Games, Games, Everywhere

The insights of game theory pervade economics, the social sciences, business, and everyday life. In economics, for example, game theory can explain trade wars as well as price wars (some illuminating examples are provided in the questions at the end of this chapter). Game theory can also suggest why foreign competition IDa};lead to greater price competition. What happens when Japanese firms enter a U.S. market where firms had tacitly coIluded on a price strategy that led to a high oligopolistic price? The foreign firms may “refuse to play the game.” They did not agree to the rules, so they may cut
prices to gain market shares. CoIlusion may break down. A key feature in many games is the attempt of players to build credibility. You are credible if you are expected to keep your promises and carry out your threats. But you cannot gain credibility with simple promises. Credibility must be consistent with the incentives of the game.

How can you get credibility? Here are some examples: Central banks earn reputations for being tough on inflation by adopting politically unpopular policies. Even greater credibility comes when the. central bank’s rules are written into law”or the nation’s constitution. Businesses make credible promises by writing contracts that inflict penalties if they do not perform as promised. A more perilous for an army to burn its bridges behind it. Because there is no retreat, the threat to fight to the death is a credible one. These few'”examples provide a small taste from the vast harvest produced by game theorists over the last half-century, This area has been enormously useful in helping and other social scientists think about situations here small numbers of people are well informed and try to outwit each other in markets, politics, or military affairs.

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