Question

Game Theory is an important strategy tool used in business, politics, sports, negotiations, and other applications. It involves helping decision makers develop strategies that incorporate likely competitor reactions.

In economics game theory is commonly used by large corporations with a limited number of major competitors. Each company develops a strong understanding of the strategies used by their competitors. Coca Cola and PepsiCo, for example, are aware and take account of of each other’s actions and reactions. Even small businesses often keep track or and react to what their competitors are doing.

How can game theory be used to explain:

Why non-price competition, such as advertising or product differentiation, is used more than price competition in many oligopolies?

Why firms in oligopolies tend to sell their products at the same price or follow similar strategies?

What happens when competing firms are allowed to collude?

Answer 1

1) In an oligopoly market, the firms operating are interdependent. They can't take any decision alone without evaluating the action of their competitor. If the firm in an oligopoly decreases the price, the firm knows that the other firm will follow him surely and they both will be losing in the revenue they are earning.

If the firm uses non-price differentiation and he will be separating his good from the other sellers in the market and maintaining a separate identity. This might help him break the interdependence and he will have some control over his market decision.

For example, there are 4 big cookie company if any one of them reduce price everyone else will also retaliate, but if he differentiates his product like his cookie is special in some kind and it has special butter in it. He will be breaking this dependence on other firm and will only be increasing the price of special cookie, not a normal one which others are also selling.

2) Firm in an oligopoly are interdependent if only one firm increase the price other doesn't follow and the firm loses in the market share. but if the frim decreases the price every other frim follows and they come at the same price. Moreover, the product sold by the firm in the oligopoly are similar so similar price works for them.

If they collude they will form a cartel like OPEC and then they can manipulate the price of the product.