The Game Theory
The Game Theory also known as the second-best theory is a theory that explains the behaviour of firms in oligopoly market conditions. According to this theory, propounded by John Forbes Nash, Jr., a Nobel laureate economist, firms in oligipoly market don't compete among other firms on price but compete on non-price factors such as quality, brand image, advertisement, after-sales service and others. The game theory sturk in the mind of John Nash in a bar in Princeton University.
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The Beautiful Mind, a 2001 American movie based on the life of Nash, a schizophrenic prodigy played by Russell Crowe, there is an eureka moment for Nash when he lays out a new theory in a bar in Princeton University. Four of the Princeton students along with Nash in the 1950 were sitting in a bar sipping whiskey. Six female friends - five brunettes and one blonde - walk into the bar for their evening night out. All the boys immediately set their eyes on the blonde, who apparently is the most beautiful in the group. One of the four guy quotes Adam Smith, father of modern economics, "In competition, individual ambition surges the common good. Every man for themselves gentlemen", hence, stating the obvious competition between the five boys to sleep with the blonde.
At that same moment, Nash who makes a direct eye contact with the blonde, sees a new theory reflecting from her blue eyes. Nash with a smile on his face says, "Adam Smith needs a revision. If we all go for the blonde, they block each other. Not a single one of us is going to get her. So once the blonde rejects us, then we go for her friends. But they will give us a cold shoulder because nobody likes to be second choice. But what if no one goes for the blonde, we don't get in each other's way. And we don't insult the other girls. That's the only way we win. That's the only way we get laid - if none of us goes for the blonde. Adam Smith said the best result comes from everyone in the group doing the best for himself, but this theory is incomplete. The best result comes when everyone in the group does what is best for himselt and the group." This new approach towards picking women made Nash sound dubious to his friends.
One firiend in the group says, "John, if this is the way for you to get the blonde for yourself then go to hell." Nash walks up to the blonde girl, thanks her, and runs to his room to design his new theory on the Nash Equilibrium which eventually wins him a Nobel Prize in economics. The Nash Equilibrium which was the organising concept on the game theory, reflects how two or more people, parties, and businesses should form their strategy against one another when there is lack of clear information, something that we notice in the conduct of oligopolists.
This is how the game theory originated. This explains why firms in oligopoly market form cartels and collude to fix price, output, and market share. The best option for them is to cut the price of their product to boost sales. But this would trigger similar moves by rival firms driving their prices down so as to leave their individual output unchanged but receiving a lower price per unit of their production. The second-best option is to form a cartel and fix their prices and compete on non-price factors so there is a win-win for all. But there is always one problem of defaulting. According to Nash, if all the boys had agreed to go for the brunettes, but one defaults on the promise and goes for the blonde, then the rest will also default and go for the blonde. This will lead to none of them getting a woman resulting in their returning home alone. This occurs sometimes in oligopoly markets. As cartels are illegal, such agreements are non-paper so there is a high chance of a firm defaulting from their agreement.
