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APPENDIX

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- Assume total maximum profits of all oligopolists is constant at 200 units.
- Alternative policies include price increases, keeping the price constant, price reductions, and an increase in advertising expenditures.

- The matrix is essentially a duopoly, but the competitor may be all other oligopolists.

Competitors’ Alternative Strategies

Raise p p = k Reduce p More ads

p107 92 88 99

p=k110 106 94 97

p116 108 100102

ads108 109 96 98

Oligopolists

Alternative

Strategies

If the oligopolist reduces p and others leave prices unchanged,

He gets 108, competitors get 92.

- This is a zero-sum game. The payoff (total profit available = 200 units) remains the same and
one player’s gains are the other player’s losses.

What policy should the oligopolist choose?

Play it safe? (Assume that opponents will always follow that strategy which produces the worst possible result from his own point of view.)

This calls for the maximin strategy.

The maximin strategy is to maximize the minimum gains you expect your opponents to permit you to take.

Secure the result that will be least harmful, no matter what the opponent decides to do.

We act pessimistically.

We assume if the oligopolist increases p, the competitor

will reduce the price.

Playing it safe, this pessimistic oligopolist reduces the price and

Gets the maximum from the minimum gains the competitors allow

If we keep our prices constant…

Competitors’ Alternative Strategies

Raise p p = k Reduce p More ads

p107 92 88 99

p=k110 106 94 97

p116 108 100102

ads108 109 96 98

Oligopolists

Alternative

Strategies

If we reduce our price…

If we increase our advertising…

- The numbers in the matrix represent losses to the competitors (since they are the gains of the oligopolist). They wish to minimize the profits of the olligopolist, which are their own losses.
- They will choose to reduce prices.
Note their potential losses with each policy they can choose.

Note the competitors’ most favorable outcome for each

Possible policy choice.

Competitors’ Alternative Strategies

Raise p p = k Reduce p More ads

p107 92 88 99

p=k110 106 94 97

p116 108 100102

ads108 109 96 98

Oligopolists

Alternative

Strategies

Here, the competitors choose the policy of minimizing the

maximum loss the oligopolist will inflict on them.

The outcome 100 is a “saddle point” where the maximum

minimum of the oligopolist = the minimum maximum of

Competitors. It is a stable equilibrium.

Competitors’ Alternative Strategies

Raise p p = k Reduce p More ads

p107 92 88 99

p=k110 106 94 97

p116 108 100102

ads108 109 96 98

Oligopolists

Alternative

Strategies

- If 100 were not a stable equilibrium, things could get complicated. Various solutions are possible.
- A player might adopt a “mixed” strategy in an attempt to take advantage of opponent’s mistakes or to keep them off balance.
- Laws of probability can be applied in evaluating possible policy choices.

The application of game theory assumes that businessmen do play a game of business according to a general theory of games and that they seek to maximize profits.

This behavior may lead to outcomes similar to those of marginal analysis. But as we saw at the beginning, it provides a fertile field for imaginative approaches.