University of Hawai‘i at Mānoa Department of Economics ECON 130 (003): Principles of Economics (Micro) Gerard Russo Lecture #25 Tuesday, April 13, 2004

ANNOUNCEMENTS LAST LECTURE Tuesday, May 4, 2004, 12:00-1:15 PM, BIL 152 Review Session Thursday, May 6, 4:30-5:30 PM, BIL 152 FINAL EXAMINATION Thursday, May 13, 2004, 12:00-2:00 PM, BIL 152

Lecture 25 Monopolistic Competition Oligopoly Introduction to Game Theory

Monopolistic Competition Many Firms Price Makers Heterogeneous/Differentiated product Free Entry and Exit

$/Q Q MR ATC MC 0 D P* Q* Monopolistically Competitive Firm in the Short-Run.

$/Q Q MR ATC MC 0 D P* Q* Monopolistically Competitive Firm in the Short-Run. Are Economic Profits Positive, Negative or Zero? ATC* Economic Profits

Monopolistic Competition in the Long-Run P>MR: “Market Power” MR=MC: “Profit Maximization” P=ATC: “Free Entry Implies Profits Equal Zero”

$/Q Q MR 2 ATC MC 0 D2D2 P2P2 Q2Q2 Monopolistically Competitive Firm in the Long-Run. P=ATC; MR=MC; P>MR. Q* P*

Oligopoly Few Firms Price Makers (fringe takers) Barriers to Entry Homogeneous or Differentiated Product

Introduction to Game Theory Prisoners’ Dilemma Dominant Strategy Nash Equilibrium Oligopoly Game Arms Race Game Advertising Game Common Resource Game Repeated Games

Prisoners’ Dilemma Bonnie’ Decision ConfessRemain Silent Clyde’s Decision Confess Bonnie: 8 years Clyde: 8 years Bonnie: 20 years Clyde: goes free Remain Silent Bonnie: goes free Clyde: 20 years Bonnie: 1 year Clyde: 1 year

An Oligopoly Game Iraq’s Decision High ProductionLow Production Iran’s Decision High Production Iraq: $40 billion Iran: $40 billion Iraq: $30 billion Iran: $60 billion Low Production Iraq: $60 billion Iran: $30 billion Iraq: $50 billion Iran: $50 billion

An Arms Race Game USA Decision ARMDISARM USSR Decision ARMUSA at risk USSR at risk USA at risk and weak. USSR safe and powerful. DISARMUSA safe and powerful. USSR at risk and weak. USA safe USSR safe

An Advertising Game Marlboro’s Decision AdvertiseDon’t Advertise Camel’s Decision AdvertiseMarlboro: $3 billion profit. Camel: $3 billion profit Marlboro: $2 billion profit Camel: $5 billion profit Don’t Advertise Marlboro: $5 billion profit Camel: $2 billion profit Marlboro: $4 billion profit. Camel: $4 billion profit.

A Common Resource Game Exxon’s Decision Drill Two WellsDrill One Well Arco’s Decision Drill Two Wells Exxon gets $4 million profit. Arco gets $4 million profit. Exxon gets $3 million profit. Arco gets $6 million profit. Drill One Well Exxon gets $6 million profit. Arco gets $3 million profit. Exxon gets $5 million profit. Arco gets $5 million profit.

Cartels and Repeated Prisoner’s Dilemma Jack’s Decision Sell 40 GallonsSell 30 Gallons Jill’s Decision Sell 40 Gallons Jack gets $1600 profit. Jill gets $1600 profit. Jack gets $1500 profit. Jill gets $2000 profit. Sell 30 Gallons Jack gets $2000 profit. Jill gets $1500 profit. Jack gets $1800 profit. Jill gets $1800 profit.