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Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life. Thinking Strategically. Interdependencies In making choices, people must consider the effect of their behavior on others.

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Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

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  1. Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  2. Thinking Strategically • Interdependencies • In making choices, people must consider the effect of their behavior on others. • Imperfectly competitive firms may consider how rivals will respond to price changes or new advertising. Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  3. Using Game Theory toAnalyze Strategic Decisions • Basic Elements of a Game • The players • Their strategies • The payoffs Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  4. Using Game Theory toAnalyze Strategic Decisions • Example • Should United Airlines spend more on advertising? • Note • The airline industry is an oligopoly with an undifferentiated product. Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  5. The Payoff Matrix for an Advertising Game American’s Choices Leave ad spending the same Raise ad spending $5,500 for United $8,000 for United Raise ad spending $5,500 for American $2,000 for American United’s Choices $2,000 for United $6,000 for United Leave ad spending the same $8,000 for American $6,000 for American Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  6. Using Game Theory toAnalyze Strategic Decisions • Dominant Strategy • One that yields a higher payoff no matter what the other players in a game choose Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  7. Using Game Theory toAnalyze Strategic Decisions • Dominated Strategy • Any other strategy available to a player who has a dominant strategy Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  8. Using Game Theory toAnalyze Strategic Decisions • Nash Equilibrium • Any combination of strategies in which each player’s strategy is her or his best choice, given the other player’s strategies Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  9. Using Game Theory toAnalyze Strategic Decisions • Nash Equilibrium • When each player has a dominant strategy, equilibrium occurs when each player follows that strategy Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  10. Using Game Theory toAnalyze Strategic Decisions • Nash Equilibrium • There can be an equilibrium when players do not have a dominant strategy Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  11. The Theory of Games • Example • Should American spend more on advertising? • Assume • United and American are the only carriers serving the Chicago – St. Louis market Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  12. $3,000 for United $8,000 for United $4,000 for American $3,000 for American $4,000 for United $5,000 for United $5,000 for American $2,000 for American Equilibrium When One Player Lacks a Dominant Strategy American’s Choices Leave ad spending the same Raise ad spending Raise ad spending United’s Choices Leave ad spending the same Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  13. $3,000 for United $4,000 for United $8,000 for American $5,000 for American $8,000 for United $5,000 for United $4,000 for American $2,000 for American What Should United and American do if Their Payoff Matrix is Modified? American’s Choices Leave ad spending the same Raise ad spending Raise ad spending United’s Choices Leave ad spending the same Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  14. The Prisoner’s Dilemma • Prisoners Dilemma • A game in which each player has a dominant strategy, and when each plays it, the resulting payoffs are smaller than if each had played a dominated strategy Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  15. The Prisoner’s Dilemma • Example • Should the prisoners confess? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  16. The Payoff Matrix for a Prisoner’s Dilemma Jasper Confess Remain Silent 0 years for Horace 5 years for each Confess 20 years for Jasper Horace 20 years for Horace 1 year for each Remain Silent 0 years for Jasper Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  17. The Prisoner’s Dilemma • Exercise • Which of these games is a prisoner’s dilemma? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  18. Which of These GamesIs a Prisoner’s Dilemma? GAME 1 Chrysler Don’t Invest Invest 4 for GM Don’t Invest 10 for each 12 for Chrysler GM 12 for GM 5 for each Invest 4 for Chrysler Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  19. Which of These GamesIs a Prisoner’s Dilemma? GAME 2 Chrysler Don’t Invest Invest 4 for GM Don’t Invest 5 for each 12 for Chrysler GM 12 for GM 10 for each Invest 4 for Chrysler Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  20. The Economics of Cartels • Prisoner’s Dilemmas Confronting Imperfectly Competitive Firms • Cartel • A coalition of firms that agrees to restrict output for the purpose of earning an economic profit Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  21. The Economics of Cartels • Economic Naturalist • Why are cartel agreements notoriously unstable? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  22. The Market Demandfor Mineral Water • Assume • 2 firms (Aquapure & Mountain Spring • MC = 0 • Cartel is formed & agree to split output and profits 2.00 • Impact of Cartel • Q = 1,000 bottles/day • P = $1/bottle • Each firm makes $500/day Price $/bottle) 1.00 MR D 1,000 2,000 Bottles/day Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  23. The Temptation to Violate a Cartel Agreement • Aquapure lowers P • P = $.90/bottle • Q = 1,100 bottles/day 2.00 • Mountains Spring retaliates • P = $.90/bottle • Both firms split 1,100 bottles/day @ $.90 • Profit = $495/day Price $/bottle) 1.00 0.90 MR D 1,100 1,000 2,000 Bottles/day Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  24. The Payoff Matrix for a Cartel Agreement Mountain Spring Charge $1/bottle Charge $0.90/bottle $0 for Aquapure $500/day for each Charge $1/bottle $990/day for Mt. Spring Aquapure $990 for Aquapure Charge $0.90/bottle $495/day for each $0 for Mt. Spring Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  25. The Prisoner’s Dilemma • Economic Naturalist • When will the rival firms stop cutting prices? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  26. The Prisoner’s Dilemma • Tit-for-tat and the Repeated Prisoner’s Dilemma • Cooperation between players will increase the payoff in a prisoner’s dilemma. • There is a motive to enforce cooperation. Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  27. The Prisoner’s Dilemma • Tit-for-tat strategy for repeated games • Tit-for-tat strategy • Players cooperate on the first move, then mimic their partner’s last move on each successive move Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  28. The Prisoner’s Dilemma • Tit-for-tat strategy for repeated games • Tit-for-tat strategy requirements • Two players • A stable set of players • Players recall other player’s moves • Players have a stake in future outcomes Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  29. The Prisoner’s Dilemma • Question • Why is the tit-for-tat strategy unsuccessful in competitive, monopolistically competitive, and oligopolistic markets? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  30. The Prisoner’s Dilemma • Economic Naturalist • How did Congress unwittingly solve the television advertising dilemma confronting cigarette producers? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  31. Cigarette Advertising as a Prisoner’s Dilemma Philip Morris Advertise on TV Don’t advertise on TV $35 million/yr for RJR $10 million/yr for each Advertise on TV $5 million/yr for Philip Morris RJR $5 million/yr for RJR Don’t Advertise on TV $20 million/yr for each $35 million/yr for Philip Morris Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  32. The Prisoner’s Dilemma • Economic Naturalist • Why do people shout at parties? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  33. Games in Which Timing Matters • Should Dodge build a hybrid viper? • Dodge Viper and Chevrolet Corvette compete for the domestic sports car market • Both know the other is considering a hybrid • If both build the hybrid they each make $60 million • If neither build they make $50 million Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  34. Games in Which Timing Matters • Should Dodge build a hybrid viper? • If Chevrolet builds and Dodge does not, Chevrolet will earn $80 million and Dodge $70 million. • If Dodge builds and Chevrolet does not, Dodge earns $80 million and Chevrolet $70 million. Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  35. Games in Which Timing Matters • Should Dodge build a hybrid viper? • Does either have a dominant strategy? • What will happen if Dodge gets to choose first? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  36. The Advantage of Being Different Is there a Nash Equilibrium? Dodge Viper Offer hybrid Don’t offer hybrid $60 million/yr for Chevrolet $80 million/yr for Chevrolet Offer hybrid $60 million/yr for Dodge $70 million/yr for Dodge Chevrolet Corvette $70 million/yr for Chevrolet $50 million/yr for Chevrolet Don’t offer hybrid $80 million/yr for Dodge $50 million/yr for Dodge Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  37. Decision Tree for Hybrid $60 million for Chevrolet $60 million for Dodge D Offer hybrid B Don’t offer hybrid $70 million for Chevrolet $80 million for Dodge Offer hybrid E A F $80 million for Chevrolet $70 million for Dodge Don’t offer hybrid Offer hybrid C Don’t offer hybrid $50 million for Chevrolet $50 million for Dodge G Dodge decides Chevrolet decides Final Outcome Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  38. Games in Which Timing Matters • Credible Threats and Promises • Credible Threat • A threat to take an action that is in the threatener’s interest to carry out Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  39. Games in Which Timing Matters • What Do You Think? • Why couldn’t Chevrolet deter Dodge from offering a hybrid by threatening to offer a hybrid of its own, no matter what Dodge did? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  40. Games in Which Timing Matters • Credible Promise • A promise to take action that is in the promiser’s interest to keep Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  41. Games in Which Timing Matters • Should a business owner open a remote office? • Pay the manager $1,000 • Make an additional $1,000 • If the manager is dishonest, she can make $500 more and cost the owner $500 Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  42. Decision Tree for the Remote Office Game Should a business owner open a remote office? Is the outcome an equilibrium? Manager manages honestly; owner gets $1,000, manager gets $1,000 C Owner opens remote office Manager manages dishonestly; owner gets -$500, manager gets $1,500 A B Managerial candidate promises to manage honestly Owner does not open remote office Owner gets $0, manager gets $500 by working elsewhere Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  43. Monopolist CompetitionWhen Location Matters • Why do we often see convenience stores located on adjacent street corners? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  44. Monopolist CompetitionWhen Location Matters • Assume • 1 mile street with 1,200 shoppers evenly distributed • Store A is located at the West end of the mile • Question • Where would you open a new store on the mile? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  45. Monopolist CompetitionWhen Location Matters • Differentiation by: • Physical location • The choice to locate at B. • Location in time • Timing of flight departures • Timing of film showings • Produce space • Soft drinks Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  46. Commitment Problems • Commitment Problem • A situation in which people cannot achieve their goals because of an inability to make credible threats or promises Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  47. Commitment Problems • Commitment Device • A way of changing incentives so as to make otherwise empty threats or promises credible Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  48. Commitment Problems • Commitment Problems • Prisoner’s dilemma • Cartels • Remote office Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  49. Commitment Problems • Commitment Devices • Underworld code, omerta • Military arms control agreements • Tips for waiters Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

  50. Games in Which Timing Matters • What do you think? • Will Sylvester leave a tip when dining on the road? Chapter 11: Strategic Choice in Oligopoly, Monopolistic Competition, and Everyday Life

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