Download Executive MPA Foundation Week II Economics I-IV

Chapters 13 & 14: Imperfect Competition & Game Theory
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Reality: Imperfect Competition
• Perfect competition and monopoly represent idealized market
structures that rarely exist
– These are useful in showing tendency and direction, but in the real world
the payoff to an action often depends not only on the action itself, but also
on how it relates to actions taken by others
– Read the 3 economist, 3 lawyer parable on page 455, it’s funny (particularly
if you are an economist)
• Game theory is a useful tool to use to analyze likely outcomes
when individual payoffs depend on the actions of others
– Three elements of game theory: 1) the players, 2) the list of possible
strategies, and 3) the payoffs associated with each combination of strategies
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Algebraic Example of Game Theory in
the Marketplace
MEXICO OIL
VENEZUELA
PETROLEUM
Cooperate
(P=5)
Cheat
(P=4)
Cooperate
(P=5)
V 100
V  25
 M 100
 M 150
Cheat
(P=4)

V  150
V  75
 M  25

 M  75
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Oligopoly
Assumptions:
• Restricted entry
• Few firms producing
Implications:
• The actions of one oligopoly firm will affect the prices and profits of the other firm(s) in
the market
• There are several possible hypotheses about how oligopoly firms behave
• May collude and act as a monopoly
• May compete against each other and drive prices to the perfectly competitive level
• May compete, but arrive at equilibrium somewhere between the monopoly and perfectly competitive
prices
•
The exact structure of the oligopoly likely depends on the products they are producing
and the degree of product differentiation
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Cournot Duopoly Model
• Two firms in the market that sell identical products
• Each firm assumes that the other will keep production levels fixed regardless of
their own production
• Each firm has a “reaction function” that determines of the optimal level of
output given the other firm’s output
Q1
Firm 2’s
reaction function
a/3b
Firm 1’s
reaction function
Q2
a/3b
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Bertrand Model
• Two firms in the market that sell identical products
• Each firm assumes that the other will keep prices fixed at the current level
regardless of the price they set
• Each firm’s best strategy is to sell just below the price of the other firm so that
they can capture the entire market demand
• The firms will continue to reduce the price until it reaches the competitive
market price
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Stackelberg Model
•
•
•
•
Two firms in the market that sell identical products
The market consists of a “leader” and a “follower”
The follower is a naïve Cournot duopolist
The leader will choose its quantity level by taking into account how that will affect the
follower’s response
Q1
Firm 2’s
reaction function
a/2b
Firm 1’s
reaction function
a/4b
Q2
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Comparison of Oligopoly Models
a
a/2
·
a/2b
Monopoly
·
Cournot
·
Stackelberg
·
Bertrand/
Perfect Competition
a/b
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Monopolistic Competition
•
•
•
•
Differentiated products
Many sellers
Free entry
Each seller faces a downward-sloping demand curve
UnderCuts
Cheap Snips
Dean Suarez Salon
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Classic Prisoner’s Dilemma
CLYDE
Squeal
BONNIE
Squeal
Remain Silent
12 years for B
12 years for C
0 years for B
20 years for C
Remain 20 years for B
Silent 0 years for C
1 year for B
1 year for C
Payoff to an action often depends not only on the action itself, but also on how it relates
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to actions taken by others
Game Theory
• Nash equilibrium - the combination of strategies in are such that
neither player has any incentive to change given the strategy of
others
• Players in games may have dominant or non-dominant strategies
– Dominant strategy - when a player has a strategy in a game that produces
better results regardless of the strategy chosen by other players (opponents)
• Each player may have a dominant strategy, but the result of each player
exercising their dominant strategy may be less beneficial for the players (e.g.
price wars) and/or society as a whole
– Non-dominant strategy - when at least one player does not have a dominant
strategy, rather the best strategy for that player is dependent on what others
choose
• Nash equilibrium may occur even if a player does not have a dominant strategy
b/c one (or more players) bases decision on what others will do
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Nash Equilibrium: Dominant Strategy
PEPSI
COKE
Advertise
Don’t
Advertise
C: $100 m
Advertise
P: $100 m
C: $250 m
P: $25 m
C: $25 m
Don’t
Advertise P: $250 m
C: $200 m
P: $200 m
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Nash Equilibrium: Non-Dominant
Strategy
ADIDAS
Advertise
NIKE
Don’t
Advertise
Advertise
N: $100
A: $100
N: $135
A: $200
Don’t
Advertise
N: $50
A: $125
N: $140
A: $115
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