Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

 
Check Your Progress: 
1. What do you understand by collusion? 
2. State the two types of Collusion. 
3. Write notes on: 
i) Price leadership by a low cost firm 
ii) Leadership by a dominant firm 
iii) Barometric price leadership 
 
 
 
 
 
 
 
 
 
2.3 THE THEORY OF GAMES: 
 
The inter-dependence of firm in oligopoly and uncertainty 
about the reaction of rivals of any action taken by a firm cannot be 
fully analysed by the traditional tools of economic theory. It is true 
that economists have developed different models : collusive 
models, limit-pricing models, managerial models and behavioural 
models. However, none of these provides a general theory of 
oligopoly in the sense that they do not fully explain the process of 
decision-making in a firm. 
The Theory of Games offers a different approach to the 
study of oligopoly. In the late 1920s, the French mathematician 
Emil Barel wrote a series of articles to show how games, war, and 
economic behaviour were similar activities in that they all involve 
the necessity of making strategic decisions. Barel's work gained 
the attention of a number of economists and mathematicians who 

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believed that if a full-fledged theory of games could be developed, 
it might provide a much better understanding of oligopolistic 
behaviour than that offered by the traditional theory. In later 
developments, games theory was advanced by work of a number 
of scholars; the most significant achievement was the publication 
in 1944 of John von Neumann and Oskar Morgenstern's 
monumental "The theory of Games and Economics Behaviour." 
Some Preliminary Definitions: 
A strategy is one firm's plan of action adopted in the light 
of its belief about the reaction of its rivals. The players in the game 
may be thought of as the firms or their managers comprising the 
oligopoly industry. The players make their moves when they 
actually decide on the strategy to be employed. Thus, when A 
decides to be a follower, that is his move. The play of a firm 
consists of a detailed description of the firm's activities in carrying 
out its move. Thus, if two firms, A and B, decide to form collusive 
oligopoly, their play would be description of how they made their 
decision to collude, how they propose to carry it out, and so forth. 
The pay-off of game or strategy is the result of the player's 
moves. It may be defined as the not gain a strategy will bring to 
the firm for any given counter strategy of the rivals. 
The pay-off matrix of a firm is a table showing the pay-offs 
coming to it as a result of each possible combination of strategies 
adopted by it and by its competitors. 
In the theory of games, the firms in oligopolistic markets are 
treated as players in a chess game; to each move by one player, 
the other may choose among several counter moves. The 
counter-moves of rivals are probable but not certain. Yet, it is 
possible to choose a strategy which will maximise the firm's 
expected gain, after making due allowance for the effects of rival's 
probable reactions.