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What does Game Theory reveal about a firm's pricing strategy?

Game Theory explains pricing strategy of firms that are in an oligopolistic market. This means that the market is dominated by a small number of large firms. For example, large airline providers such as British Airways or Air France. The firms are interdependent. If BA lowers it prices to flights to France, Air France is likely to lose revenue and profit. Due to this, there may be a chance that oligopolies want to collude. BA admitted in 2007 that they fixed the price of fuel with Virgin Airlines. Due to interdependence, prices in these industries are unlikely to change. This is known as 'sticky' prices. 

Game Theory explains why 'sticky' prices occur. If collusion was possible and legal, BA and Air France would raise their prices to the same level. This would increase their profits without risking loss of demand and profit, a huge payoff. But, collusion, at least in the UK, is illegal. Therefore, no formal agreement can be made by BA and Air France to raise prices simultaneously so there is a huge amount of risk to them raising prices. BA could not completely trust Air France to follow an informal agreement. If, for example, BA raises its prices and Air France lowers, Air France increases its revenues whereas BA has reduced their own. Consequently, the most rational and risk averse approach as set out by Game Theory is to stay at Nash Equilibrium. This is the point where neither firm increases or decreases its prices. This eliminates chances of profit loss, but also profit gain. Game Theory is relevant to an oligopolistic firm as it influences their pricing strategy to be consistent. It is unlikely to sharply increase prices. As, if it does this, its rivals in the market can easily undercut and profit from it. If it decreases, the other firms will also follow. This is why ‘sticky’ prices occur. 

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