You are on page 1of 31

# p  



|

p        .

.

.

ÚAssume no cooperation or collusion among firms ÚThis model helps explain why the prices in some oligopolistic markets change very slowly over time ± individual firms are basically Ô Ô to change price because of what other firms might do. ] .

À . B. ×    ÚAssume that we have 3 firms: A. & C ÚProducts are similar ÚThe shape of the demand curve for A¶s product tells us how much QD changes when there is a price change (elasticity) ± this depends on the pricing behavior and similarity of the substitutes B and C.

then they maintain the higher price because they don¶t believe that people will switch. Ú If B and C  then they also raise price because they don¶t believe that people will switch. 2. ë . so they can increase profits by also charging more. then they maintain the lower price because they believe that people will switch. If firm A lowers price then B and C can follow the price change or ignore it. Ú If B and C  then they also lower price because they are afraid of losing their market share to firm A. Ú If B and C  the price change by A. Ú If B and C  the price change by A. ×    Consider what happens when A changes its price: 1. If firm A raises price then B and C can follow the price change or ignore it. and they can capture some of firm A¶s market share by having a lower price.

so consumers are more likely to switch between products. If A lowers price and B and C do not follow: Ú consumers are more likely to substitute toward A Ú decrease in the Price of A => big increase in QD for A So if A raises price and B and C do not follow: Ú consumers are more likely to substitute toward B and C Ú increase in the Price of A => big decrease in QD for A If the other firms do not follow then the demand for A¶s product will be relatively ELASTIC (flat slope).  . ×    0otice that if the competitors B and C ignore the price change ± then we have more price difference than before.

then there is going to be less substitution taking place and the demand for A¶s product is going to be relatively I0ELASTIC (steep slope). ×    Úwn the other hand. if the other firms do follow A¶s price changes. £ .

Ú This makes my demand I0ELASTIC (steep) below the current price º . Ú What will you do if I raise price? Ú 0othing. ×    0ow«Pretend that you are firms B and C and I am firm A. Ú What will you do if I lower price? Ú Follow and also lower price so that I do not capture your market share. Keep your price low to try and capture my market share. Ú You do not follow => this makes my demand ELASTIC (flat) above the current price. And you think that your product is a close substitute for my product.

they do not have much incentive to change price: ÚA price   Ô . ×    ÚWhen firms believe that their product is a close substitute for their competitor¶s product.

 .

ÚA price   Ô . so they have nothing to gain by lowering price.Ô  .

.

 .

so they have a lot to lose by raising price.Ô  . D .

p     ÚThe payoff of many actions depends upon the actions of others ÚFor example. an imperfectly competitive firm must weigh the responses of rivals when deciding whether to cut their prices ÚThe decisions of competing firms are often interdependent [ .

    ÚA mathematical technique for analyzing the decisions of interdependent oligopolistic firms in uncertain situations. | . but may eventually learn which way the opposition is leaning. ÚA ³game´ is simply a competitive situation where two or more firms or individuals pursue their interests and no person can dictate the final outcome or ³payoff´. ÚPlayers choose their strategy without certain knowledge of the other players strategies.

u.

    ÚBasic elements ÚThe players ÚThe strategies ÚThe payoffs ÚPayoff matrix ÚThe fundamental tool of game theory. ÚThis is simply a way of organizing the potential outcomes of a given game in a table that describes the payoffs in a game for each possible combination of strategies || .

given the other players¶ strategies Ú IwW: 0ash equilibrium is achieved when all players are playing their best strategy given what the other players are doing.     Ú Dominant strategy Ú A strategy that yields a higher payoff no matter what the other players in a game choose Ú Dominated strategy Ú Any other strategy available to a player who has a dominant strategy Ú 0ash Equilibrium Ú Any combination of strategies in which each player¶s strategy is his best choice. |] .

.

Ú If each firm decides not to advertise. each will earn a profit of \$50. they will earn \$10. Ú If one firm advertises and the other does not.        Ú Duopoly situation ± each of the two firms A and B must decide whether to mount an expensive advertising campaign.000. and drive the competition into a loss.000. Ú If both firms advertise. the firm that does will increase its profits by 50% to \$75.000 each because the advertising expense forced by competition wipes out large profits |À .

u .

|ë .000 ÚLet¶s assume they cannot collude. ÚA ³Dominant Strategy´ is the one that is best no matter what the opposition does. and therefore do not know what the competition is doing.    ÚIf firms could agree to collude. the optimal strategy would obviously be to  advertise ± maximize joint profits = \$100.

p    Firm B Don¶t Advertise Advertise  ! .

\$ Don¶t Advertise " ! "# Firm A # %! Advertise ".

\$ "%! | .

0 &  '(p  ) .

you will each be charged with the lesser crime. Ú If Bugsy confesses (turns state¶s evidence) and you do not. During your interrogation. Ú If neither of you confesses. and sent up the river for 1 year. The cops pick you up. Ú If you and Bugsy both confess to the liquor store heist. Without a confession. and immediately after your arrest you and Bugsy are separated and questioned individually by the DA. Bugsy will go free while you will be convicted of the liquor store robbery and get sent to the big house for 7 years. Ú Bugsy is told the exact same information. the DA has insufficient evidence for a conviction. Ú What will you do? |£ . you are told the following: Ú The police do have sufficient evidence to convict you and Bugsy of a lesser crime.  * Ú You and your friend Bugsy are the prime suspects for knocking over a liquor store. you will each get a 5 year sentence.

 Bugsy " . p    You Don¶t Confess Confess " %  " #  Don¶t Confess +%  +. "    Confess +#  +   |º .

 ).

 ÚPrisoner¶s Dilemma ÚEach player has a dominant strategy ÚIt results in payoffs that are smaller than if each had played a dominated strategy ÚProduces conflict between narrow self- interest of individuals and the broader interest of larger communities |D .

0  .

 .

   ).

 ÚWhy do people shout at parties? ÚWhy does everyone stand up at concerts? |[ .

    .

 .

  .

.

    A Left Right "%!! "%!! Top ! %!! B Bottom ".

%!! "\$!! ! %!! A¶s behavior is predictable in this case. ] .

wne more « A Left Right "%!! "%!! Top ! %!! B ".

 "\$!! Bottom %!-!!! %!! ! Here. A¶s behavior is again predictable ± choose Right is the dominant strategy ± but now B stands to lose a great deal if by chance A chooses left instead ]| .

  .

 ÚCartel ÚA group of firms who sell a similar product who have joined together in an agreement to act as a monopoly ± restrict output and raise price Ú0ormally cartels involve several firms ÚMake retaliation against a dissenter difficult ÚAgreements are not legally enforceable and are hence inherently unstable ]] .

  .

.

Ú to increase profits ± this need for profit can turn out to be the downfall of most cartels ± GREED ]À . firms might try to cooperate.   Ú to reduce the uncertainty of a noncooperative situation ± competition over market share makes firms unsure of what to do with regard to pricing decisions ± they¶re afraid to change prices ± so to avoid the possibility of a price war.

.

.

 Ú w     .

  Ú          .

        .

   Ú       .

         .

                       !     " #  \$ .

          ! " #  \$ .

       Ú %      .

          .

&  !              .

   Ú        !             .

  .

    .

       ]ë .

 0   .

. Ú è     .

   .

 .

.

 Ú .

.

Ú .

   Ú .

.

    .

.

 .

  .

.

    Ú   .

 .

    .

       .

  .

.

   .

 .

 .

    .

 .

.

 Ú ! "#\$% .

    .

 &      .

    .

     .

.

 .

   .

& '( .

  Ú .

 .

  .

 .

   .

.

 .

.

 ] .

u .

' .

.

ÚCheating by 1 firm = selling the water at < P* => that firm gains entire market. ÚEach will produce ½ of the output. Ú2 firms sell bottled water with MC = 0 ÚThe firms agree to act as a monopolist and set price in order to maximize joint profits (P*). ]£ . Ú0o enforcement mechanism.

p       .

/   01%!!!-1%2!!3  !! ]º .

p  4.

    .

    % 355!6! ]D .

00) or cheat (price = 0.90) ÚIs there a dominant strategy for each firm? ÚIs there an incentive to cut prices even more? ][ .          ÚFirms 1 & 2 Úwptions: collude (price = \$1.

  & p ÚPreviously we assumed that players moved at the same time ÚHowever. timing is of the essence ÚDecision tree or game tree ÚA diagram that ÚDescribes the possible moves in a game in sequence ÚLists the payoffs that correspond to each possible combination of moves À .

  .

7.89    .

     ÚAssuming people are narrowly self- interested does not always capture the full range of motives ÚRestaurants frequented mainly by out-of- towners have the same tipping rates as those with mainly repeat customers ÚPeople care about being treated justly ÚSympathy for a trading partner can make a business person trustworthy À| .