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In order to understand how game theory explains market structures one must first be able to define game theory. Game theory is defined in The Principles of Macroeconomics as “the study of how people behave in strategic situations” (365). Strategic thinking is necessary in almost all business decisions. It’s used to evaluate the ripple affect of the decisions made. In other words, one must think about how one’s actions will affect other people as well as what actions others will likely make in response.
Game Theory is a tool not generally used when evaluating monopolistic or competitive markets. It cannot be used while assessing monopolistic markets because in a monopolistic market has only one or very few sellers, thus they don’t need to take into consideration the actions of other firms because there are none. In a competitive market there are many firms and the consequences of one firms actions have little or not effect on the entire market. Game Theory is useful when evaluating firms operating in an oligopoly market. In an oligopoly market there are few sellers and they are all interdependent upon one another.
An example of how game theory is implemented market strategies is evident in a situation where there is a duopoly. Let’s say for example there is a duopoly in which two people are selling apples in a small town. The two sellers (Jimmy and Timmy) both have an unlimited source of apples of which they can sell to turn a profit. From a seller’s standpoin...