strategic choice in oligopoly, monopolistic competition, and everyday life
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Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life. Thinking Strategically. Interdependencies In making choices, people must consider the effect of their behavior on others. - PowerPoint PPT PresentationTRANSCRIPT
Strategic Choice in Oligopoly, Monopolistic Competition,
and Everyday Life
Strategic Choice in Oligopoly, Monopolistic Competition,
and Everyday Life
1
Slide 2
Thinking Strategically
Interdependencies In making choices, people must
consider the effect of their behavior on others.
Imperfectly competitive firms may consider how rivals will respond to price changes or new advertising.
Slide 3
Using Game Theory toAnalyze Strategic Decisions
Basic Elements of a Game The players Their strategies The payoffs
Slide 4
Example Should United Airlines spend more on
advertising? Note
The airline industry is an oligopoly with an undifferentiated product.
Using Game Theory toAnalyze Strategic Decisions
Slide 5
The Payoff Matrix for an Advertising Game
Raise adspending
Leave adspendingthe same
Raise adspending
Leave adspendingthe same
$5,500 for American$5,500 for American
$5,500 for United$5,500 for United
American’s Choices
United’s Choices
$2,000 for American$2,000 for American
$8,000 for United$8,000 for United
$6,000 for American$6,000 for American
$6,000 for United$6,000 for United
$8,000 for American$8,000 for American
$2,000 for United$2,000 for United
Slide 6
Dominant Strategy One that yields a higher payoff no
matter what the other players in a game choose
Dominated Strategy Any other strategy available to a
player who has a dominant strategy
Dominant and Dominated Strategies
Slide 7
Any combination of strategies in which each player’s strategy is her or his best choice, given the other player’s strategies
When each player has a dominant strategy, equilibrium occurs when each player follows that strategy
Nash Equilibrium
Slide 8
Nash Equilibrium
There can be an equilibrium when players do not have a dominant strategy
Example Should American spend more on
advertising? Assume United and American are the
only carriers serving the Chicago – St. Louis market
Slide 9
Equilibrium When One Player Lacks a Dominant Strategy
Raise adspending
Leave adspendingthe same
Raise adspending
Leave adspendingthe same
$4,000 for American$4,000 for American
$3,000 for United$3,000 for United
$3,000 for American$3,000 for American
$8,000 for United$8,000 for United
$2,000 for American$2,000 for American
$5,000 for United$5,000 for United
$5,000 for American$5,000 for American
$4,000 for United$4,000 for United
American’s Choices
United’s Choices
Slide 10
What Should United and American do if Their Payoff Matrix is Modified?
Raise adspending
Leave adspendingthe same
Raise adspending
Leave adspendingthe same
$8,000 for American$8,000 for American
$3,000 for United$3,000 for United
$5,000 for American$5,000 for American
$4,000 for United$4,000 for United
$2,000 for American$2,000 for American
$5,000 for United$5,000 for United
$4,000 for American$4,000 for American
$8,000 for United$8,000 for United
American’s Choices
United’s Choices
Slide 11
The Prisoner’s Dilemma
A game in which each player has a dominant strategy, and when each plays it, the resulting payoffs are smaller than if each had played a dominated strategy
Example Should the prisoners confess?
Slide 12
The Payoff Matrix for a Prisoner’s Dilemma
Confess Remain Silent
Confess
RemainSilent
Jasper
Horace
5 years5 yearsfor eachfor each 20 years for Jasper20 years for Jasper
0 years for Horace0 years for Horace
1 year1 yearfor eachfor each0 years for Jasper0 years for Jasper
20 years for Horace20 years for Horace
Slide 13
The Economics of Cartels
Cartel A coalition of firms that agrees to
restrict output for the purpose of earning an economic profit like a monopoly
Yet, cartel agreements are notoriously unstable. Why?
Prisoner’s Dilemmas Confronting Imperfectly Competitive Firms
Slide 14
The Market Demandfor Mineral Water
Pri
ce $
/bo
ttle
)
Bottles/day
Assume• 2 firms (Aquapure &
Mountain Spring• MC = 0• Cartel is formed & agree
to split output and profits
2,000
D
1.00
1,000
MR
2.00
Impact of Cartel• Q = 1,000 bottles/day• P = $1/bottle• Each firm makes $500/day
Slide 15
The Temptation to Violate a Cartel Agreement
Pri
ce $
/bo
ttle
)
Bottles/day
D
1.00
1,000 2,000
MR
2.00
1,100
0.90
Aquapure lowers P• P = $.90/bottle• Q = 1,100 bottles/day
Mountains Spring retaliates• P = $.90/bottle• Both firms split 1,100
bottles/day @ $.90• Profit = $495/day
Slide 16
The Payoff Matrix for a Cartel Agreement
Charge $1/bottle Charge $0.90/bottle
Charge$1/bottle
Charge$0.90/bottle
Mountain Spring
Aquapure
$990/day for $990/day for Mt. SpringMt. Spring
$0 for$0 forAquapureAquapure$500/day $500/day
for eachfor each
$0 for $0 for Mt. SpringMt. Spring
$990 for$990 forAquapureAquapure $495/day $495/day
for eachfor each
Slide 17
Food For Thought
When will the rival firms stop cutting prices?
Slide 18
Cooperation between players will increase the payoff in a prisoner’s dilemma. There is a motive to enforce
cooperation. Tit-for-tat strategy
Players cooperate on the first move, then mimic their partner’s last move on each successive move
Tit-for-tat and the Repeated Prisoner’s Dilemma
Slide 19
Tit-for-tat strategy requirements Two players A stable set of players Players recall other player’s moves Players have a stake in future
outcomes
Tit-for-tat and the Repeated Prisoner’s Dilemma
Slide 20
Why is the tit-for-tat strategy unsuccessful in competitive, monopolistically competitive, and oligopolistic markets?
Food For Thought
Slide 21
Why did the ban on television advertising beneficial to cigarette producers?
Cigarette Advertising as a Prisoner’s Dilemma
Slide 22
Cigarette Advertising as a Prisoner’s Dilemma
Advertise on TV Don’t advertise on TV
Advertise on TV
Don’tAdvertiseon TV
$5 million/yr$5 million/yrfor Philip Morrisfor Philip Morris
$10 million/yr$10 million/yr for eachfor each
$35 million/yr$35 million/yr for RJRfor RJR
Philip Morris
RJR
$20 million/yr$20 million/yr for eachfor each$35 million/yr$35 million/yr
for Philip Morrisfor Philip Morris
$5 million/yr$5 million/yr for RJRfor RJR
Determinants of a Successful Cartel
A successful cartel requires a good enforcement mechanism: detect cheating and punish cheating sellers.
Determinants of cost of detecting price chiseling Number of buyers Customer turnover Availability of price information
Food for Thought
Which of the following type of auction encourages collusion: sealed-bid or open-bid auction?
Many manufacturers offer minimum price guarantee such as Best Buy or Circuit City, does this pricing practice facilitate collusion?
Slide 25
Games in Which Timing Matters
Should Dodge build a hybrid viper? Dodge Viper and Chevrolet Corvette
compete for the domestic sports car market
Both know the other is considering a hybrid
If both build the hybrid they each make $60 million
If neither build they make $50 million
Slide 26
Should Dodge build a hybrid viper? If Chevrolet builds and Dodge does
not, Chevrolet will earn $80 million and Dodge $70 million.
If Dodge builds and Chevrolet does not, Dodge earns $80 million and Chevrolet $70 million.
Games in Which Timing Matters
Slide 27
Should Dodge build a hybrid viper? Does either have a dominant
strategy? What will happen if Dodge gets to
choose first?
Games in Which Timing Matters
Slide 28
The Advantage of Being Different
Offer hybrid Don’t offer hybrid
Dodge Viper
Chevrolet Corvette
Offer hybrid
Don’t offer hybrid
$60 million/yr$60 million/yrfor Dodgefor Dodge
$60 million/yr$60 million/yr for Chevroletfor Chevrolet
$70 million/yr$70 million/yrfor Dodgefor Dodge
$80 million/yr$80 million/yr for Chevroletfor Chevrolet
$80 million/yr$80 million/yrfor Dodgefor Dodge
$70 million/yr$70 million/yr for Chevroletfor Chevrolet
$50 million/yr$50 million/yrfor Dodgefor Dodge
$50 million/yr$50 million/yr for Chevroletfor Chevrolet
Is there aNash Equilibrium?
Slide 29
If Dodge and Chevrolet make their decisions independently and simultaneously, two equilibria arise. Dodge offers viper while Chevrolet does not Chervorlet offers viper while Dodge does not
What will happen if Dodge gets to choose first?
Multiple Equilibria
Slide 30
Decision Tree for Hybrid
A
Dodgedecides
Offer hybrid
Don’t offerhybrid
B
C
$50 million for Chevrolet$50 million for Dodge
Offerhybrid
Don’toffer
hybrid
Offerhybrid
Don’toffer
hybrid
Chevroletdecides
$80 million for Chevrolet$70 million for Dodge
$70 million for Chevrolet$80 million for Dodge
$60 million for Chevrolet$60 million for DodgeD
E
F
G
FinalOutcome
Slide 31
Credible Threats
Credible Threats A threat to take an action that is in
the threatener’s interest to carry out
Why couldn’t Chevrolet deter Dodge from offering a hybrid by threatening to offer a hybrid of its own, no matter what Dodge did?
Slide 32
A promise to take action that is in the promiser’s interest to keep
Credible Promise
Slide 33
Should a business owner open a remote office? Pay the manager $1,000 Make an additional $1,000 If the manager is dishonest, she can
make $500 more and cost the owner $500
Credible Promise
Slide 34
Decision Tree for the Remote Office Game
A
Owner does not open remote office
Manager manages honestly;owner gets $1,000,manager gets $1,000
Managerial candidatepromises to managehonestly
B
Owner opensremote office
C
Manager manages dishonestly;owner gets -$500,manager gets $1,500
Owner gets $0,manager gets $500 byworking elsewhere
Should a business owner open a remote office?Is the outcome an equilibrium?
Slide 35
Monopolistic CompetitionWhen Location Matters
Why do we often see convenience stores located on adjacent street corners?
Slide 36
Assume 1 mile street with 1,200 shoppers evenly
distributed Store A is located at the West end of the
mile Question
Where would you open a new store (say Store B) on the mile?
If you were Store A, why did you locate at the West end in the very beginning?
Monopolistic CompetitionWhen Location Matters
Slide 37
Differentiation by: Physical location
The choice to locate at B. Location in time
Timing of flight departures Timing of film showings
Product space (product differentiation) Soft drinks
Monopolistic CompetitionWhen Location Matters
Slide 38
Commitment Problems
A situation in which people cannot achieve their goals because of an inability to make credible threats or promises
Example Prisoner’s dilemma Cartels Remote office
Slide 39
A way of changing incentives so as to make otherwise empty threats or promises credible
Example Underworld code, omerta Military arms control agreements Tips for waiters
Commitment Device
Slide 40
The Strategic Role of Preferences
Game theory assumes that the goal of the players is to maximize their outcomes.
In most games, players do not attain the best outcomes.
Altering psychological incentives may also improve the outcome of a game.
Slide 41
Question In a moral society, will the business
owner open a remote office?
The Strategic Role of Preferences
Slide 42
The Remote Office Game with an Honest Manager
A
Owner does not open remote office
Manager manages honestly;owner gets $1,000,manager gets $1,000
Managerial candidatepromises to managehonestly
B
Owner opensremote office
C
Manager manages dishonestly;owner gets -$500,manager gets -$8,500
Owner gets $0,manager gets $500 byworking elsewhere
The value of dishonesty to the manager is $10,000
Slide 43
Preferences as Solutions to Commitment Problems Concerns about fairness, guilt, humor,
sympathy, etc. do influence the choices people make in strategic interactions.
Commitment to these preferences must be communicated for them to influence choices.
The Strategic Roleof Preferences
EndEnd
44