Question

TOPIC: Game Theory and Equilibria

1. In the collusion game, we found that collusion was only sustainable in the infinite horizon repeated game. One Nash Equilbrium of that game can be found when all players play a “grim trigger” strategy, where they collude until an opponent chooses to compete, and then compete for all future rounds as a punishment. In such a game, if the one period bonus that comes from competing is low enough, firms always collude and the punishment is never triggered.

However, let’s think a little deeper about this Nash Equilibrium. Is the punishment (vowing to compete forever after one deviates) realistic, especially if firms can communicate freely? Why or why not? (Hint: Is a grim trigger Nash Equilibrium a Subgame Perfect Nash Equilibrium? What kinds of Nash Equilibria does Subgame Perfection rule out in sequential games?)

Answer 1

So in order to conclude this very answer we can divide the whole summary into the below parts, viz:

1. Game Theory : Game theory is the study of the ways in which interacting choices of economic agents produce outcomes with respect to the preferences (or utilities) of those agents, where the outcomes in question might have been intended by none of the agents. In other terms we can say that Game theory is said to be as the process of modeling the strategic interaction between two or more players in a situation containing set rules and outcomes. While used in a number of disciplines, game theory is most notably used as a tool within the study of economics.

2. Equilibria or Equilibrium : The term Equilibria is derived from Equilibrium which is referred as the state in which market supply and demand balance each other, and as a result, prices become stable. Generally, an over-supply of goods or services causes prices to go down, which results in higher demand. The balancing effect of supply and demand results in a state of equilibrium.

Altogether, Game Theory and Equilibrium are important factors which are needed to be considered before making any decision which has a direct influence or impact on economy.

3. Nash Equilibrium : Nash Equilibrium is a stable state of a system involving the interaction of different participants, in which no participant can gain by a unilateral change of strategy if the strategies of the others remain unchanged.

*Conclusion : In the end it can be concluded that the punishment is realistic, if the firms compete on freely basis. As all the above terms state us the positive aspects which is needed to be considered before questioning that it is realistic or not. However, if we talk about decision making. So if careful consideration is not provided to all the above stated aspects it may lead to create unrealistic situations, wherein the market place and the firms cannot survive and hence leads to economic failure.