Micro Chapter 23

1
Micro Chapter 23

• Presentation 2- Game Theory

2
Homogeneous Oligopoly

• An oligopoly in which the firm produces a
  standardized product
• Ex- steel, cement, copper, aluminum

3
Differentiated Oligopoly

• An oligopoly in which the firms produce a
  differentiated product
• Considerable non-price competition through heavy
  advertising
• Ex- automobiles, sporting goods, tires

4
Control Over Price

• Oligopolies are price makers and can set price
  and output levels to maximize profit
• Oligopolies have few rivals but must consider how
  they will react to any change in price, output,
  product characteristics or advertising

5
Mutual Interdependence

• A situation in which each firms profit depends
  not entirely on its own price and sales
  strategies but also on those of the other firms
• Ex- McDonalds considers Burger King, Rawlings
  considers the reactions of Wilson

6
Barriers to Entry

• 1. Economies of Scale
• 2. Large expenditure of capital (human-made
  resources)- industries such as jet engine, auto,
  petroleum refineries
• 3. Ownership and control of raw materials- mining
  and electronics

7
Mergers

• Combining of two or more competing firms may
  substantially increase their market share leading
  to economies of scale and lower costs on
  production inputs

8
Concentration Ratio

• The percentage of total output produced and sold
  by an industrys largest firms
• When the 4 largest firms in an industry control
  40 of the market, that industry is considered
  oligopolistic
• Ex- the 4 largest cereal producers make 78 of
  American breakfast cereals

9
Shortcomings of Concentration Ratios

• 1. Localized markets- ratios are measured
  nationally
• 2. Interindustry Competition- between two
  products associated with different industries
  (ex- copper and aluminum)
• 3. World Trade- doesnt take into account imports

10
Herfindahl Index

• A measure of the concentration and
  competitiveness of an industry
• Sum of the squared percentage market shares of
  all of the firms in an industry
• Index(S12)(S22).(Sn2)
• Where S1 is the percentage of the market share
  of firm 1

11
Herfindahl Index Contd

• Ex- Single firm industry 1002 10,000
• Ex- 4 firms with equal 25 market share
• (252)(252)(252)(252) 2500
• the larger the Herfindahl Index, the greater
  the market power within an industry
• the closer to zero, the more competitive

12
Game Theory

• Oligopoly pricing behavior has the
  characteristics of certain games of strategy such
  as chess
• The best way to play the game depends on the way
  ones opponent plays
• Shown in a payoff matrix (2 firms)

13
Collusion

• A situation in which firms act together in
  agreement to fix prices, divide a market, or
  otherwise restrict competition
• Both firms could agree to a high pricing strategy

14
Dominant Strategy

• One strategy is better for a given player,
  regardless of what his/her opponent chooses to do

15
Game Theory Video

• http//www.youtube.com/watch?vAOEbJF0k8vM

16
Game Theory
Game Theory Model to Analyze Behavior

• Uptown Dominant
• Strategy Low
• Rareair Dominant
• Strategy Low

RareAirs Price Strategy

• 2 Competitors
• 2 Price Strategies
• Each Strategy Has a Payoff Matrix

High
Low
A
B
12
15
High
12
6
Uptowns Price Strategy
C
D
6
8
Low
15
8
17
Incentive to Cheat

• In the previous example, both firms could
  increase profit by utilizing a low price strategy
• Each firm could increase profit from 12 million
  to 15 million by breaking the agreement with low
  prices

18
Nash Equilibrium
NASH EQUILIBRIUM when each player is pursuing
their best possible strategy in the full
knowledge of the other players strategies. A
Nash equilibrium is reached when nobody has any
incentive to change their strategy. It is named
after John Nash, a mathematician and Nobel
prize-winning economist. https//www.youtube.com/w
atch?vCemLiSI5ox8
19
An Example of a Nash Equilibrium
Column
a
b
0,1
1,2
a
Row
b
1,0
2,1
(b,a) is a Nash equilibrium. To prove this
Given that column is playing a, rows best
response is b. Given that row is playing b,
columns best response is a.
20
Prisoners Dilemma Video

• https//www.youtube.com/watch?vt9Lo2fgxWHw

21
Prisoners Dilemma An illustration of Nash
Equilibrium
Consider Arts options
Art and Bob are both suspects in a crime, and
they are both offered the following deal if they
confess
1. If Bob denies and Art denies, then Art will
get two years. Art is better off confessing and
getting one year.
Arts Strategies
Confess
Confess
Deny
2. If Bob confesses and Art denies, then Art will
get ten years, so Art is much better off
confessing and taking three years.
Confess
3 yrs.
3 yrs.
1 yr.
10 yrs.
Consider Bobs options
Bobs Strategies
1. If Art denies and Bob denies, then Bob will
get two years. Bob is better off confessing and
getting one year.
Deny
10 yrs.
1 yr.
2 yrs.
2 yrs.
2. If Art confesses and Bob denies, then Bob will
get ten years, so Bob is much better to confess
and take three years.
Thus, both parties will rationally choose to
confess, and take three years even though they
could have been better off denying.
Each party does this because,
considering the possible options of the other
party, they always found the better option was to
confess. When neither party has an incentive to
change their strategy, they are in Nash
Equilibrium.
22
Cartels

• A cartel is an organization of independent firms
  whose purpose is to control and limit production
  and maintain or increase prices and profits.
• EX- OPEC controlling oil production
• Like collusion, cartels are illegal in the United
  States.

23
Coffee Problem
STARBUCKS
Dont Advertise Advertise
Dont Advertise 15/15 10/20
Advertise 20/10 12/12
SF COFFEE

1. What is Starbucks dominant strategy
2. What is SF Coffees dominant strategy
3. Is there a Nash Equilibrium?
4. If they collude what is their profit?
5. If no collusion, what is their profit?

24
(No Transcript)
25
(No Transcript)
26
(No Transcript)