In what ways is game theory of use in analyzing the behaviour of firms in an oligopolistic market?

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An oligopolistic market is a market dominated by a small number of participants who are able to collectively exert control over supply and market prices. A recurrent theme of oligopoly theory is whether prices are determinate with oligopolistic interaction. *A number of interesting new developments on the oligopoly front can be traced back to Stigler (1964) who examined the relationship between collusion and the information structure of an oligopolistic market. He argued that the basic problem in colluding to maximize joint profits is that if policing the agreement. This is a problem in the theory of information, since secret price cutting must be detectable for retaliation to be possible, or for a threat of retaliation to be credible (*quoted from Oligopoly, Competition and Welfare - Geroski, Phlips, Ulph). The basic dilemma suggests that whatever the point chosen on the profit frontier, each member finds it profitable to produce more than the quota allotted to him and so has an incentive to cheat whether the other members cheat or not.

The prisoner's dilemma is a situation where each player has two strategies and the profits are such that for each player, cheating is a dominant strategy, i.e., the best strategy no matter what strategy the other player chooses. This can be illustrated by the basic game theory model.

Game theory is the framework used to analyze situations of interdependent or strategic decisions, i.e., decisions whose output depends on the decisions of all agents involved. The main elements of the theory are: set of players, set of strategies and each player's payoff. Thus, since an oligopoly is a situation in which firm's decision depends on the decisions of the other firms, game theory provides the appropriate framework to analyze oligopolistic industries. The players are the different firms, they choose strategies regarding some...