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Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Strategy Perloff: Chapter 14.

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Presentation on theme: "Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Strategy Perloff: Chapter 14."— Presentation transcript:

1 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Strategy Perloff: Chapter 14

2 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Preventing Entry Nash equilibrium Where each firm maximise its profits given that the other also maximises its profits. No firm can individually take another action and increase its profits.

3 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Mixed Strategies Where firms are uncertain, they assume different strategies are played with certain probabilities. Suppose each firm enters with probability of 0.5. All outcomes are equally likely. Average profits are zero. Firm 2 cannot improve on this by playing pure strategy. Do not enter Do not enter Enter Firm 1 Firm 2 $0 $1 $-1 $0

4 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Preventing Entry: Sequential Decisions Accommodated Entry: It is irrational to take a strategic action to prevent entry, but output is reduced from Monopoly level to maximise profit (Stackelberg). Blockaded entry: Market conditions are such that no other firm can enter profitably. Strategic action is unnecessary. Deterred entry: Strategic action is taken to prevent entry: –Paying to prevent entry –Credible threat –Commitment (Extension to Stackelberg) –Creating and using cost advantages

5 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Blockaded entry One firm in the market (incumbent) makes monopoly profits. New firm joins, both firms make duopoly profit. –Market conditions may be such that these are negative. –Incumbent knows this and continues to produce the monopoly output. –Natural monopoly.

6 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Paying to prevent entry Incumbent Enter Do not enter (π m, $0) (π m – b (π d,π d =R – F) Do not pay Second stageFirst stage Pay for exclusive rights (entry is impossible) Entrant (π i,π e ) Will pay b to prevent entry if π-b>π d

7 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved (Non)credible threat Incumbent ($300, $300) (–$100,–$100) Cournot output Large output (π i,π e )

8 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Commitment: Stackelberg American (4.6, 4.6) (3.8, 5.1) (2.3, 4.6) 48 Leader’s decisionFollower’s decisionProfits(π A,π U ) (5.1, 3.8) (4.1, 4.1) (2.0, 3.1) (4.6, 2.3) (3.1, 2.0) (0, 0) 96 United

9 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Commitment: Deter Entry Incumbent Enter Do not enter (b) Entrant’s Fixed Cost Is $16. ($900, $0) ($450, $209) Accommodate (q i = 30) Accommodate (q i = 30) Enter Do not enter ($416, $0) ($208, $0) Deter (q i = 52) Entrant Incumbent Enter Do not enter (a) Entrant’s Fixed Cost Is $100. ($900, $0) ($450, $125) Enter Do not enter ($800, $0) ($400, $0) Deter (q i = 40) Entrant (π i,π e )

10 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Constructing the decision tree Stackelberg F=100 Monopoly F=16 (Stackelberg)

11 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Creating and using cost advantages Should a firm by a new piece of equipment which increases total cost but lowers marginal cost. –Implication is that output will expand. Answer is clearly no if firm is certain it will remain a monopoly. What if the firm fears that a new entrant will join.

12 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Reducing MC whilst increasing TC Incumbent Enter Do not enter ($900, $0) ($400, $300) Do not invest Enter Do not enter ($500, $0) ($132,–$36) Invest Entrant (π i,π e )

13 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Monopoly Advertising Monopoly advertises to raise profits. Demand curve shifts: –Changes in tastes –Information about new products

14 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved How much to advertise B Q c, Units of Coke per year Q 2 = Q 1 = 24 MR 1 2 D 2 D 1 p 2 = 12 p 1 = 11 e 2 e 1 π 1 MC = AC Price of coke, p e, $ per unit Advertising level maximises profit when the last $ spent on advertising give $1 extra gross revenue.

15 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Strategic Advertising in Oligopolies Advertising that helps rivals. Advertising that hurts rivals.

16 Source: Perloff. Some parts: © 2004 Pearson Addison- Wesley. All rights reserved Advertising Game


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