Question

To what extent has game theory improved our understanding of how the market
structure is formed and how it evolves? Discuss and explain. How can we
characterize market structure in a meaningful way? Be sure to also discuss the
conceptual issues, especially those pertaining to oligopoly, price coordination, and
collusion.

Answer 1

Game theory

Game theory refers to the framework wherein it enable decision making in case where the agents' payoff is dependent upon the actions taken up by the other players in the economy.

Role of Game theory in understanding the market structure

While understanding the market structure, it is evident that game theory is of great use in the business world. Game theory plays a pivotal role while analyzing the economic environment while fixing the prices. Competing firms has the option to either accept the pricing structure which is agreed upon by the other companies or can introduce a lower price structure. Though it is in the common interest of the companies to cooperate with the competing firms, the firm can follow a logical process to default as well. As a result, all the companies are in a worse off situation. Though this is considered to be a fairly basic scenario, decision analysis may influence the general business scenario and is a considered as the prima facie while using the compliance contracts.

Game theory has further extended their usage to cover various business disciplines.From optimal business strategies to wagering war decisions, ideal auction strategies and voting mechanisms, game theory provides a hypothetical decision framework with huge market impact.

Game theory for Oilgopoly in practice

Oligopoly refers to the market structure where there are only few firms which would produce a particular product. Firms involved in an Oligopolistic competition may profit from collusion, yet the collusive arrangements are considered to be unstable. Oligopoly firms may collude in the market to set a price level or the output level for the existing market conditions for profit maximisation. Under collusive market conditions, oligopolistic firms pursue their individual self-interest and produce the maximum quantity of a product which is more than the monopolist and also charge a lower price for their products under the prevailing market conditions.

Collusive conditions are considered to be illegal which would be difficult for the firms to coordinate actions and this would undermine the other firms in this collusive arrangement. The promise that the oligopolistic firms will earn huge profits would become an incentive for the oligopolists to cooperate towards collusion.

Price leadership takes place when a dominant competitor firm would fix the price and the other firms will follow suit. This is an informal type of collusive arrangement and is completely legal. Price fixing is considered to be illegal in the United States and there are also antitrust laws which would prevent the oligopolistic firms from collusion.

When applying game theory to oligopoly, this condition renders the oligopolistic firms to be interdependent as they are affected not only by their own decisions regarding the constraint as to how much to produce, but also by the other firms in the market. Game theory provides a concise view of how a firm will behave in case of interdependence.

Thus the firm can decide the price level or the market structure using the game theory and can also decide upon the necessary actions to be taken to sustain in the prevailing business environment.