Micro Review
Game Theory and Taxation
Dominant Strategy
• One strategy is better for a given player,
regardless of what his/her opponent chooses
to do
Game Theory
Game Theory Model to Analyze
Behavior
RareAir’s Price Strategy
Uptown: Dominant
Strategy = Low
Rareair: Dominant
Strategy = Low
High
Uptown’s Price Strategy
•
•2 Competitors
•2 Price Strategies
•Each Strategy Has
a Payoff Matrix
A
$12
Low
B
$15
High
$12
C
$6
$6
D
$8
Low
$15
$8
O 23.2
Nash Equilibrium
John F. Nash, 1928 -
Russell Crow portrays John Nash in A Beautiful Mind
NASH EQUILIBRIUM : when each player is pursuing their
best possible strategy in the full knowledge of the other
players’ strategies. A Nash equilibrium is reached when
nobody has any incentive to change their strategy.
An Example of a Nash Equilibrium
Column
a
b
a
1,2
0,1
b
2,1
1,0
Row
(b,a) is a Nash equilibrium.
To prove this:
Given that column is playing a, row’s best response is b.
Given that row is playing b, column’s best response is a.
Tax
Incidence
Efficiency Loss of a Tax
P
S’
14
Tax Paid by
Consumers
Price (Per Bottle)
12
S
Tax $2
10
8
6
4
2
0
Efficiency
Loss (or
Tax Paid by Deadweight
Loss)
Producers
5
10
15
20
Quantity
D
25
(Millions of Bottles Per Month)
Q
Tax Incidence
Demand Elasticity and the Incidence
of an Excise Tax
P
P
St
Tax
Tax
S
S
a
Pi
Pe
P1
Pa
St
a
b
P1
Pb
De
c
b
c
Dt
0
Q2
Q1
Tax Incidence and
Elastic Demand- burden on the
supplier
Q
0
Q2Q1
Tax Incidence and
Inelastic Demand- burden on
the consumer
Q