Summary

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  1. Game theory is the study of what happens when economic actors—like the firms and consumers we’ve studied up until this point—behave strategically. Every game features three key elements: players, strategies, and payoffs. Dominant strategies are always the best action for players to take regardless of their opponents’ actions, while dominated strategies are never the best action. Identifying any dominant and dominated strategies in a game makes solving for the Nash equilibria easier. [Section 12.1]

  2. In simultaneous-move games, a player must choose her strategy without first knowing her opponent’s choice. The mutual-best-response concept of Nash equilibrium is a natural way to predict the outcomes of such games. Depending on the particular structure of the strategies and payoffs, games can have one, multiple, or even mixed-strategy Nash equilibria. Players may also vary their strategies if faced with an irrational or erratic opponent. In addition, players may be interested in using a maximin strategy to minimize their losses in a game. [Section 12.2]

  3. The outcome of a one-shot simultaneous game differs from the outcome of a repeated simultaneous game. Backward induction is used to find the equilibria of multistage games. When applied to a repeated prisoner’s dilemma, backward induction reveals that cooperation is still not an equilibrium when a repeated game has a known final stage (regardless of how many stages there are). However, when the actors play an infinite game or do not know with certainty which is the final round, cooperation can be an equilibrium. [Section 12.3]

  4. In sequential games, players take actions in turn, meaning that one player sees the other’s action before choosing her own strategy. As with other multistage games, backward induction can be used to find the equilibria of sequential games. [Section 12.4]

  5. Players often use strategic moves to ensure that their later outcomes are favorable. Economic actors may strategically use side payments, credible commitments, and reputation. Entry deterrence is one of the most common applications of strategic moves in microeconomic analysis. [Section 12.5]