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Lecture 4. Strategic Interaction Game Theory Pricing in Imperfectly Competitive markets. Game Theory. Tool used for analyzing multiagent economic situations involving strategic interdependence. How Do We Describe a Game?. A game is described by: number of players/agents

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Lecture 4

Lecture 4

Strategic Interaction

Game Theory

Pricing in Imperfectly Competitive markets

Game theory
Game Theory

  • Tool used for analyzing multiagent economic situations involving strategic interdependence

How do we describe a game
How Do We Describe a Game?

  • A game is described by:

    • number of players/agents

    • the “strategies” available to each player

    • each player’s preferences over outcomes of the game

  • For any game, a strategy choice by each one of the players results in a unique outcome of the game

What is a strategy
What is a Strategy?

  • A strategy is an action plan for a player. It specifies:

    • what action the player takes

    • when the player takes the action

    • the way that the action choice depends on the information the player has when taking the action

  • Two action plans that specify different actions represent two different strategies

Predicting behavior in games
Predicting Behavior in Games

  • If games are to help us understand observables, we need a way of predicting how agents behave in game settings; i.e., we need a notion of equilibrium for games

  • The standard notion of equilibrium is the Nash equilibrium

  • Roughly speaking a Nash equilibrium has the feature that each player’s strategy choice is best for that player given other players’ strategies

Determinants of pricing decision
Determinants of Pricing Decision

  • Economic analysis of pricing in imperfectly competitive markets identifies the following elements of the market environment as important to pricing decision:

    • number of competitors/ease of entry

    • similarity of competitors’ products

    • capacity limitations

    • on-going interactions

    • Information on past pricing decisions


  • Simultaneous price setting

  • Identical products

  • No capacity constraints

  • One time interaction

    Price competition results in price equal marginal cost for all firms and zero profits


  • Bertrand paradox (p=mc even though few firms in market) can be resolved by relaxing certain assumptions:

  • No Capacity Constraints

  • Undifferentiated Products

  • One-shot competition

Capacity constraints
Capacity Constraints

  • Suppose each firm has max capacity of Ki

  • If firm j sets a higher price than firm i, j may get the left-over demand that firm i can’t satisfy if demand exceeds i’s capacity

  • So setting price above MC may be worthwhile


  • Same analysis can be applied to situations where firms decide first on how much to produce and then on what price to set

  • If total quantity produced is low relative to market demand, then it is as if constrained

  • Firms will set prices such that total demand just clears total output


  • Capacity (or output) constraint limits the usefulness of price competition

  • Can get p>mc and firms can earn economic profits

Cournot vs bertrand
Cournot vs. Bertrand

  • Cournot:

    -when demand is large relative to capacity

    -when capacity is more difficult to adjust than price

  • Bertrand:

    -when demand is small relative to capacity

    -when capacity is easier to adjust than price