Motivation and Hr
Lecture 10: Game Theory/ Oligopoly
Managerial Economics BSP 1005 D2 November 2011
Sanjeev Mohta
Oligopoly
Small number of firms Great deal of interdependence Interdependence leads to strategic behavior Conditions may promote collusion No single model of oligopoly Many models depending on circumstances
Conclusions from some Oligopoly models
The oligopoly firms will conspire and collaborate to charge the monopoly price and get monopoly profits. The oligopoly firms will compete on price so that the price and profits will be the same as those of a Perfectly competitive industry. The oligopoly price and profits will be somewhere between the monopoly and Perfectly competitive ends of the scale. Oligopoly prices and profits are "indeterminate." That is, they may be anything within the range, and are unpredictable.
Applying Game Theory to Oligopoly
Price Competition (Bertrand) Location (Differentiation) : Hotelling
Capacity Competition : Simultaneous (Cournot) Capacity Competition : Sequential (Stackleberg)
The Setting
Key Assumptions: 2 Firms Same Marginal Cost Homogeneous product
Price Competition
Bertrand model
Sellers with unlimited capacity compete on price Suppose one of the two firms charges price p, above marginal cost The other firm has three choices: price > p: lose all customers price = p: split the market in half price < p: gain the whole market, even marginally below p The same logic would apply to the other firm
Bertrand Model : Strategies
Firm 1’ action P > MC P < MC P = MC Firm 2’s best response Undercut Firm 1 Get out of the market P = MC, or get out of the market
In the case 1, if Price is greater than the monopoly price, the best response would be for Price to be the Monopoly price.
Nash Equilibrium
For each firm's response to be a best response to the other's each firm must undercut the other as long as P> MC Where does this stop? P = MC (!)
8
Avoiding Bertrand Paradox
Repeated Game
Example : Tit for
Managerial Economics BSP 1005 D2 November 2011
Sanjeev Mohta
Oligopoly
Small number of firms Great deal of interdependence Interdependence leads to strategic behavior Conditions may promote collusion No single model of oligopoly Many models depending on circumstances
Conclusions from some Oligopoly models
The oligopoly firms will conspire and collaborate to charge the monopoly price and get monopoly profits. The oligopoly firms will compete on price so that the price and profits will be the same as those of a Perfectly competitive industry. The oligopoly price and profits will be somewhere between the monopoly and Perfectly competitive ends of the scale. Oligopoly prices and profits are "indeterminate." That is, they may be anything within the range, and are unpredictable.
Applying Game Theory to Oligopoly
Price Competition (Bertrand) Location (Differentiation) : Hotelling
Capacity Competition : Simultaneous (Cournot) Capacity Competition : Sequential (Stackleberg)
The Setting
Key Assumptions: 2 Firms Same Marginal Cost Homogeneous product
Price Competition
Bertrand model
Sellers with unlimited capacity compete on price Suppose one of the two firms charges price p, above marginal cost The other firm has three choices: price > p: lose all customers price = p: split the market in half price < p: gain the whole market, even marginally below p The same logic would apply to the other firm
Bertrand Model : Strategies
Firm 1’ action P > MC P < MC P = MC Firm 2’s best response Undercut Firm 1 Get out of the market P = MC, or get out of the market
In the case 1, if Price is greater than the monopoly price, the best response would be for Price to be the Monopoly price.
Nash Equilibrium
For each firm's response to be a best response to the other's each firm must undercut the other as long as P> MC Where does this stop? P = MC (!)
8
Avoiding Bertrand Paradox
Repeated Game
Example : Tit for