Which of the following describes a Nash equilibrium? A. A firm chooses its dominant strategy, if one exists. B. Every competing firm in an industry chooses a strategy that is optimal given the choices of every other firm. C. Market price results in neither a surplus nor a shortage. D. All firms in an industry are earning zero economic profits.
The correct answer and explanation is:
The correct answer is:
B. Every competing firm in an industry chooses a strategy that is optimal given the choices of every other firm.
Explanation:
A Nash equilibrium is a fundamental concept in game theory that describes a situation where no player can gain by unilaterally changing their own strategy, assuming the strategies of the other players remain fixed.
Let’s break down the options:
- A. A firm chooses its dominant strategy, if one exists.
While a dominant strategy is a strategy that is best regardless of what others do, a Nash equilibrium does not require every player to have or choose a dominant strategy. A Nash equilibrium can exist without dominant strategies. So this statement is not a full description of Nash equilibrium. - B. Every competing firm in an industry chooses a strategy that is optimal given the choices of every other firm.
This captures the essence of Nash equilibrium perfectly. Each firm’s choice is a best response to the strategies chosen by all other firms. No firm can improve its outcome by changing its strategy alone. This mutual best-response situation defines Nash equilibrium. - C. Market price results in neither a surplus nor a shortage.
This describes market equilibrium in the context of supply and demand, not Nash equilibrium. Market equilibrium means quantity demanded equals quantity supplied at a certain price — unrelated to strategic decision-making between firms. - D. All firms in an industry are earning zero economic profits.
This describes long-run equilibrium in perfectly competitive markets, where firms make zero economic profit due to free entry and exit. This is not the definition of Nash equilibrium, which focuses on strategic stability rather than profit levels.
More on Nash Equilibrium:
In a Nash equilibrium, each player’s strategy is a best response to the strategies chosen by others. This does not necessarily mean the outcome is socially optimal or maximizes total welfare, but it is stable because no single player has an incentive to deviate.
For example, in an oligopoly (few firms competing), firms choose quantities or prices taking into account competitors’ actions. The Nash equilibrium is the set of strategies where no firm wants to change its choice, given the choices of rivals.
This concept applies widely in economics, political science, biology, and any strategic interaction where participants’ decisions depend on others’ decisions