Game theory is a wide field of survey that involves analyzing ways in which strategic determinations are derived. The survey is applied in countries where strategic interactions among rational participants produce results with regard to the penchants of those participants ( Fudenberg & A ; Tirole 1991 ) . Game theory is a subdivision of applied mathematics that is largely used in the societal scientific disciplines state of affairss like. economic sciences. psychological science. political scientific discipline. and doctrine.
The theory is besides used in other Fieldss like. biological science. technology. political scientific discipline. international dealingss and computing machine scientific discipline. Game theory can be classified as ; non-cooperative ( or strategic ) games and co-operative ( or coalitional ) games ( Fernandez & A ; Bierman 1998 ) . Non-cooperative games are involved with how intelligent persons interact with one another in an attempt to accomplish their ain ends. Co-operative games are where participants co-operate in their moves ( schemes ) to accomplish the coveted common ends.
‘Strategic-form’ or ‘normal form’ games and ‘extensive form’ games. ‘Strategic form’ games are games where actions by participants are taken at the same time and order of the drama is irrelevant to the game’s result. ‘Extensive form’ games are games where actions are taken by the participants in a sequence and order of drama is relevant to a game’s result. They are normally presented in a tree diagram. Symmetric and Asymmetric games ; Asymmetric games are where the final payments for playing a peculiar move depend merely on the other player’s schemes.
Symmetrical game is where individualities of the participants can be changed without altering the final payment to the schemes. Zero-sum games and non-zero amount games ; Zero-sum games are where the entire benefits to all participants add up to zero ( Camerer 2003 ) . In non-zero amount games. the entire benefits do non needfully adds up to nothing. Discrete and uninterrupted games ; distinct games have finite figure of participants. moves. events and results. Continuous games have infinite Numberss.
The basic elements of game theory are ; an agent ( an entity with preferences/options ) . game ( All state of affairss in which at least one agent can merely move to maximise his public-service corporation through expecting responses to his actions by one or more other agents ) . public-service corporation ( sum of benefits/welfare an agent derives from happening of an event ) . final payment ( an ordinal public-service corporation figure assigned to a participant at event of a certain result ) . result ( an assignment of a set of final payments. one to each participant in the game ) . scheme ( player’s program on which action to take to accomplish his/her desired final payment ) and trees and matrices ( ways of stand foring games that is based on order of drama ) ( Fernandez & A ; Bierman 1998 ) . Game theory is based on the undermentioned premises: Players in a game are able to do their ain penchants i. e. they are free agents.
Players are economically rational and they can. measure outcomes. cipher waies to results and take actions that they think will give their preferable results. Agents’ intent is to maximise their public-service corporation. Game outcome depends on the actions taken by the participants ( Camerer 2003 ) . Game theory has been used to explicate in different Fieldss to explicate varied phenomena. In economic sciences. game theory has been employed to explicate concern behaviours and economic conditions. Economic theories have embraced game theory in explicating and exhibiting certain economic behaviours. Economists have used other related theories in seeking to understand rational interaction of strategic economic determinations that are made by people.
These theories are closely linked to game theory and they include. determination theory. general equilibrium theory and mechanism design theory. Decision theory is a game theory of a individual participant against nature that focuses on penchants and the formation of beliefs ( Fernandez & A ; Bierman 1998 ) . The theory is used to show how best to get information before doing a determination. Equilibrium theory is a subdivision of game theory that deals with trade and production and largely with where there are comparatively big figure of single consumers and manufacturers ( Fudenberg & A ; Tirole 1991 ) . It is widely used in the macroeconomic analysis of wide based economic policies like pecuniary and financial policies. stock markets analysis. involvement and exchange rates surveies.
Mechanism design theory is built on game theory but have particular focal point on the effects of different types of regulations ( schemes ) . Example of a game theory is monetary value game used by companies in a duopolistic market to increase their market portion. In a duopoly market. two houses control the market and they use factors like monetary values. quality merchandises and services. publicities. stigmatization and publicity to vie over the market portion ( Samuelson 2008 ) . When market portion of one company increases. the other company’s portion decreases. Firms in sectors that sells homogenous merchandises ( e. g. energy sector ) . uses pricing scheme to win increase their market portion.
Taking illustration of two oil companies in a duopolistic market in current oil monetary value rush. the companies are faced with job of seting their monetary values upwards since this will adversely impact the demand of their oil merchandises and therefore cut down their grosss. Increase in rough oil monetary values has been experienced in the universe. and oil and crude oil companies have to increase their retail monetary values upwards to recognize net incomes from their venture. Companies besides have objective of increasing the volume of their gross revenues. by increasing the market portion of their merchandises. Since crude oil companies trades homogenous merchandises. the chief selling tool to increase their market portion is monetary value. For two companies in a duopoly market. if one company increases its monetary values. and other maintains or even reduces. the former loses market portion to the latter.
Both companies face the undermentioned possibilities from their moves ; decrease of market portion of their merchandises and hence their hereafter grosss and net income or decrease in their net income border or loss and hence psychiatrist of their fiscal public presentation and growing in the hereafter. Therefore each of the houses is faced with quandary of which move to take in this state of affairs of crisp addition in their natural stuffs. The two houses have the undermentioned strategic job ; to guarantee profitableness of their companies amid high cost of their gross revenues. and force per unit area to keep their monetary values at competitory monetary value over their challengers in order to increase demand of their merchandises.
These are conflicting ends that direction of each company must decide by doing strategic monetary value determinations. Pricing schemes for the two houses are either to increase the monetary value that would consequences to increase in gross and retain its market portion. cut down monetary value which consequences to increase in market portion of its merchandises or keep the monetary value ( Ibid 2008 ) . Each company want to maximise its public-service corporation in the pricing moves i. e. to choose a move that will see its market portion maintained or increased and besides guarantee profitableness of the company. Each scheme that the companies may take hold deductions on the other i. e. move by one house affects the other house.
Example. in instance of one house diminishing its monetary values. this will affects negatively market portion of the other as the demand of the former company’s merchandise additions. Therefore. each company is expected to take pick that will ensue to its favour. Since the two houses are viing for success in their concern. there is no cooperation expected while doing this really of import pricing pick. However. both steadfast being the merely provider in the market. they can collaborate and put their monetary value reciprocally in a manner that will guarantee that no company will lose out to the other. Such agreements are common in oligopolistic markets. where manufacturers when faced by monetary value force per unit area reciprocally agree to put their monetary values at the same degree that will keep the market portion degrees.
In this game. each participant ( company ) prefers to increase its market portion over the other over keeping the current market portion. Therefore. they are taking conflicting moves to win over the other. The information about the available strategic picks is available to both houses. Both houses besides know the current market portion of their merchandises and monetary values of the rival group. Each company has information about the strengths of the other company and cognize how much they can back up low monetary values in the monetary value wars. They besides know that the cost of petroleum oil has increased in the universe market and that monetary value was the tool to increase their grosss and growing. The lone information both companies do non hold is which pick their rival brand and when.
Companies will non do monetary value alterations at the same clip ; therefore the company that will do monetary value alterations after the other will hold advantage over the other as it has anterior information that is really of import in doing the pricing determinations. This game is an extended game and the moves are in a sequence order. Therefore. timing of their moves is really of import as it will give the 2nd company advantage to do a well informed move. Using a conjectural instance. we take illustration of one company doing first move and so the other follows. Using the game tool we can acquire the possible results and solutions in an economic state of affairs like ours. The final payments assigned to each possible consequence indicate state of affairss where a company can profit ( high final payments ) or lose out to the other viing company ( low final payments ) .
Using a conjectural illustration of oil companies BP Inc and Shell Plc as companies that operates in a monopolistic market. we can analyze results of pricing moves made by the two companies. The game can be used to give solutions to the monetary value job in a tight monopolisic market. The pricing game is based on the undermentioned premises: both BP Inc and Shell Plc are rational entities and in their moves their aims are to increase their market portion. Both houses make a consecutive move on pricing that take extended signifier ( Fudenberg & A ; Tirole 1991 ) . Shell Plc makes their determination after the BP Inc makes their pricing move. There is perfect market information symmetricalness ( all company has all market information ) .
Other factors that affect influence market portion of the companies are changeless. Schemes employed are monetary value increase. monetary value decrease or keeping the monetary value degree. Payoffs ( public-service corporation maps ) for the moves are assigned as: Company that increases its market portion over the other gets 5. company that losingss its market portion to the other gets -5. The final payments represent the companies gain or loss in market portion. The scope for final payment is from -5 to 5. with both the lowest and the highest value stand foring the highest addition and the highest loss. The medium values represent an result of moderate alteration in the market portion of the companies. The game can be represented in a tree diagram as follows: BP Inc
P^ Pv P¦ Shell P^ Pv P¦ P^ Pv P¦ P^ Pv P¦ ( 0. 0 ) ( -5. 5 ) ( -2. 4 ) ( 5. -5 ) ( 3. 3 ) ( 4. 2 ) ( 4. 0 ) ( 2. 4 ) ( 2. 2 ) If BP Inc increases its monetary values ( P^ ) due to increased universe petroleum oil monetary values. and blast Plc additions ( P^ ) excessively the result will be ( 0. 0 ) i. e. their market portion would non alter but their gross revenues may cut down due to reduced demand. If Shell Plc reduces ( Pv ) the monetary values after BP Inc has increased its monetary values. the wage offs are ( -5. 5 ) i. e. BP Inc will loss its market portion at a rate that is same as one Shell Plc will increase its market portion.
In the scenario that BP Inc will raise its monetary values and Shell maintains its monetary values ( P¦ ) . the final payments are ( -2. 4 ) i. e. market portion for BP will cut down ( Pv ) but at low rate compared to Shell increase rate will be. On the other manus. if BP Inc reduces its monetary values foremost and so Shell raises its monetary values. the result will be ( 5. -5 ) i. e. market portion for BP will increase at a rate that’s same as the one Shell Plc will lose its portion. If both houses reduces their monetary values. the final payment is traveling to be ( 3. 3 ) i. e. their market portion will non alter but their gross revenues will be better ( higher gross than if monetary values are higher ) . However. if BP reduces its monetary values but Shell maintains its monetary value. the wage off will be ( 4. 2 ) i. vitamin E.
BP’s market portion will increase relatively higher than Shell’s. In the last scenario. in instance BP maintains its monetary value degree but Shell Plc increases its monetary value the result final payment will be ( 4. 0 ) i. e. BP’s portion will increase over Shell’s at comparatively higher rate. But if BP maintains its monetary values and Shell reduces its monetary values. the wage off will be ( 2. 4 ) i. e. Shell Plc will increase its market portion at a higher rate than BP Inc. In the last possible scenario. if both BP and Shell maintains their monetary values. the final payment will be ( 2. 2 ) i. e. there is non traveling to be alterations in the market portion. though both houses will hold higher gross revenues than if they raise their monetary values.
The game theory provides the solution that the 2nd ( shell ) should take a move to cut down its monetary value. if BP increases as it will greatly increase its market portion. Besides it can acquire increased market portion and net income if it maintains its monetary values. after BP increases its monetary values. To the company that makes the first move. the best solution is to keep the monetary value degree as it will hold higher final payments without put on the lining the move by the Shell. These options are the lone 1 that will increase their market portion and profitable growing. The monetary value game theory can be used to understand economic alterations in duopolistic markets. The game can be used in doing strategic pricing and selling determinations.
The attack is of import to economic theoreticians in depicting the economic principle that relates to trade good monetary values. demand and supply kineticss ( Guala 2005 ) . Despite the utility of game theory. there are some challenges to this theory. The premises on which the theory is based sometimes do non keep ( Fernandez & A ; Bierman 1998 ) . Game theorist premise that participants ever act in a manner to straight maximise their public-service corporation sometimes is violated by human behaviours i. e. in pattern. human behaviour frequently deviates from this theoretical account. This is because of the undermentioned factors that need to be considered ; unreason. new theoretical accounts of deliberation. and different motivations ( ) .
In existent life some people tend to react irrationally in a state of affairs where they are ideally expected to react rationally. Besides different people are motivated by different things and therefore be given to react otherwise in the same state of affairs. To this terminal some theoreticians take game theory as tool for proposing how people should react but non as a tool to foretell human behaviours and that game theory is used to explicate strategic concluding instead than strategic behaviours. Other restrictions of the theory are based on the premises that monetary values alterations are the lone factors that will impact the demand of the oil merchandises and accordingly the market portion. In existent life there are rational factors that affect the market portion of a merchandise or a company.
Quality of merchandises and services. trade name strength. publicities and other selling schemes influences the demand of a merchandise and its market portion. Companies may besides be motivated by other factors other than increasing market portion when doing pricing determinations. The theory besides does non delegate specific values to stipulate to what per centum a company addition or lose the market portion. Since it’s an economic analysis it should give results that can be easy understood and that make economic sense. However. the theory is really of import in giving the general description of how persons are expected to react given a certain economic conditions.
In the economic field the theory has been instrumental in explicating behaviours of houses and individuals’ manufacturers and consumers. The theory is besides really of import in understanding how strategic determinations relate. Mention: Camerer. C. ( 2003 ) . Behavioral Game Theory: Experiments in Strategic Interaction. Princeton: Princeton University Press Fernandez. L F. ; Bierman. H S. ( 1998 ) . Game Theory with Economic Applications. Addison-Wesley Fudenberg. D. . and Tirole. J. ( 1991 ) . Game Theory. Cambridge. Ma: MIT Press Guala. F. ( 2005 ) . The Methodology of Experimental Economics. Cambridge: Cambridge University Press Samuelson. L. ( 2005 ) . Economic Theory and Experimental Economics. Journal of Economic Literature 43:65-107.