Game Theory and Competitive Strategy in Economics

Economic Rent and the Music Industry

Economic rent is the difference between the actual payment to the factor of production and the minimum amount that the factor is willing to accept. In the music industry, consider top-quality rock musicians. You might assume that there are a limited number of these musicians who will continue to play almost no matter their pay. This results in a perfectly inelastic supply curve, or something close to it.

Given the high demand for rock music, the wage for these musicians will be very high, leading to significant economic rent. If there were a larger supply of top-quality rock musicians, or a more elastic supply, then the economic rent would be smaller.

Game Theory Concepts and Examples

Cooperative vs. Noncooperative Games

Noncooperative games involve players who act independently, without formal communication or binding contracts. An example is a race in research and development to obtain a patent.

Cooperative games allow for binding contracts and agreements between players. An example is a formal cartel agreement like OPEC, or a joint venture.

Dominant Strategy and Equilibrium

A dominant strategy is the best choice for a player regardless of the other player’s actions. When both players have dominant strategies, the outcome is a stable equilibrium because neither has an incentive to change.

Nash Equilibrium

A Nash equilibrium occurs when both players believe they are making the best possible choice given the other player’s action. It differs from a dominant strategy equilibrium because it depends on the opponent’s behavior.

Maximin Solution

A maximin strategy involves choosing the option that maximizes the minimum possible gain, regardless of the opponent’s actions. It’s more likely than a Nash equilibrium when irrational behavior is expected.

Tit-for-Tat Strategy

The tit-for-tat strategy involves cooperating as long as the opponent cooperates and switching to a noncooperative strategy if the opponent defects. It’s rational in infinitely repeated games like the prisoner’s dilemma.

First-Mover Advantage

A first-mover advantage occurs when the first player to act gains a higher payoff. Examples include setting industry standards or influencing consumer perception (e.g., “Kleenex” becoming synonymous with facial tissue).

Strategic Moves and Reputation

A strategic move is a commitment that limits one’s options but can influence the opponent’s behavior. Building a reputation for unpredictability or making credible threats can be strategic moves.

Winner’s Curse

The winner’s curse is the tendency for the winner of a common value auction to overpay. This is because the winner is likely the one who overestimated the item’s value the most.

Exercises and Applications of Game Theory

The document also includes exercises exploring topics like:

• Challenges to collusion in oligopolistic industries
• Factors leading to overcapacity in industries
• Strategic decision-making in a duopoly market