AP Economics
Mr. Bernstein
Module 65:
Game Theory
December 10, 2014
AP Economics
Mr. Bernstein
Game Theory
• Study of how interdependent decision makers
make choices
• Used to study the decisions of oligopolists
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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
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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
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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
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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!
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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
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