Presentation is loading. Please wait.

Presentation is loading. Please wait.

McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 13: Oligopoly Games and Strategy.

Similar presentations


Presentation on theme: "McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 13: Oligopoly Games and Strategy."— Presentation transcript:

1 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 13: Oligopoly Games and Strategy

2 13-2 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Objectives After studying this chapter, you will be able to:  Use game theory as a tool for studying strategic behaviour  Use game theory to explain how price and output are determined in oligopoly  Use game theory to explain other strategic decisions  Explain the implications of repeated games and sequential games

3 13-3 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Game Theory  Game theory is a tool for studying strategic behaviour, which is behaviour that takes into account the expected behaviour of others and the mutual recognition of interdependence.  What Is a Game?  All games share four features:  Rules  Strategies  Payoffs  Outcome

4 13-4 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Game Theory  The Prisoners’ Dilemma  The prisoners’ dilemma game illustrates the four features of a game.  The rules describe the setting of the game, the actions the players may take, and the consequences of those actions.  In the prisoners’ dilemma game, two prisoners (Alf and Bob) have been caught stealing a car.

5 13-5 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Prisoner’s Dilemma  Rules of the game  Prisoners are put in separate rooms and cannot communicate with the other.  They are told that they are a suspect in the earlier crime.  If both confess, they will get 3 years.  If one confesses and the other does not, the confessor will get 1 year while the other gets 10.

6 13-6 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Prisoners’ Dilemma  Strategies (possible actions)  They can each:  Confess to the bank robbery  Deny having committed the bank robbery

7 13-7 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Prisoners’ Dilemma  Payoffs  4 outcomes are possible:  Both confess.  Both deny.  Alf confesses and Bob denies.  Bob confesses and Alf denies.  The Payoff Matrix is illustrated on the following slide

8 13-8 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Prisoners’ Dilemma Payoff Matrix

9 13-9 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Prisoners’ Dilemma  A dominant strategy emerges.  Alf and Bob should both deny, because:  If they both deny, they will only get 2 years—but they don’t know if the other will deny.  If Alf denies, but Bob does not, Alf will only get 1 year.  If Alf denies, but Bob confesses, Art will get 10 years.  They both eventually decide it is best to confess — Nash equilibrium.

10 13-10 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia The Prisoners’ Dilemma  In a Nash equilibrium, each player takes their best possible action given the action of their opponent.  In equilibrium, both will confess. Each thinks:  If I confess, but my accomplice does not, my sentence will only be 1 year. This is better for me than 2 years.  If my accomplice confesses, but I do not, my sentence will be 10 years. If I confess too, I will only have a 3- year sentence.

11 13-11 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Oligopoly Games  A Price-Fixing Game  A game like the prisoners’ dilemma is played in duopoly.  A duopoly is a market in which there are only two producers that compete.  Duopoly captures the essence of oligopoly.

12 13-12 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Oligopoly Games  Suppose that the two firms enter into a collusive agreement:  A collusive agreement is an agreement between two (or more) firms to restrict output, raise price, and increase profits.  Such agreements are illegal in Australia and are undertaken in secret.  Firms in a collusive agreement operate a cartel.

13 13-13 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia MC D ATC Quantity (thous. of switchgears/week) Price and cost (thous. of $/ unit ) Costs and Demand Quantity (thous. of switchgears/week) Price and cost (thous. of $/ unit ) Minimum ATC Individual FirmIndustry Figure 13.1

14 13-14 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Oligopoly Games  The possible strategies are:  Comply  Cheat  Because each firm has two strategies, there are four possible outcomes:  Both comply  Both cheat  Trick complies and Gear cheats  Gear complies and Trick cheats

15 13-15 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Oligopoly Games  Colluding to Maximise Profits  These firms can benefit from colluding.  They maximise industry profits if they agree to set the industry output level equal to the monopoly output level.  They must agree on how much of the monopoly output each will produce.  For each firm, price is greater than MC. For the industry, MR = MC.

16 13-16 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Economic Profit Quantity (thous. Of switchgears/week) Price and cost (thous. of $/ unit ) Colluding to Make Monopoly Profits Quantity (thous. of switchgears/week) Price and cost (thous. of $/ unit ) MC ATC D Individual Firm Industry 99 8 MR MC 1 Collusion achieves monopoly outcome Figure 13.2

17 13-17 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Oligopoly Games  A Price-Fixing Game – one firm cheats on a collusive agreement  For the complier, ATC now exceeds price and for the cheat, price exceeds ATC.  The complier incurs an economic loss and the cheat earns an increased economic profit.  The industry output is larger than the monopoly output and the industry price is lower than the monopoly price

18 13-18 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Economic profit Economic loss One Firm Cheats Quantity (thousands of switchgears/week) Price & cost 10 Quantity (thousands of switchgears/week) Quantity (thousands of switchgears/week) Price & cost ATC ATC Complier CheaterIndustry D7.5 Complier’s output Cheat’s output Figure 13.3

19 13-19 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Oligopoly Games  A Price-Fixing Game – both firms cheat  Industry output is increased, the price falls, and both firms earn zero economic profit—the same as in perfect competition.

20 13-20 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Oligopoly Games  You’ve now seen the four possible outcomes: 1.If both comply, they make $2 million a week each. 2.If both cheat, they earn zero economic profit. 3.If Trick complies and Gear cheats, Trick incurs an economic loss of $1 million and Gear makes an economic profit of $4.5 million. 4.If Gear complies and Trick cheats, Gear incurs an economic loss of $1 million and Trick makes an economic profit of $4.5 million.  The next slide shows the payoff matrix for the duopoly game.

21 13-21 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Duopoly Payoff Matrix

22 13-22 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Oligopoly Games  The Nash equilibrium is where both firms cheat.  The quantity and price are those of a competitive market, and the firms earn normal profit.  Other games of strategy:  The Razor Blade R & D Game.  A Game of Chicken

23 13-23 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Repeated Games and Sequential Games  A Repeated Duopoly Game  If a game is played repeatedly, it is possible for duopolists to successfully collude and earn a monopoly profit.  If the players take turns and move sequentially many outcomes are possible.  In a repeated prisoners’ dilemma duopoly game, additional punishment strategies enable the firms to comply and achieve a cooperative equilibrium, in which the firms make and share the monopoly profit.

24 13-24 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Repeated Games and Sequential Games  A cooperative equilibrium might occur if cheating is punished  One possible punishment strategy is a tit-for-tat strategy.  A more severe punishment strategy is a trigger strategy in which a player cooperates if the other player cooperates but plays the Nash equilibrium strategy forever thereafter if the other player cheats.

25 13-25 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Repeated Games and Sequential Games  A Sequential Entry Game in a Contestable Market  In a contestable market—a market in which firms can enter and leave so easily that firms in the market face competition from potential entrants—firms play a sequential entry game.  A Contestable Air Route  Example: Agile Air and Wanabe sequential entry game in a contestable market

26 13-26 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Agile Versus Wanabe: A Sequential Entry Game in a Contestable Market

27 13-27 McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia END CHAPTER 13


Download ppt "McTaggart, Findlay, Parkin: Microeconomics © 2007 Pearson Education Australia Chapter 13: Oligopoly Games and Strategy."

Similar presentations


Ads by Google