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Game Theory

### Basic Ideas of Game Theory:

Basic Ideas of Game Theory Game theory is the general theory of strategic behavior.  Generally depicted in mathematical form.  Plays an important role in modern economics.

### Rules, Strategies, Payoffs, and Equilibrium:

Rules, Strategies, Payoffs, and Equilibrium Economic situations are treated as games.  The rules of the game state who can do what, and when they can do it.  A player's strategy is a plan for actions in each possible situation in the game.

### Rules, Strategies, Payoffs, and Equilibrium:

Rules, Strategies, Payoffs, and Equilibrium Economic situations are treated as games.  A player's payoff is the amount that the player wins or loses in a particular situation in a game.  A players has a dominant strategy if that player's best strategy does not depend on what other players do.

### Nash Equilibrium:

Nash Equilibrium Occurs when each player's strategy is optimal, given the strategies of the other players.  A player's best response (or best strategy) is the strategy that maximizes that player's payoff, given the strategies of other players.  A Nash equilibrium is a situation in which each player makes his or her best response.

### Prisoner's Dilemma:

Prisoner's Dilemma Famous example of game theory.  Strategies must be undertaken without the full knowledge of what other players will do.  Players adopt dominant strategies, but they don't necessarily lead to the best outcome.

### Prisoner’s Dilemma:

Prisoner’s Dilemma

### Bonnie’s Decision Tree:

Bonnie’s Decision Tree

### Economic Applications of Game Theory:

Economic Applications of Game Theory Cheating on a cartel Trade wars between countries Advertising Games without dominant strategies

### Cheating on a Cartel:

Cheating on a Cartel Cartel members' possible strategies range from abiding by their agreement to cheating.  Cartel members can charge the monopoly price or a lower price.  Cheating firms can increase profits.  The best strategy is charging the low price.

### Cheating on a Cartel:

Cheating on a Cartel

### Decision Tree for the Coca Cola Company:

Decision Tree for the Coca Cola Company

Trade Wars Between Countries Free trade benefits both trading countries. Tariffs can benefit one trading country.  Imposing tariffs can be a dominant strategy and establish a Nash equilibrium even though it may be inefficient.

### Effects of a Tariff on Japanese Televisions:

Effects of a Tariff on Japanese Televisions Price to Buyers with a Tariff 600 800 \$350 \$300 \$250 Price with No Tariff Price to Sellers with a Tariff Q C A B E P \$100 Tariff Supply of Japanese Televisions to U.S. Market U.S. Demand for Japanese Televisions Televisions (thousands per year)

### Decision Tree for the United States:

Decision Tree for the United States

Advertising The prisoner's dilemma applies to advertising.  All firms advertising tends to equalize the effects.  Everyone would gain if no one advertised.