MBA 299

1
MBA 299 Section Notes

• 5/9/03
• Haas School of Business, UC Berkeley
• Rawley

2
AGENDA

• Old exam questions (5-7)
• Dominant strategies
• Nash equilibrium (NE)
• IDSDS
• Repeated games and SPNE
• Cournot equilibrium
• Suggested answers to the conceptual (old) exam
  questions

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OLD FINAL EXAM QUESTIONS 5

• Q Which of the following statements about the
  inferior technology used by the fringe firms is
  correct?
• Answer A
• LRAC 10
• Eliminate option D. since if AC and MC are gt10
  the fringe would never be willing to sell at 10
• If MC falling at 10 then LRAC is declining,
  similarly if MC is rising at 10 then LRAC is
  falling so B. and C. do not make sense as options
  here

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OLD FINAL EXAM QUESTIONS 6

• Q A number of possible marginal revenue curves
  for the one firm with the superior technology are
  also illustrated
• Answer D
• MR dR/dQ
• Market demand is not the same as firm specific
  demand
• If this was a monopoly (supply) market then ACEF
  is the MR curve, but since there are at least two
  firms producing here (note the other MR curve at
  HG), the market price is 10, after point H the
  situation is just like the monopoly situation
  again . . . therefore MR is flat from B to H and
  then follows the normal MR curve from E to F

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OLD FINAL EXAM QUESTIONS 7

• Q Find the equilibrium set of prices (in a
  sealed bid auction)
• Answer D 3 NE in this game
• Do NOT use IDWDS (as I did in class last week)

2
400
401
402
0,0
0,0
0,0
400
0,0
½, ½
1,0
401
1
0,0
0,1
1,1
402
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DOMINANT STRATEGIESBest Strategy Regardless of
What the Other Player Does
2
2
L
B
R
L
B
R
1,0
0,0
0, ½
U
0,0
0,0
0, ½
U
0,0
½, ½
1,1
M
1
1,0
½, ½
1,1
M
1
0,0
0,1
0,2
D
0,0
0,1
0,2
D
2 has a DS R, but 1 does not so there is no
solution in DS notice that MR is a NE
2s DS is R, 1s DS is M so the solution in DS is
(M,R) notice that MR is a NE too
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NASH EQUILIBRIUMBest Response Given the Other
Players Strategy
2
2
L
B
R
L
B
R
1,1
0,0
0, ½
U
1,1
0,0
0, ½
U
0,0
½, ½
1,0
M
1
0,99
½, ½
100,98
M
1
0,0
0,1
0,2
D
0,0
0,1
99,99
D
2 Nash Equilibria (U,L) and B,M
NE is U,L Notice this outcome is not efficient
Every game has a NE
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ITERATED DELETION OF STRICTLY DOMINATED
STRATEGIES (IDSDS) Problem 4 P.S. 1Eliminate
Strategies That Will Never Be Played in EQM
2
L
R
8,5
2,4
U
5,4
6,3
M
1
4,1
4,8
D
First eliminate row D, next eliminate column
R Solution in IDSDS is also a NE
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REPEATED GAMES SPNECredible Threats Can Shift
the EQM in a Repeated Game
2
L
C
R
If each player believes the other player will
punish them with the lower NE in stage 2 if they
fail to play C or M in stage 1 (respectively)
then the unique SPNE in this stage game played
twice without discounting is (M,C), (D,R)
1,1
5,0
0,0
U
0,5
4,4
0,0
M
1
0,0
0,0
3,3
D
Note Stage game NE underlined here
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PROBLEM SET 2 QUESTION 1 COURNOT EQM (I)

• Q(p) 2,000,000 - 50,000p
• MC1 MC2 10
• a.) Find the Cournot EQM
• P(Q) 40 - Q/50,000
• Find each firms mutual best response
• ?i qiP(Q)-c qi40 Q/50,000 -10 qi40
  qiqj/50,000 -10 ?j
• For both firms their best play is to maximize
  profit, therefore take the derivative of the
  profit function and set it equal to zero
• d ?i/dqi 40qi qi2 qiqj/50,000 10qi
• 40 2qi qj/50,000 10 0
• gt 2qi qj 1,500,000 gt 3qi 1,500,000
• q1q2500,000

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PROBLEM SET 2 QUESTION 1 COURNOT EQM (II)

• b.) What is the profit for each firm in EQM?
• ?i (p-c)qi (40-1,000,000/50,000-10)500,000
  5M
• c.) What is the monopoly profit level?
• Setting MR MC
• MR dP(Q)/dQQ P(Q) -Q/50,000 40 -
  Q/50,000 40 Q/25,000
• MC 10
• 40 Q/25,000 10
• Q 750,000
• P 25
• gt ?m (25-10)750,00011.25M

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SUGGESTED ANSWERS TO SHORT ANSWER QUESTIONS
Question 11 (I)Warning These are Evans
Answers Not Professor Hermalins

• Part a.) Two possible reasons why Tartot cards
  are 5 and palm reading 1
• Physical barrier to entry The capital outlay
  required for Tarot cards represent a barrier to
  entry (BTE). Street vendors tend to face
  borrowing constraints so capital outlays can be
  important BTE. As with any BTE, restrictions on
  entry allow the owners of the assets to
  permanently increase price above long-run
  average cost.
• Human capital barrier to entry While anyone can
  sound credible reading a palm sounding credible
  when reading Tarot cards might take some
  specialized investment in human capital. In this
  context we view tarot card readers as prepared
  types and palm readers and unprepared types
  where prepared types earn rents for erecting
  human capital barriers to entry.

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SUGGESTED ANSWERS TO SHORT ANSWER QUESTIONS
Question 11 (II)Warning These are Evans
Answers Not Professor Hermalins

• Part b.) Sensible strategies for Farrell and
  Saloner
• Because intellectual property (IP) cannot be used
  as the basis of sustainable competitive advantage
  F S will drive profit to zero through a form of
  Bertrand competition if they do not coordinate on
  either price or RD spend dimensions. Explicitly
  coordinating on price is illegal, tacit
  collusion, however, may be possible since this is
  duopoly competition in a repeated game. If F S
  could send each other credible signals that
  deviation from a cooperative outcome (say cost
  x) would be punished in future rounds (with say
  marginal cost pricing) it may be possible to
  sustain equilibrium prices above marginal cost.
• Coordinating on RD is another solution. F S
  could form a joint venture to manage all RD
  activity where the RD entity was paid cost plus
  a x markup. F S could then take the (same)
  raw technology and compete against one another
  for contracts on the basis of implementation
  efficiency.

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SUGGESTED ANSWERS TO SHORT ANSWER QUESTIONS
Question 11 (III)Warning These are Evans
Answers Not Professor Hermalins

• Part c.) Katz-Shapiro network cards
• Since the nature of KSs product is networking
  KSs installed base acts a network externality,
  or a demand side economy of scale, which supports
  its dominant market position. However, KS earns
  most of its profits from services supporting
  its network software, therefore it is
  potentially vulnerable to competition over
  services. Therefore KS uses leasing to 1.
  prevent resale of its (used) technology and to
  2. build switching costs against entrants into
  the services segment.
• To the first point note that KS faces no other
  software competition in this segment so it is
  particularly interested in forestalling
  competition from itself. With regard to point 2.
  KS faces competition over services so it uses
  leasing to create barriers to entry. Leasing
  network cards as opposed to selling them outright
  creates switching costs for the lessee if they
  move to a new services vendor in the form of
  three work days per computer. The desire to
  avoid switching costs makes customers willing to
  pay more for KSs services than they would to a
  competitor of KS.

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SUGGESTED ANSWERS TO THE CASE QUESTION Question
14 Part a (I)
1. Suppliers
Commodities sugar, grains etc. not dangerous
Market only growing 1 See next page for details
3. Competitors
4. Substitutes
Company

• Breakfast bars/sweets
• Fruit/yogurt/healthy stuff
• Coffee Shoppe foods/prepared food
• Skip breakfast
• Based on price realization of cereal (7) vs. all
  food at home (13) and the CPI (17) substitutes
  appear to be gaining on cold cereal

2. Buyers (Retailers)
Generally ignored in the case but we know they
are growing more powerful
5. BTE
Mfg. and marketing scale Brand Few technological
barriers
2. Buyers (Consumers)
2 segments sugar healthy
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SUGGESTED ANSWERS TO THE CASE QUESTION Question
14 Part a (II)
3. Competitors

• Player
• Quaker
• Ralston Purina
• Kellogg
• General Mills
• General Foods
• Other

1987 8 6 41 21 13 11
1990 7 6 39 24 11 13
Change 1 - -2 3 -2 2
Comment/brand Oats are growing TMNT licensing
brands Corn Frosted Flakes, Raisin Bran
etc. Cheerios and extensions PL is growing,
eroding price realization
note 1 market share is worth 70 million in
revenue . . . so the change in Kelloggs market
share is significant
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SUGGESTED ANSWERS TO THE CASE QUESTION Question
14 Part b

• The category is barely growing in spite of the
  fact that real price realization has been
  falling. Furthermore, Kellogg is losing market
  share. As the 1 player (think Stackelberg) it
  looks like Kellogg reduced prices less than its
  competitors because it needs to reset the
  category price equilibrium at a lower price point
  to increase category growth. Furthermore,
  Kellogg appears to be reducing its price
  realization relative to its direct competitors
  to increase market share in the short run . . .
  perhaps in the hope that it can retain some of
  these customers once competitors respond.
• Cereal brands are somewhat differentiated but
  price is clearly a major factor in the consumer
  calculus. Therefore, Kelloggs defection from
  the well established oligopoly game is likely to
  lead to price cuts from competitors in the next
  round.

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SUGGESTED ANSWERS TO THE CASE QUESTION Question
14 Part c

• The fact that the market leader is competing on
  price in an industry where the oligopoly game is
  well established is a bad sign for the cold
  cereal industry since it implies that profits are
  at an unsustainable level.
• Innovate in new categories A happier solution
  for all players would be for Kellogg to innovate,
  perhaps by developing new products that address
  new trends in breakfast consumption behavior
  (e.g., breakfast bars), to increase intrinsic
  demand for its cold cereal. Extending its
  products into competing categories might also
  allow Kellogg to play the oligopoly game across
  categories.
• Brand development within category 1. One
  weakness in Kelloggs cereal portfolio is in oats
  so introducing an oat brand is obvious strategy
  to consider. 2. General Mills has been growing
  faster than the category through brand
  extensions. This may also be a good strategy for
  Kellogg.
• Cost cutting is another obvious strategy. The
  problem with cost reduction is, of course, that
  it doesnt help increase demand -- the central
  issue here.
• Other marketing maneuvers could be productive
  here. For example reducing spend on promotions
  of legacy brands in favor of brand building
  activities like advertising and new product
  promotion.