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Ebook Advanced microeconomic theory (3/E): Part 2

Part 2 book “Advanced microeconomic theory” has contents: Game theory, information economics, auctions and mechanism design, sets and mappings, calculus and optimization. Invite to references. | PART III STRATEGIC BEHAVIOUR CHAPTER 7 GAME THEORY When a consumer goes shopping for a new car, how will he bargain with the salesperson? If two countries negotiate a trade deal, what will be the outcome? What strategies will be followed by a number of oil companies each bidding on an offshore oil tract in a sealed-bid auction? In situations such as these, the actions any one agent may take will have consequences for others. Because of this, agents have reason to act strategically. Game theory is the systematic study of how rational agents behave in strategic situations, or in games, where each agent must first know the decision of the other agents before knowing which decision is best for himself. This circularity is the hallmark of the theory of games, and deciding how rational agents behave in such settings will be the focus of this chapter. The chapter begins with a close look at strategic form games and proceeds to consider extensive form games in some detail. The former are games in which the agents make a single, simultaneous choice, whereas the latter are games in which players may make choices in sequence. Along the way, we will encounter a variety of methods for determining the outcome of a game. You will see that each method we encounter gives rise to a particular solution concept. The solution concepts we will study include those based on dominance arguments, Nash equilibrium, Bayesian-Nash equilibrium, backward induction, subgame perfection, and sequential equilibrium. Each of these solution concepts is more sophisticated than its predecessors, and knowing when to apply one solution rather than another is an important part of being a good applied economist. 7.1 STRATEGIC DECISION MAKING The essential difference between strategic and non-strategic decisions is that the latter can be made in ‘isolation’, without taking into account the decisions that others might make. For example, the theory of the consumer developed in Chapter 1 is a model of .