2. Micro Review Game Theory and Taxation

3. Dominant Strategy One strategy is better for a given player, regardless of what his/her opponent chooses to do

4. Uptown: Dominant Strategy = Low Rareair: Dominant Strategy = Low Game Theory Game Theory Model to Analyze Behavior RareAir’s Price Strategy Uptown’s Price Strategy AB CD $12 $15 $6 $8 $6 $15 High Low 2 Competitors 2 Price Strategies Each Strategy Has a Payoff Matrix O 23.2

5. Nash Equilibrium NASH EQUILIBRIUM : when each player is pursuing their best possible strategy in the full knowledge of the other players’ strategies. A Nash equilibrium is reached when nobody has any incentive to change their strategy. John F. Nash, 1928 - Russell Crow portrays John Nash in A Beautiful Mind

6. An Example of a Nash Equilibrium ab b 2,1 0,1 1,0 1,2 Row Column a (b,a) is a Nash equilibrium. To prove this: Given that column is playing a, row’s best response is b. Given that row is playing b, column’s best response is a.

7. Tax Incidence Efficiency Loss of a Tax 0 2 4 6 8 10 12 14 510152025 Q P Price (Per Bottle) Quantity (Millions of Bottles Per Month) S D S’ Tax $2 Tax Paid by Consumers Tax Paid by Producers Efficiency Loss (or Deadweight Loss)

8. Tax Incidence 0 P QQ P 0 Tax Incidence and Elastic Demand- burden on the supplier Tax Incidence and Inelastic Demand- burden on the consumer Demand Elasticity and the Incidence of an Excise Tax DeDe DtDt Tax StSt S StSt S Q2Q2 P1P1 PePe PaPa P1P1 PiPi PbPb Q1Q1 Q2Q2 Q1Q1 a a b b c c