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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