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Intermediate Market Structures
&Game Theory
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Competitive Market
Market
You
Other Firms
Impersonal Price Taker
Entry inresponse
to profit
potential
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Monopoly Market
Market
You
Barriers to entry Control of price Long term profit potential
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Monopolistic Competitive Market:
Market
You
Other Firms
Many Competitors
Free entry & exit Prodct !ariety
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Oligopoly Market
Market
You
Barriers to entry Control of price Long term profit potential Fe" #ellers Inter$dependent
decisions
%ey to eha!ior isinter$personal
reactions'
(o" do I respond
to yor actions )or
do yo potentially
respond to me*+
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Intermediate Market StructuresMonopolistic Competition
Many Small uyers
Many Small Sellers
!on"homogeneous product
#$S%T
Free $ntry & $'it
#$S%T
(er)ect In)ormation
!o uyer market po*er Many alternative vendors Some product loyalty
EL,#TIC -EM,.-
Price #etter+must choose price,Impersonal+- graphs"market. )irm,
Firm price elasticity high
(ro)its *ill induce entry
osses *ill induce e'itLong /n Profit 0 1
!o mistakes
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T/C
TFC
Monopolistic Competition
Indstry
ike competition. you need t*o graphs0ike Monopoly. 1 is do*n*ard sloping
P
2
-
#
P3
23
P
2firm
,TC
MC
Firm
23 firm
,4C
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M/
ike Competition. (rice set *here 2S321 ike Monopoly. Set 2)irm*here M#3MC
Set (rice at ma' ( given 2)irm+on 1,
(45TC647$ntry +or (85TC687$'it,
M#8(M# steeper than demand +-',
P3
/elati!ely elastic demand
6
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Intermediate Market Structures9inked 1emand
Many Small uyers
Fe* Sellers
!on"homogeneous product
#$S%T
Some arriers
(er)ect In)ormation
!o uyer market po*er 5lternative vendors kno*n Some product loyalty
Competitors respond to each otherPrice #etter+must choose price,
#ome Parallel eha!ior
Price #taility o!er time
(ro)its may induce entry osses may induce e'it
!o mistakes
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Game Theory
(layers 5ctors e))ected ;y their o*n actions and those o) others ?hat opponent does a))ects the values o) alternative actions
Strategies I) you = I *ill = 1epends upon dynamics o) market
Is decision making se@uential or simultaneousA Is decision making repeatedA
Is learning possi;leA (ayo))s
May ;e monetary !eed to @uanti)y
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Bo* Game Theory *orks
1eals *ith personal competition I) small num;er o) competitors. get to kno* each
others patterns O*n actions a))ect others actions. *hich. in turn.
a))ect *hat is ;est strategy
Individual chooses ;est e'pected payo)) Factor in opponents strategy Factor in importance o) gain and loss Factor in past and potential )uture impact
!ash $@uili;rium D no incentive to change given competitors strategy
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Firm B
5dvertise 1ont 5dvertise 0 5dvertise E -7 E " E
E -7 E 7 E
E""""""""""""""""""""""""""E""""""""""""""""""""""""""""E 1ont 5dvertise E 7 E E
E " E E
I) )irm 5 5dvertises. Firm s ;est strategy is to advertise!otice 5s payo))s depend on s choice0I) )irm 5 1oes not advertise. Firm s ;est strategy is to 5dvertise
There)ore. Firm has a dominant strategy to advertise0 +;oth arro*s,Firm 5 also has a dominant strategy to advertise0The !ash e@uili;rium is to ;oth advertise0!either has an incentive to change strategy. i) the other does not0This sho*s ;y t*o arro*s into ;o'. and at least one out o) other ;o'es0, Beatifl Mind
G5M$ TB$O#Y(ayo))s *ith the di))erent strategies
.
Firm ,
http://www.haverford.edu/math/butler/governing.dynamics.htmlhttp://www.haverford.edu/math/butler/governing.dynamics.html -
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G5M$ TB$O#YT*o !ash e@uili;ria
Firm B
5dvertise 1ont 5dvertise 0
5dvertise E - E H E
E - E 7 E
E""""""""""""""""""""""""""E"""""""""""""""""""""""""""E1ont 5dvertise E 7 E E
E H E E
I) )irm 5 5dvertises. Firm s ;est strategy is to not advertise
I) )irm 5 1oes not advertise. Firm s ;est strategy is to 5dvertiseFirm 5 has the same incentives as Firm
There are t*o !ash $@uili;ria:
5ny cell *ith t*o arro* coming in is a !ash $@uili;rium
Both .ash E6iliria ha!e one firm ad!ertising and the other not
!
.
Firm ,
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G5M$ TB$O#Y(risoners 1ilemma
Firm B
5dvertise 1ont 5dvertise
5dvertise E H E - E
E H E 7 E
E""""""""""""""""""""""""""E"""""""""""""""""""""""""""E1ont 5dvertise E 7 E E
E - E E
I) )irm 5 5dvertises. Firm s ;est strategy is to advertise
I) )irm 5 1oes not advertise. Firm s ;est strategy is to 5dvertiseFirm 5 has the same incentives0
Only one !ash $@uili;rium e'ists:
oth advertise. even though this costs them
.
Firm ,
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(ractical 5pplication o)Game Theory: 5dvertising
5dvertising Some o) advertising increases total demand
;y in)orming customers
Some o) advertising is destructive as itattempts to take other vendors customers
The )irst adds to value. the latter destroyssome value as it adds to private value
This creates a Game Theory situation The payo)) o) my actions depends on others
actions My actions a))ect the payo))s o) others actions
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$'ample
#ules:
0 Simultaneous decisions
-0 (ayo))s depend upon your and your
competitors choices
0 (ayo)) Matri' is symmetrical
H0 You are either (epsi or Coca Cola
0 You have to decide *hether to advertise ornot
J0 In class you have one competitor team
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K
Coke
0 1ont 5dvertise 5dvertise 0
1ont 5dvertise E 7 E 7 EE 7 E -7 E
E"""""""""""""""""""""""E""""""""""""""""""""""""E5dvertise E -7 E 77 E
E 7 E 77 E
$ntries are pro)its. given the com;ination o) choices0You are either Firm 5 or Firm ?hat do you choose to doLadvertise or notAThere *ill ;e up to K rounds""each time each team chooses
simultaneouslyThen results *ill ;e ta;ulatedCumulative pro)it is the criterion )or *inningThere "ill e one chance to negotiate "ith yor competitor
?hat *ill you chooseA
Pepsi
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?hy did *e do *hat *e did: (ayo))
5ssume that i) you advertise. it costs you N77 +;uilt into the num;ers;elo*, and that the payo))s are as in the ta;le:
Pepsi
5dvertise 1ont 5dvertise
5dvertise E 7 E 7 EE 7 E -7 E
E""""""""""""""""""""""""""E"""""""""""""""""""""""""""E
1ont 5dvertise E -7 E 77 E
E 7 E 77 E
!otice that this is a prisoners dilemma situation0
Bo* did your team respondA
Bo* much pro)it did you makeA
!
Coca Cola
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Profits !s Pricing'The Incentive )or !o change
(ay"o))s a;ove diagonal to $''on
(ay"o))s ;elo* diagonal to Cro*n
Exxon
Cro"n
N0
N0H
N0-
N0-H
N07
N0-7
H7
K77
H77
J7
H
H7
J7
7K7
7-7
K7
7
H
Incorporating kno"ledge of competitor5s response rles ot certain options7
!
Only stale choice is88888888888887
$ntries in Ta;leare (ro)its
no change
37 Tale assmesindependent action0
?ith this assumption.;oth lo*ering price isthe only !ash
$@uili;rium097 Beha!ioral
,ssmption:a0 #aising price *illnot ;e responded to.;0 1ropping price *ill0
5rro* indicatespre)erred choice
Initial
situation
Chooses ro"
Chooses colmn
.ash E6ilirim'
!o incentive toautonomouslychange strategy
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Game Theory over Time
More than one decision earning possi;le
Tit")or"tat
1ecision tree
Options and payo))s in se@uential decisions $': Take a Po; at N77. or *ait )or possi;le Po; QN-77
Take Po;A
Y
!
!e*
O))er
Y
Y
!
!
Outcome
N77
N7
N-77
N77
The key to success is
0 5ssess pro;a;ility o) Po;
-0 1ecide *illingness to risk0
0 1ecide a;out )irst Po;0
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The argaining (rocess
%ltimatum 5ll"or"nothing
Take"it"or"leave"it
Credi;le threat One that is in threateners ;est interest
Credi;le promise One that is in promisers ;est interest
Commitment (ro;lem"not tied to promise
Commitment device"ties one to threat orpromise