The Game Theory, developed by Neumann and Morgenstern provides an insight into real world behaviour of economic agents (such as producers) in situations where the outcome (profit or loss) depends not only on the policy made by one agent (firm) but also on what other agent. The game theory as applied to do in reaction to the policy choice made by the first agent. The game theory as applied to oligopoly, seeks to explain the behaviour of interactive decision – marking problem where a number of large firms aim to maximize their own profits by choosing some appropriate policy, but the actual outcome of this policy to a large extent depends upon what the other oligopoly arises because the outcome of a policy is not solely related to the policy followed by one individual firm for maximizing its gain, but also of the policy followed by others in reaction and the consequence of those reactions on the outcome for this firm.
Since, oligopoly involves decisions by a firm where it has to take account of likely reactions of other firms to its decision because each firm is subject to intense market rivalry, the behaviour or oligopolist firm must be strategic. Strategic behaviour means that an oligopolist firm must take explicit account of the impact of its decisions on competing firms and the reactions that are expectations and those rival firms. Strategy is thus a well-planned course of action where all reactions and conflicts of interests are taken account of.
Thus, while strategy is a course of action adopted by a firm, the outcome of that strategy ( profit or loss) is called pay off. The various outcomes of different strategies can be presented in a tabular form which is called Pay-Off Matrix.
To explain the basic elements of the Game Theory, we analyse the behaviour of an oligopoly where there are only two large firms in an industry. This type of market structure where only two firms operate is called Duopoly. The firms under duopoly face intense rivalry where all moves of one firm regarding price and output decisions are closely watched by the other and this other firm responds to those decisions by making appropriate changes in its own policies. Since both of firms are seeking profit maximisation in this market of intense rivalry, the consequences of their strategies can be presented in a pay – off matrix.SUBMIT ASSIGNMENT NOW!