing whatever the other player did in the previous period.
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