Game theory is one of the main additions to the new A2 specifications. It is a welcome addition to any economics course, leading students nearer to the frontiers of economic research. The topic has often been used as extension material to stretch the most able A level students, but it must now be covered by those who take economics on for the second year. This challenges teachers to address this exciting topic in an engaging way, while also helping students understand the theoretical concepts required for their examination. Two ideas for introducing game theory follow, along with a way to use it as a real-life market.
Game 1: Sweets for cheats
When students start learning game theory they are soon confronted with the prisoners' dilemma. To introduce this concept I put the matrix shown below on the board. After a brief introduction, I challenged students to play against each other at the front of the class, to maximise their payoff (sweets, or grapes for the health-conscious). They were told not to communicate with each other and stood back to back.
After the pair had decided their strategies, I got the class to tell them how many sweets they should each receive. Students were asked why they opted for their chosen strategy, and many explained that they were trying to get the "five" payoff by playing strategy 2. This can lead into an explanation of why both players playing strategy 2 is the Nash equilibrium. (This is the outcome where both players have done the best they can. Total gains will be less than they could have got by colluding, but both gain something, basing their choices on reasonable assumptions about each other's likely decisions.)
If students explain that they "cheated" and had worked together to get three sweets, this can lead to a discussion of the gains of collusion and the collusive equilibrium. If you have a particularly honest group, you can have a second round where students can communicate, and they should hopefully both choose the collusive outcome (both playing strategy 1).
This activity can be followed by other games where the Nash equilibrium can be found, such as Game 2 (below). Alternatively, students could attempt an examination-style question such as: "With reference to game theory, explain the benefits of two airlines colluding."
Game 2: Petrol wars
This second example can be used to explain oligopolistic behaviour in real markets. This is based on a scenario of competing petrol stations in a town (see panel).
You run a petrol station. Your task is to compete with the other petrol stations in your area in order to make the most profit you can. You do this by making decisions about your petrol station and the shop on your petrol station forecourt.
The full cost of sourcing petrol is £1 per litre.
It is known that consumers will generally not pay more than £1.25 for a litre of petrol, and last week all petrol stations in the area charged this price (£1.25).
You know that there are different types of customers.
* Some customers like the cheapest petrol price. They are very …