Game Theory:

Inside Oligopoly
Chapter 10
Group 9

▪ Raka Sukmana Ardi ▪ Regina Kusuma Mutti

▪ Remanfri Estomihi Lumbangaol

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Overview of Games and Strategic Thinking
Relates closely with strategies of the firms that will determine the payoffs (profits or losses)
of each involved firm and it is interdependence.

Sequence of Decision Making Frequency of the Game

Simultaneous-move game One-shot game
Game in which each player makes decisions Game in which the underlying game is played
without knowledge of the other players’ only once
decisions

Sequential-move game Repeated game

Game in which one player makes a move after Game in which the underlying game is played
observing the other player’s move more than once
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1. Simultaneous-Move,
One Shot Games
Theory
Strategy Dominant Strategy
Decision rule that describes the actions a player A strategy that results in the highest payoff to a
will take at each decision point. player regardless of the opponent’s action

Normal-form game Secure Strategy

A representation of a game indicating the A strategy that guarantees the highest payoff
players, their possible strategies, and the payoffs given the worst possible scenario
resulting from alternative strategies

Nash Equilibrium
A condition describing a set of strategies in which
no player can improve her payoff by unilaterally
changing her own strategy, given the other
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players; strategies.
 Player B

“
Set of strategy from
Strategy Left Right Player B
Player A Up 10, 20 15, 8

Down -10, 7 10, 10

Set of strategy from Dominant Strategy Safe Strategy

Player A
Nash Equilibrium
• Player A is to go Up
• Player B is to go Left
• Player A is to go Up (both Up
strategy bringing bigger
payoffs)
• Player B, does not have any
dominant strategy
• Player A is Up (minimum
payoff is 10)
• Player B is Right (minimum
payoff is 8)

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Application of One-Shot Games
Pricing Decision Advertising & Quality Decision
Player B Player B

Bertrand Duopoly
Low High Don’t
Strategy Strategy Advertise
Price Price Advertise
Player A Player A
Low
0, 0 50, -10 Advertise $4, $4 $20, $1
Price
High Don’t
-10, 50 10, 10 $1, $20 $10, $10
Price Advertise

Nash Equilibrium is when both are charging Low Price
Each firm’s best strategy is to charge
low price regardless of the other firm’s
action. Profits are less than the firms Sample Case
would earn if they colluded and
“agreed” to charge high prices. But this
is a one shot game, what if the other
firm cheated the agreement?
This is called dilemma
In most oligopolistic markets, advertising increases the
demands for a firm’s product by taking customers away
from other firms in the industry (switch brand)
Nash Equilibrium happens when both firms decide to
Advertise.
Collusion will not work as this is a one-shot game.
Each firm will have the possibility to cheat and
receive bigger payoffs. 7
Application of One-Shot Games
Coordination Decision Monitoring Employees
Player B Worker
120-Volt 90-Volt
Strategy Strategy Work Shirk
Outlets Outlets
Player A Manager
120-Volt Monitor -1, 1 1, -1
$100, $100 $0, $0
Outlets
Don’t
90-Volt 1, -1 -1, 1
$0, $0 $100, $100 Monitor
Outlets
Game theory can also be used to analyze interactions
2 firms must decide whether to produce appliances between manager and worker.
requiring 120-Volt or 90-volt outlets. This is called
coordination game. Players would engage in a Mixed (randomized) strategy
whereby a player randomizes over two or more
There are Two Nash Equilibrium: available actions in order to keep from being able to
• Both firms produce 120-volt outlets predict his or her action.
• Both firms produce 90-volt outlets

How to reach the Nash Equilibrium:

• Both firms communicating 8
• Government sets the standard
Application of One-Shot Games
Nash Bargaining
Union

Strategy 0 50 100

Management 0 0, 0 0, 50 0, 100

50 50, 0 50, 50 -1, -1

100 100, 0 -1, -1 -1, -1

2 players “bargain” over some object of value.

There are Multiple Nash Equilibrium:

• Management asked $100, Union asked $50
• Both parties asked $50
• Union asked $100, Management asked $100
Bargainers often perceive a 50 – 50 split to be “Fair”.
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2. Infinitely Repeated
Games
Infinitely Repeated Game

▪ A game that is played over and over again

forever and in which players receive payoffs
during each play of the game.
▪ The stages of the game are t = 0, 1, 2, .... An
infinitely repeated game is also sometimes
called a supergame.
Theory
▪ Present Value
𝑇
𝜋1 𝜋2 𝜋𝑇 𝜋𝑡
𝑃𝑉𝐹𝑖𝑟𝑚 = 𝜋0 + + 2
+ ⋯+ 𝑇
=෍
1 + 𝑖 (1 + 𝑖) (1 + 𝑖) (1 + 𝑖)𝑡
𝑡=0
𝜋 = Profit
𝑖 = Interest If 𝜋 𝑇 = 𝜋 And 𝑇 = ∞

𝜋1
𝑃𝑉𝐹𝑖𝑟𝑚 = 𝜋
1+𝑖

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 Supporting Collusion with Trigger Strategies
Trigger Strategy = A strategy that is contingent on the past play of a game and
in which some particular past action

Table 10 - 7

Price Low High

Low 0,0 50 , - 40

High - 40 , 50 10 , 10

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Factors Affecting Collusion in Pricing Games

▪ Number of Firms
▪ Firm Size
▪ History of the Market
▪ Punishment Mechanisms

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3. Finitely Repeated
Games
Finitely Repeated Game

➢ Games with an uncertain Final periode :

Players do not know when the game will end

➢ Games with a know final periode :

Players know when it will end
player will punish other player if cheat, in the next periode

Probability Game will end = Ѳ

Where 0 < Ѳ

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➢ Notice if Ѳ
if Firm A don’t cheat, profit $10( )
If Firm A Cheat, profit $50 >$ 10 ( dominant strategy )

➢ Notice if Ѳ
If Firm A don’t cheat, profit $100 ( )
If Firm A Cheat, profit $50 < $100
Since $50 < $100 firm A has no intensive To cheat
The firm can collude Charge high price
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 In the 2nd / (last) game
there is no tommorow
Every player couldn’t punish
each other
Every player will set low
price in 2nd game or in the
last periode

Firm A earn : $10 ( no cheat ) + $50 ( cheat ) = $60

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4. Multistage Games
Multistage game : Game that each player make sequential decision

Theory :

To understand Multistage of Game, it’s useful to introduce

Extensive-form game
This inform :
➢ identification who the player
➢ Information available of each stage
➢ The sequence move of player
➢ and the payoff resulting from alternative strategy
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 Firm A : First mover
Firm B : second mover

Subgame perfect equilibrium :

Condition describing set of strategies that
constitute of nash equilibrium and allows no
player to improve his payoff at anystage by
changing strategies

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 Sequential move bargaining

Nash equilibrium :
Management give $99 to union
And union accept it

Subgame perfect equilibrium :

Management give $1 to union and
union accept it
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Summary
Game Theory is a tool for a manager in making decisions in oligopoly market:
▪ Pricing strategy
▪ Advertising & Quality strategy
▪ Coordination strategy
▪ Entering new market
▪ Product Innovation
▪ Employee monitoring
By also put into consideration the details of the situation:
▪ Simultaneous-move, one-shot/finitely/infinitely repeated game,
▪ Multistage game
▪ Sequential-move bargaining game
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Thanks!
Any questions?

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