Oligopoly-Game Theory

Interdependence: When the profit of each firm DEPENDS on the actions of the other firms in the market.

A dominant strategy is one that is always best for a player, no matter the strategy of a rival player.

A Nash equilibrium is the outcome where all players are satisfied with their choice, given the choice of the rival.

A Prisoners’ Dilemma is a game such that players pursue their dominant strategy and the game comes to Nash equilibrium. However, the outcome is an undesirable one and could have been avoided through some kind of cooperative agreement (collusion).

Collusion: When firms cooperate to raise their joint profits--in most cases this is illegal.

Cartel: A group of firms (or producers) that agree to work together to limit output, increase price and increase profitability. The most explicit example would be OPEC.

Firms in oligopoly type industries use game theory and strategic behavior to make profitable decisions.