Uncertainty and Game Theory
Life is full of uncertainty and strategic behavior. A capsule history of exploring for oil in Russia will illustrate this point. During the, turmoil of the early 19905, oil production in Russia declined sharply. and Russia fell from being the world’s largest oil producer to number three. Western oil companies were invited. to participate in investing in and, modernizing the Russian oil fields. Suppose that you are in charge of a Texaco joint venture in Siberia. What obstacles would you face? You would of course face the normal risks that plague oil producers -everywhere-s-the risks of a price plunge. of embargoes, or of an attack on your tankers by some hostile regime. Added to these are the uncertainties of operating in a new area: you are unfamiliar with the geological formations, with the terrain for getting the oil to the market. with the success rate on drilling wells. and with the skills of the workforce. In addition to these uncertainties is a set of political risks’ involved in dealing with a divided central government in Moscow, with autonomous regions, with localities, and with the Russian “mafia” in a country where property .rights, bribes; ‘and taxation are subject to haggling and the rule of bureaucracy rather than the rule of law.
The dilemmas of the Texaco joint venture show that economic activity often raises complexities that are notcaptured in our ‘elementary theories. One topic, called the economics of uncertainty, analyzes the impact of the many uncertainties involved in economic life. Our oil company must deal with the uncertainties of drilling. of volatile prices. and of shifting markets. Households must contend with uncertainty about future wages or employment and about the return on their’ investments in education or’ in financial assets. Occasionally. people. suffer from misfortunes such as devastating hurricanes. earthquakes. Firms must also contend with uncertainties. about the prices of their products and inputs. political form oil in unstable countries, taxes and interest rates, the course of technological change in their industry. and the strength of rivalry from domestic and foreign competitors.
A second topic. known as game analyzes those aspects of economic life which involve haggling, bargaining. and strategist. In perfectly competitive markets; all parties take prices as given and need not worry about others’ reactions to their actions. In most circumstances. however. strategic considerations ‘are of the essence, Our oil company must worry about whether a big oil find will simply be expropriated by the’ Russians. An oligopolistic firm must worry about how other firms will react to its price or output decisions, Will a price cut to a price war? the price war lead to bankruptcy? Many large firms engage in collective bargaining with a union to determine wages and conditions of work. Will too tough a position lead to a crippling strike?
We often see elements of bargaining in economic policy-making. When governments decisions about taxes and expenditures, these often result from intricate bargaining between political parties, or between the president and Congress, the many power brokers in Congress. A dramatic game of chicken took place between President Clinton and the Republicans in 1994 when the congressional Republicans shut down the government and threatened to cause a default on the national debt in an effort to get President Clinton to capitulate on their budget demands. life involves elements of strategy and bargaining about me allocation of chores or the division of the family’s income. No study of the of economic life is without a thorough study of the fascinating interplay of uncertainty and game theory.
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