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AP Economics Mr. Bernstein Module 65: Game Theory December 10, 2014

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AP Economics Mr. Bernstein Game Theory Study of how interdependent decision makers make choices Used to study the decisions of oligopolists 2

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AP Economics Mr. Bernstein Non-Cooperative Games Each player competes to maximize individual payoffs and ignores the effects of his/her action on the payoffs received by the rival 3

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AP Economics Mr. Bernstein Terms to Know Payoff Matrix Diagram showing payoffs to each player in a game depend on the actions of both Dominant Strategy Action that is a player’s best action regardless of what the other player does Nash Equilibrium Occurs when the game ends, and each player is happy with the outcome, given the choice made by the rival Neither player can improve their position with another move 4

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AP Economics Mr. Bernstein The Prisoner’s Dilemma Criminals don’t know that police lack evidence Each player has an incentive to choose an action that benefits his/herself at the other player’s expense Both players are then worse off than if they had acted cooperatively 5

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AP Economics Mr. Bernstein The Prisoner’s Dilemma, cont. Confession is the dominant strategy when Johnny and Frankie cannot talk (collude) Both players confess and the game reaches a Nash equilibrium – but an undesirable outcome! 6

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AP Economics Mr. Bernstein Repeated Interaction and Tacit Collusion Repeated Interaction leads to Strategic Behavior Players take into account the effect of their action on future behavior of competitors “Tit for tat” strategy Firm begins by cooperating, then each day does whatever their competitor did yesterday Tacit Collusion Competitors collude, without formal agreement, to reduce output and increase prices 7

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