Evaluate the use of game theory as a tool to explain oligopolistic behaviour

Authors Avatar

Evaluate the use of game theory as a tool to explain oligopolistic behaviour (25 marks)

An oligopoly is a market structure that consists of a few dominating large firms in a particular industry. Game theory is the theory that explains the interaction between firms and decision that firms make.

To some extent, using game theory as a tool to explain oligopolistic behaviour can have limits as the game theory is based on the idea that humans act rationally in making decisions. However, it could be argued that human beings do not act rationally all the time. Therefore, can we completely rely on game theory to use as a tool to explain oligopolistic behaviour?

Nevertheless, the game theory can still be used in understanding the budget of firms for advertising and branding programmes. This can be seen as being essential as oligopolistic firms prefer non-price competition to prevent price wars in a particular industry (and oligopolistic markets prefer price rigidity). In fact, over the years, Nike has gradually increased the amount of money to put towards sports sponsorship programmes and more TV advertising. Many other competitors such as K Swiss and Reebok have responded by increasing their sponsorship schemes. Therefore, game theory can be used to understand the strategic decisions that firms make on the size of advertising and branding budgets and plays a significant part in making sure that market share in an industry is retained.

Join now!

On the other hand, the game theory is based upon human being acting rationally on behalf of companies through taking calculated risks. However, we have seen in the recent bank crisis that this doesn’t seem to be the case. For example, the Royal Bank of Scotland took over ABN AMRO banking group to be more competitive on a global scale, only after the takeover was is realised that ABN AMRO were heavy in toxic debt. Therefore, how can we possibly apply a theory to oligopolistic behaviour such as game theory, based on rationality, when such large and well established institutes ...

This is a preview of the whole essay