Ch09 Market Structure2 2012

Ch t 9 &10Chapters: 9 &10

Oligopoly &Oligopoly &Game TheoryGame TheoryGame TheoryGame Theory

Few sellers of a productpNon-price competition[ ]Barriers to entryBarriers to entryDuopoly - Two sellersPure oligopoly - Homogeneous productDifferentiated oligopoly - Differentiated g yproduct

Sources of OligopolyE i f lEconomies of scaleLarge capital investment requiredg p qPatented production processesBrand loyaltyBrand loyaltyControl of a raw material or resourceGovernment franchiseLimit pricing- pricing low toLimit pricing pricing low to discourage entry

Measures of OligopolyMeasures of Oligopoly• Concentration RatiosConcentration Ratios

4, 8, or 12 largest firms in an industry

• Herfindahl Index (H)Herfindahl Index (H)H = Sum of the squared market shares of all firms in an industryall firms in an industry

• Theory of Contestable MarketsIf entry is absolutely free and exit is entirelyIf entry is absolutely free and exit is entirelycostless then firms will operate as if theyare perfectly competitiveare perfectly competitive

Measurement of Oligopoly powerConcentration ratioConcentration ratio

The concentration ratio is expressed in the terms CRx, which stands for the percentage ofthe market sector controlled by the biggest x firms. For example, CR3 = 70% would indicatethat the top three firms control 70% of a market.CR4 is the most typical concentration ratio for judging what kind of an oligopoly it is A CR4CR4 is the most typical concentration ratio for judging what kind of an oligopoly it is. A CR4of over 50% is generally considered a tight oligopoly; CR4 between 25 and 50 is generallyconsidered a loose oligopoly. A CR4 of under 25 is no oligopoly at all. We would add that aCR3 of over 90% or a CR2 of over 80% should be considered a super-tight oligopoly.The problem with this measure is that CR4 does not indicate what the relative size of thefour largest companies is. It may be that a CR4 of 80 means that one company controls50% of the market, while the others have 10% share each. That's a very different marketstructure than one where every firm has a 20% share.

Herfindahl (or Herfindahl Hirschman) indexThe H index is a far more precise tool for measuring concentration. It is obtained by squaring the market-share of each ofthe players, and then adding up those squaresThe formula for this index is: H = (%S1)2 + (%S2)2 + (%S3)2 +….(%Sn)2. Here %S stands for the percentages of themarket owned by each of the larger companies, so that %S1 is the percentage owned by the largest company, %S2 bythe second, and so on. n stands for the total number of firms you are counting.The H index gives added weight to the biggest companies The higher the index the more concentration and (within limits)The H index gives added weight to the biggest companies. The higher the index, the more concentration and (within limits)the less open market competition. A monopoly, for example, would have an H index of S12 or 1002, or 10,000. Bydefinition, that's the maximum score. By contrast, an industry with 100 competitors that each has 1% of the market wouldhave a score of 12 + 12 + 12+ ...12 or a total of 100.A more typical situation might be a duopoly. If each of the two firms has a market shares of 50%, the H index would be(50)2 + 502 =2500 + 2500 = 5000. With two firms that have of 75% and 25% respectively, the H index would be: (75)2+(25)2 = 5,625 + 625 = 6,250A 1,000-1,800 value generally indicates moderate concentration. Anything over 1,800 is taken to be acute concentration.The US Antitrust Department has traditionally judged the "seriousness" of a merger by using the Herfindahl Index. If amerger or acquisition increases the index by 100 or more or pushes the overall index above 1,000, it is likelier toattract Federal Trade Commission (FTC) scrutiny.

(http://www.oligopolywatch.com/2003/08/15.html)

29 Dec, 2011, 09.37PM IST, PTI

CCI approves merger of Nippon Steel, Sumitomo Metal IndustriesNEW DELHI Competition atchdog CCI has appro ed the proposed merger of JapanNEW DELHI: Competition watchdog CCI has approved the proposed merger of Japan-based steel giants Nippon Steel Corporation and Sumitomo Metal Industries.

"The Commission is of the opinion that the proposed combination is not likely top p p yhave an appreciable adverse effect on competition in India and therefore, theCommission hereby approves the proposed combination," Competition Commissionof India (CCI) said in an order yesterday.

Earlier this month, the two companies received a nod for their business integration by the JapanFair Trade Commission (JFTC).

A merger agreement will be executed in April next year, after which it will be sent for approval by theCompanies' shareholders in June 2012. The business integration is scheduled to be complete onOctober 1, 2012.

In India, the operations of the two companies are mainly related to the sale of various types of steelproducts.

Steel producers in the country may be categorised as integrated steel producers and otherSteel producers in the country may be categorised as integrated steel producers and otherproducers (non- integrated) based on the level of integration ranging from availability of rawmaterial to production of range of finished steel products.

Kinked Demand Curve Model

Proposed by Paul SweezyProposed by Paul SweezyIf an oligopolist raises price, other firms will not follow so demand will be elasticwill not follow, so demand will be elasticIf an oligopolist lowers price, other firms will follow so demand will be inelasticwill follow, so demand will be inelasticImplication is that demand curve will be ki k d MR ill h di i ikinked, MR will have a discontinuity, and oligopolists will not change price

h i l hwhen marginal cost changes

Kinked Demand Curve ModelKinked Demand Curve Model

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Cournot ModelCournot Model

• Proposed by Augustin Cournot• Behavioral assumptionBehavioral assumption

– Each firm tries to maximize profits under the assumption that the other holds outputthe assumption that the other holds output constant.

• Bertrand ModelBertrand Model– Firms assume that their market rivals will

not change their prices.not change their prices.

Cournot Model(Contd )Cournot Model(Contd..)

• Example– Two firms (duopoly)Two firms (duopoly)– Identical products– Marginal cost is zeroMarginal cost is zero– Initially Firm A has a monopoly and then

Firm B enters the marketFirm B enters the market

Cournot Model(Contd..)Cournot Model(Contd..)

Adj t t• Adjustment process– Entry by Firm B reduces the demand for

Fi A’ d tFirm A’s product– Firm A reacts by reducing output, which

increases demand for Firm B’s productincreases demand for Firm B s product– Firm B reacts by increasing output, which

reduces demand for Firm A’s productreduces demand for Firm A s product– Firm A then reduces output further

This continues until equilibrium is attained– This continues until equilibrium is attained

Note (1) The share of A steadily decreases and that of B increases,until equilibrium is reached.

(2) Market will reach an equilibrium when each firm’s expectation(2) Market will reach an equilibrium when each firm s expectationabout the output of the other turn out to be correct.

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Cournot Model(Contd..)( )• Equilibrium

– Firms are maximizing profits simultaneously

– The market is shared equally among the firms

– Final Cournot Equilibrium (P=$4& Q=8)is above the competitive equilibriumis above the competitive equilibrium(P=0 & Q=12) and below the monopolyequilibrium(P=$6 and Q=6) in terms ofequilibrium(P $6 and Q 6) in terms ofPrice.

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Reaction Functions

B’sIf A dB s

Output If A produces the

produces nothing, B acts like a

12

the competitive output B

acts like a monopoly

output, B produces nothing.

6

A’s O t t0 Output12

06

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Cournot ModelReaction functions:

12

Firm A’s (best response) reaction function

6B (Q

B)

4E

Out

put o

f

Firm B’s reaction function3

1264

O

3

Output of A (QA)

Cournot model with n Firms

)1/( +QQ )1/( += nnQQ cn

Where:Where:

Qn = Total Quantity supplied by n firmsn y pp y

Qc = Perfect Competition Supply

n = No. of firms in the industry svj

Bertrand model & Price WarsSecond firm assumes the first will keep priceconstant and proceeds to capture the entireconstant and proceeds to capture the entiremarket by charging a slightly lower price.The first firm then assumes second will keep itsThe first firm then assumes second will keep its

price constant, and lowers price slightly belowthat of the second, and tries to capture entirethat of the second, and tries to capture entiremarket.This continues until price falls to competitiveThis continues until price falls to competitive

market price.Collusion is the best way to avoid uncertaintyCollusion is the best way to avoid uncertaintyand mutually destructive price wars………

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CartelsCartelsCollusionCollusion– Cooperation among firms to restrict

competition in order to increase profitsp pMarket-Sharing Cartel– Collusion to divide up markets– Collusion to divide up marketsCentralized Cartel

F l t b fi t– Formal agreement among member firms to set a monopoly price and restrict outputIncentive to cheat– Incentive to cheat

Centralized Cartel

Equilibrium Condition: MR = MC1=MC2

Cement Prices Firm Up In South On Despatch Holidays

Posted online: 2003-11-26 00:00:00+05:30

Mumbai, Nov 25: Cement prices in the south are on the upswing following the leading players in the regionresorting to despatch holidays. However, the situation in the rest of the country does not seem to haveimproved much with the impending elections being considered as a dampening factor in the northern belt.

Another method the manufacturers are resorting to is despatch holidays to push up demand. Retail prices inAnother method the manufacturers are resorting to is despatch holidays to push up demand. Retail prices inBangalore stood at Rs 164 per bag and is expected to go up by another Rs 10 in another week. The region didnot witness any despatches for a four-day period in October-end. Prices in Chennai are currently around theRs 165 mark.

D d i H d b d ti t b k d i i th R 130 140 i b d Th d dDemand in Hyderabad continues to be weak and prices are in the Rs 130-140 price band. The demandcontinues to be weak. Prices have risen by Rs 30-35 per bag in course of the last fifteen days, with industryplayers having observed a despatch holiday during November 5-14.Kerala is enjoying the highest price in the region at around Rs 170 per bag. Industry observers point out thatthere is no possibility for an immediate price increase in the state.p y p

Demand in the east continues to be weak with ex-dump prices remaining low. Retail prices in Kolkata are atRs 160 per bag. Analysts, however, fear that it being the year-ending period for Lafarge, the company may

ff fbring down prices in an effort to push volumes. With the impending elections in four states in the north, pricesin the region are not expected to go up immediately. While cement prices in Raipur stands at Rs 105-108 perbag, Rajasthan prices stood at Rs 120-125.

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OPEC chief Abdullah ElBadri said on a visit to Tehran Tuesday the current price of around $100 forab l f il “ ti f t ” I ll d f O d ti t t i t d

OPEC Chief says oil price levels satisfactory nowFinancial Chronicle, Date : 11/02/2011

barrel of oil was “satisfactory,” as Iran called for Opec production quotas to remain steady.

El-Badri said he was optimistic the next meeting of the Organisation of Petroleum Exporting Countries,in Vienna in December, will agree to “satisfactory production” quotas given “the special situation of theworld economy ” Libya was “returning strongly” to the market after months of being off-line because ofworld economy. Libya was returning strongly to the market after months of being off-line because ofthe revolution that toppled late leader Moamer Kadhafi, the Opec secretary general noted. It shouldreach normal output levels of 1.5 million barrels per day (bpd) by the end of 2012, El-Badri said.

The official total Opec output ceiling for 2011 was 24.8 million bpd, not including Iraq, which is exemptp p g p , g q, pfrom the quota system as it recovers from its war, according to the cartel’s chief. Counting Iraq, Opec’sSeptember production was 29.9 million bpd, he said. “We must try to reach agreement on a level ofproduction in December that all the countries must respect,” El-Badri said.

Iran’s oil minister, Rostam Qasemi, said that his country wants Opec’s overall output held steady, takinginto account the returning Libyan oil exports. Qasemi said “the current price (for oil) is a good price.” Headded that “Iran is going to hold consultations on maintaining a stable level of Opec’s production ceilingtaking into account Libya’s return to the market.” Saudi Arabia and Kuwait have been pumping more oilthis year to make up for the shortfall caused by Libya’s absence Iran the secondbiggest Opecthis year to make up for the shortfall caused by Libya s absence. Iran – the secondbiggest Opecproducer after Saudi Arabia – wants to see those countries reduce that extra production as Libya stepsback into the market.

World oil prices Tuesday were trading around $92 a barrel for Texas light sweet crude and $108 for aWorld oil prices Tuesday were trading around $92 a barrel for Texas light sweet crude and $108 for abarrel of Brent North Sea crude. OPEC’s revised estimate of world oil demand for 2011 is 87.81million barrels per day.

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Horizontal summation of MCMC1= 4 + 0.2Q1 MC2= 2 + 0.2Q2 ∑MC = 3 + 0.1Q

MC1 Q1 MC2 Q2 ∑MC Q6 10 6 20 6 30

At output levelof 32, each firmin the industry is6 10 6 20 6 30

6.1 10.5 6.1 20.5 6.1 316.2 11 6.2 21 6.2 326 3 11 5 6 3 21 5 6 3 33

in the industry ishaving an MC of6.2.In fact, we areadding Q keeping6.3 11.5 6.3 21.5 6.3 33

6.4 12 6.4 22 6.4 34

adding Q, keepingMC constant.Similarly for otherlevels of outputtoo.

MC1=0.2Q MC2=0.2Q MC3=0.2Q ∑MC = 0.06667QMC1 Q MC2 Q MC3 Q ∑MC Q

0 0 0 0 0 0 0 0

Acasewhere

1 5 1 5 1 5 1 152 10 2 10 2 10 2 303 15 3 15 3 15 3 45

therearethreefirms

4 20 4 20 4 20 4 605 25 5 25 5 25 5 756 30 6 30 6 30 6 90

Centralised cartel: numerical exampleGiven:Q C Q C QQ= 120 – 10P; MC1 = 4+0.2Q1 ; MC2 = 2+0.2Q2Find: (1) the best level of output & price for the cartel,

d (2) t t f h fiand (2) output for each firm. MC1 =4+0.2Q1-> MC1 – 4 =0.2 Q1 Q1= 5MC1 - 20 (1)

MC2 =2+0.2Q2-> MC2 – 2 =0.2Q2 Q2= 5MC2 - 10 (2)

Adding up 1& 2 to obtain ∑MC: Q = 10MC - 30 (3)g p ∑ ( )

Solving(3) for MC Q+30 = 10MC 0.1Q + 3 = MC (4)

Marginal Revenue: MR = 12-0 2 Q (5)Marginal Revenue: MR = 12-0.2 Q (5)

MR = MC 12-0.2 Q = 0.1Q + 3 9= 0.3Q Q =30 (6)

Q > 6 4 0 2Q i Q1 10 (7)Q1 => 6 = 4+0.2Q1 i.e. Q1 = 10 (7)

Q2 => 6 = 2+0.2Q2 i.e. Q2 = 20 (8)Source: Salvatore, 6th ed., p. 388, Q.10

Price Leadership(1)

• Implicit Collusion

• Price Leader (Barometric Firm)– Largest, dominant, or lowest cost firm in the industry

A dominant firm with full information about market– A dominant firm with full information about marketdemand and industry costs can set prices so that itearns economic profit whilst the passive fringe earns

l t f ta normal rate of return.– Demand curve of the leader is defined as the

market demand curve less supply by the followers.• Followers

– Take market price as given and behave as perfectcompetitorscompetitors

Price Leadership(2)

The Dominant Firm Model (3)( )

P Sf

D

Q0

The Dominant Firm Model (4)

P MC=Sf

MC L

D L

DMR L

Q0 svj

The Dominant Firm Model (5)

P MC=Sf

MC L

P* D LP

D

Q0 QL

MR L

Qfsvj

Q. In an industry there is one large firm and many smallfirms. The large firm is the price leader in this industry.Th ti t d k t d d f fi ’ d t iThe estimated market demand for firms’ product is asfollows:

QM = 40,700 - 100P, where QM is units per month.

It has been predicted that small firms in the industry willIt has been predicted that small firms in the industry willsupply output to the market according to the followingfunction: Qs = 700 + 25P

The large firm's marginal cost function isMCL = 100 + 0.016QLL L

(a) What quantity will the large firm sell? What price will the large firm set?the large firm set?

(b) What quantity will the small firms sell?svj

The Dominant Firm Model (Example)( p )

P, MC,MR

MCL=100 + 0.016QL407

Qs=700 + 25P

Q 40000 125P

320

265

QD=40000 - 125PL

D

265

100

MR

Q0 700 40000 4070020000

MRL

6875 svj

Harmful Effects of Oligopolyg p y

☺Price is usually greater than long-run☺Price is usually greater than long runaverage cost (LAC)

☺Quantity produced usually does not☺Quantity produced usually does notcorrespond to minimum LAC

☺Price is usually greater than long run☺Price is usually greater than long-runmarginal cost (LMC)Wh diff i d d i☺When a differentiated product isproduced, too much may be spent ond i i d d l hadvertising and model changes.

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Game Theory and Strategic BehaviorGame Theory and Strategic BehaviorGame theory is a method of studyingstrategic situations.strategic situations.A strategic situation is where the outcomesdepend not just on your actions, but that ofdepend not just on your actions, but that ofothers too.Except perfect competition and monopoly, restp p p p y,all market structures, operate in strategicsituations.In short, markets that are characterized byimperfect competition constitute strategicgsituation, where actions of firms affect eachother. svj

Strategic Behavior

• Game Theory– Players – decision makers, managers– Strategies – choices like change price, advertise

or not etc– Payoff matrix – outcome or consequence of each

t tstrategy• Nash Equilibrium

– Each player chooses a strategy that is optimal (or best) given the strategy of the other player

– A strategy is dominant if it is always optimalsvj

Game TheoryGame Theory

Advertising Example

Advertise Don't AdvertiseAdvertise (4 3) (5 1)

Firm B

Advertise (4, 3) (5, 1)Don't Advertise (2, 5) (3, 2)Firm A


What is the optimal strategy for Firm A if Firm B chooses to p gyadvertise?


Firm B


Game TheoryGame TheoryWhat is the optimal strategy for Firm A if Firm B chooses to p gyadvertise?

If Firm A chooses to advertise, the payoff is 4. Otherwise, the payoff is 2. The optimal strategy is to advertise.


Firm B


Game TheoryGame TheoryWhat is the optimal strategy for Firm A if Firm B chooses p gynot to advertise?


Firm B



If Firm A chooses to advertise, the payoff is 5. Otherwise, the payoff is 3. Again, the optimal strategy is to advertise.


Firm B



Regardless of what Firm B decides to do, the optimal g , pstrategy for Firm A is to advertise. The dominant strategyfor Firm A is to advertise.


Firm B


Game TheoryGame TheoryWhat is the optimal strategy for Firm B if Firm A chooses to p gyadvertise?


Firm B



What is the optimal strategy for Firm B if Firm A chooses to p gyadvertise?

If Firm B chooses to advertise, the payoff is 3. Otherwise, the payoff is 1. The optimal strategy is to advertise.


Firm B


Game TheoryGame TheoryWhat is the optimal strategy for Firm B if Firm A chooses p gynot to advertise?


Firm B



If Firm B chooses to advertise, the payoff is 5. Otherwise, the payoff is 2. Again, the optimal strategy is to advertise.


Firm B


Game TheoryGame TheoryRegardless of what Firm A decides to do, the optimalg , pstrategy for Firm B is to advertise. The dominant strategyfor Firm B is to advertise.


Firm B


Game TheoryGame TheoryThe dominant strategy for Firm A is to advertise and the gydominant strategy for Firm B is to advertise. The Nash equilibrium is for both firms to advertise.


Firm B



A Second Advertising Example


Firm B




Firm B



If Firm A chooses to advertise, the payoff is 4. Otherwise, the payoff is 2. The optimal strategy is to advertise.


Firm B




Firm B


Game TheoryyWhat is the optimal strategy for Firm A if Firm B chooses not to advertise?

If Firm A chooses to advertise, the payoff is 5. Otherwise, the payoff is 6. In this case, the optimal strategy is not to advertise.

Firm BAdvertise Don't Advertise

Advertise (4, 3) (5, 1)Don't Advertise (2 5) (6 2)Firm A Don t Advertise (2, 5) (6, 2)

Game TheoryGame TheoryThe optimal strategy for Firm A depends on which strategy p gy p gyis chosen by Firms B. Firm A does not have a dominant strategy.


Firm B




Firm B



If Firm B chooses to advertise, the payoff is 3. Otherwise, the payoff is 1. The optimal strategy is to advertise.


Firm B




Firm B



If Firm B chooses to advertise, the payoff is 5. Otherwise, the payoff is 2. Again, the optimal strategy is to advertise.


Firm B


Game TheoryGame TheoryRegardless of what Firm A decides to do, the optimal g , pstrategy for Firm B is to advertise. The dominant strategyfor Firm B is to advertise.


Firm B



The dominant strategy for Firm B is to advertise. If Firm B gychooses to advertise, then the optimal strategy for Firm A is to advertise. The Nash equilibrium is for both firms to advertiseadvertise.


Firm B


Prisoners’ DilemmaPrisoners’ DilemmaTwo suspects are arrested for armed robbery. Theyare immediately separated. If convicted, they willare immediately separated. If convicted, they willget a term of 10 years in prison. However, theevidence is not sufficient to convict them for morethan the crime of possessing stolen goods, whichcarries a sentence of only 1 year.

The suspects are told the following: IfIf youyou confessconfessandand youryour accompliceaccomplice doesdoes not,not, youyou willwill gogo freefree.. IfIfyouyou dodo notnot confessconfess andand youryour accompliceaccomplice does,does, youyouwillwill getget 1010 yearsyears inin prisonprison (and(and hehe goesgoes free)free).. IfIf youyoubothboth confessconfess youyou willwill bothboth getget 55 yearsyears ininbothboth confess,confess, youyou willwill bothboth getget 55 yearsyears ininprisonprison.[ ] svj

Prisoners’ DilemmaPrisoners Dilemma

Payoff Matrix (negative values)

I di id l BConfess Don't Confess

Confess (5, 5) (0, 10)

Individual B

Individual A ( , ) ( , )Don't Confess (10, 0) (1, 1)Individual A

Prisoners’ DilemmaPrisoners Dilemma

Dominant StrategyBoth Individuals Confess

I di id l B

(Nash Equilibrium)

Confess Don't ConfessConfess (5, 5) (0, 10)

Individual B

Individual A ( , ) ( , )Don't Confess (10, 0) (1, 1)Individual A

Prisoners’ DilemmaPrisoners’ Dilemma

Firm B

Application: Price Competition

Low Price High PriceLow Price (2, 2) (5, 1)High Price (1 5) (3 3)Firm A High Price (1, 5) (3, 3)

Prisoners’ Dilemma

Firm BApplication: Price Competition

Low Price High PriceLow Price (2, 2) (5, 1)

Firm B

Firm A High Price (1, 5) (3, 3)Firm A

At Nash equilibrium no player has an incentive toi d d tl ( il t ll ) h hi t tindependently(unilaterally) change his own strategy.Why (3,3) is not the Nash equilibrium?1. Firms go by their dominant strategy and reach (2,2). Now, as long as

Firm-B doesn’t change its strategy, Firm-A has no incentive tounilaterally change its strategy and same with Firm-B also. Therefore(2,2) is the Nash equilibrium.

2 (3 3 ) ld b t bl it ti lik i t l2. (3,3,) could be an unstable situation, like in a cartel.3. It is also be an illegal activity inviting prosecution (see the news item

on next slide).

These companies tried to break out of prisoners dilemma by colluding!These companies tried to break out of prisoners dilemma by colluding!

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China fines baby formula firms $108 million for priceChina fines baby formula firms $108 million for price--fixing: Xinhuafixing: XinhuaAFP | Aug 7, 2013, Times of India

BEIJING: China has fined six mostly foreign baby formula companies a total of$108 million for price-fixing, the official Xinhua news agency reported onWednesday.

The firms fined were Mead Johnson and Abbott from the US, Dumex, asubsidiary of France's Danone, Friesland of the Netherlands, New Zealandgiant Fonterra at the centre of a health scare this week and China'sgiant Fonterra -- at the centre of a health scare this week -- and China sBiostime, Xinhua said, citing the National Development and ReformCommission (NDRC).In a corporate statement, Mead Johnson said it had been handed aIn a corporate statement, Mead Johnson said it had been handed apenalty of 204 million yuan ($33 million). Biostime said in a filing to theHong Kong stock exchange that it had been given a 163 million yuan fine.Fonterra, which has had to recall products in several countries this weekpover a botulism scare, was fined 4.5 million yuan, it said. It cooperated fullywith Chinese authorities and accepted their decision, it said.

The NDRC, China's top economic planner, launched the investigation into highprices it said resulted from a monopoly-like situation, mostly targeting overseasfirms. Several of them announced price cuts last month.

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Prisoners’ DilemmaApplication: Nonprice Competition

Firm BAdvertise Don't Advertise

Advertise (2, 2) (5, 1)Don't Advertise (1, 5) (3, 3)Firm A Don t Advertise (1, 5) (3, 3)

Prisoners’ DilemmaPrisoners’ Dilemma -

Application: Nonprice Competition

Dominant Strategy: AdvertiseDominant Strategy: Advertise

Fi BAdvertise Don't Advertise

Advertise (2, 2) (5, 1)

Firm B

Firm A ( , ) ( , )Don't Advertise (1, 5) (3, 3)Firm A

Prisoners’ Dilemma

Application: Cartel Cheating

Fi BCheat Don't Cheat

Cheat (2, 2) (5, 1)

Firm B

Firm A ( , ) ( , )Don't Cheat (1, 5) (3, 3)Firm A

Prisoners’ DilemmaPrisoners’ Dilemma

Application: Cartel Cheating

Dominant Strategy: Cheat

Fi B

Dominant Strategy: Cheat

Cheat Don't CheatCheat (2, 2) (5, 1)

Firm B

Firm A ( , ) ( , )Don't Cheat (1, 5) (3, 3)Firm A

Extensions of Game Theory

• Repeated Games– Many consecutive moves andMany consecutive moves and

countermoves by each player• Tit-For-Tat StrategyTit For Tat Strategy

– Do to your opponent what your opponent has just done to youopponent has just done to you

Extensions of Game Theory

• Tit-For-Tat Strategy–Stable set of playersStable set of players–Small number of players–Easy detection of cheatingEasy detection of cheating–Stable demand and cost conditions–Game repeated a large andGame repeated a large and

uncertain number of times

Tit-For-Tat Strategy- ExampleFIRM - B

Low price High Price

FIRM -A

Low price High PriceLow price (1, 1) (3, -1)High price (-1, 3) (2, 2)

Q Show what first 5 moves in tit forQ. Show what first 5 moves in tit-for-tat strategy would be (in an infinitenumber of games) if firm A starts bycooperating but B does not cooperatep g pin the next time period.

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Extensions of Game TheoryExtensions of Game Theoryyy

• Threat StrategiesC dibilit–Credibility

–ReputationReputation–Commitment–Example: Entry deterrence

1. A has a Dominant Strategy of Charging a high price.

2 Given A’s high price B may charge a low price2. Given As high price, B may charge a low price.3. How to prevent this?

4 A can threaten to lower price4. A can threaten to lower price.

5. Will B believe it ????

6. Firm A can actually carry out the threat achieve credibility in long y y y grun.

7. Can B threaten A ????

• A can deter entry by threatening to reduce the price. But it won’tsound credible as profits are much lower with low price.

A can make a credible threat by expanding the capacity before• A can make a credible threat by expanding the capacity beforeneeded. In that case the pay-off matrix will be Table:10-7

• Building excess capacity becomes a credible threat becauseg p yprofits with low price is higher now, i.e 4 with entry.

• In 10.6 A had a dominant strategy of High Price. But after capacityi (10 7) it d ’t h d i t t t It t texpansion (10.7) it doesn’t have a dominant strategy. Its strategy

will now depend on what B does. Out come in 10.7 is (8.0)

Entry DeterrenceFi B

Enter Do Not EnterLow Price (4, -2) (6, 0)

Firm B

Firm A

No Credible Entry Deterrence

( ) ( )High Price (7, 2) (10, 0)Firm A

Firm BEnter Do Not Enter

Low Price (4, -2) (6, 0)High Price (3 2) (8 0)Firm A

Credible Entry Deterrence

High Price (3, 2) (8, 0)

• A can deter entry by threatening to lower price. But it won’t soundcredible as profits are much lower with low pricecredible as profits are much lower with low price.

• A can make a credible threat by expanding the capacity and creatingexcess capacity. In that case the pay-off matrix will be Table:10-7

• Building excess capacity becomes a credible threat because profitswith low price is higher now, i.e 4 with entry.

1. Boeing produces first(100,0)

2. If AB produces then, (-10,-10)

3 Role of Govt a subsidy to AB?3. Role of Govt. – a subsidy to AB?

International CompetitionInternational Competition

Boeing Vs. Airbus Industries

Ai bProduce Don't Product

Produce (-10, -10) (100, 0)

Airbus

Boeing ( , ) ( , )Don't Produce (0, 100) (0, 0)Boeing

Sequential GamesSequential Games

• Sequence of moves by rivals• Payoffs depend on entire sequencePayoffs depend on entire sequence• Decision trees

D i i d– Decision nodes– Branches (alternatives)

• Solution by reverse induction– From final decision to first decision

High-Price, Low-Priceg ,Strategy Game

ice

Firm A Firm B

BHigh Price

Low PriHigh Price

$100 $100

$130 $50

A

High Price

w Price

Low

Hig $130 $50

$180 $80

BH g

Low Price

ow Price$150 $120

High-Price, Low-PriceSt t GStrategy Game

ice

Firm A Firm B

BHigh Price

Low PriHigh Price

$100 $100

$130 $50XA

High Price

w Price

Low

Hig $130 $50

$180 $80XX

BH g

Low Price

ow Price$150 $120

X

High-Price, Low-PriceStrategy GameStrategy Game

ice

Firm A Firm B

BHigh Price

Low PriHigh Price

$100 $100

$130 $50XX Solution:B h fi

A

High Price

w Price

Low

Hig $130 $50

$180 $80XXX Both firms

choose lowiB

H g

Low Price

ow Price$150 $120

X price.

Airbus and BoeingAirbus and Boeing

Jet

Airbus Boeing

BJumbo Jet

Sonic CA380

$50 $50

$120 $100

A

Jumbo Jet

nic Cruiser

No A

A3 $120 $100

$0 $150

BJ

Sonic Cruiser

o A380

$0 $200r


Jet

Airbus Boeing

BJumbo Jet

Sonic CA380

$50 $50

$120 $100

XA

Jumbo Jet

nic Cruiser

No A

A3 $120 $100

$0 $150XBJ

Sonic Cruiser

o A380

$0 $200

Xr


Jet

Airbus Boeing

BJumbo Jet

Sonic CA380

$50 $50

$120 $100

X Solution:Airbus builds

A

Jumbo Jet

nic Cruiser

No A

A3 $120 $100

$0 $150XXAirbus buildsA380 andBoeing builds

BJ

Sonic Cruiser

o A380

$0 $200

XX Boeing buildsSonic Cruiser.

r

First the turn of A to decide to charge high price or low priceFirst, the turn of A to decide to charge high price or low price

Once A decides to charge low price, now it is the turn of B to decide on whether to chargehigh price or low price; since the pay-offs on low price (140 & 150) are higher than at highprice(80 & 100), B decides on low price.

Now the final round of decision to be taken by A, i.e., to advertise or not. Here A compares80 (under No Advt) and 140 (Advertise) and decides to advertise. Thus the final equilibrium is :LowLow price,price, LowLow price,price, AdvertiseAdvertise..

Low price, Low price, Advertise. Low price, Low price, Advertise.

Answer: High Price High Price AdvertiseAnswer: High Price, High Price , Advertisesvj

Example-1

• Players: A and BSt t i Ad ti D N t Ad ti• Strategies: Advertise , Do Not Advertise

• Payoffs: Companies’ Profits

• Each firm earns $50 million from its customerscustomers

• Advertising costs a firm $20 millionAdvertising captures $30 million from• Advertising captures $30 million from competitor

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Solution - 1

BAdvertise Don’t

AdvertiseAdvertise

Advertise 30, 30 60, 20

A Don’t Advertise

20, 60 50, 50

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Solution - 2

BAdvertise Don’t

Advertise

Advertise 50, 50 80, 40

A Don’t Ad ti

40, 80 70, 70Advertise

Dominated Strategy- Example (Contd.)

Hi h L M di

B’s PricesHigh Low Medium

High (1000,1000) (900,1100) (500,1200)g ( , ) ( , ) ( , )

ces

Low (1100,400) (800,800) (450,500)

A’s

Pri

Medium (1200,300) (500,350) (400,400)

A

Dominated Strategy- Examplegy p

Low MediumB’s Prices

Low Medium

es

High (900,1100) (500,1200)

s P

rice

Medium (500,350) (400,400)A’s

Maximin Strategy- Example

Don’tHyundai

Min forAdvertise Don t Advertise

Min for Suzuki

Advertise (6,6) (20,4)

zuki 6

Don’t Advertise (4,20) (10,10)

Suz

4Advertise

Min for Hyundai 6 4 Note: Hyundai earns a minimum Rs.6 cr if it advertises and Rs.4 cr if it doesn’t; thus it decides to advertise and chooses the maximum of the Minimum. Similarly, Suzuki earns minimum of Rs.6 cr if it advertises and Rs.4 cr if it doesn’t and it chooses to advertise.

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Example - 2PLAYER - 1

PLAYER - 2

L C RT 63 45 18 29 12 19T 63,45 18,29 12,19

M 40,40 20,60 15,50

B 80 30 10 70 21 80B 80,30 10,70 21,80

1) Find the Nash Equilibria of the simultaneousmove game.

2) Find the Nash Equilibrium of the sequential

1) Find the Nash Equilibrium of thesimultaneous move game. A-> MC & BR

2) Find the Nash Equilibrium of the sequential) q qmove game (1 move each), when player 1moves first.

3) Find the Nash Equilibrium of the sequentialmove game (1 move each), , when player 2

move game, when player 1 moves first. A->TL

3) Find the Nash Equilibrium of the sequentialmove game, when player 2 moves first. A->BRg ( ), , p y

moves first.4) Assume that player 2 is currently moving

first, but that player 1 can become theleader(first mover) by making a certain

BR4) Assume that player 2 is currently moving

first, but that player 1 can become theleader(first mover) by making a certainexpenditure/investment. What is themaximum that palyer 1 will spend to( ) y g

expenditure/investment. What is themaximum that palyer 1 will spend tobecome the leader?

maximum that palyer 1 will spend tobecome the leader? A-> 63 – 21 = 42

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Example - 3PLAYER 2

PLAYER - 1PLAYER - 2

L C RT 15 43 19 26 22 40T 15,43 19,26 22,40

M 25,20 10,17 30,38

B 22 60 18 80 20 90B 22,60 18,80 20,90

1) Identify any dominant strategy for either player

1) None.2) C dominated by Rstrategy for either player.

2. Solve using dominance

2) C dominated by R.3) Then:

T dom by Mgarguments, successively. T dom by M.

B dom by M.4) L dom by R4) L dom by R5) Result: MR

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Example - 3PLAYER 2

PLAYER - 1PLAYER - 2

L C RT 13,3 1,4 7,3M 4,1 3,3 6,2B 1 9 2 8 8 1B -1,9 2,8 8,-1

1) Identify any dominant 1) None.) y ystrategy for either player.

)2) R dominated by C.3) Then B dom by M.

2. Solve using dominancearguments, successively.

) y4) Then L dom by C.5) Then T dom by M.6) Result: MC

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Example - 4Two companies are involved in developing a new technology that will allowstorage of large quantity of digital information. Given the risks and therelatively small expected size of this market, compatibility of the technologiesi i t t S i f d d i d l i it Bl R t h lis very important. Sony is far advanced in developing its BlueRay technology.Toshiba has been into the arena with its incompatible product, HD DVD. Ifthey both adopt the same technology, they each may gross $200M from salesand if they adopt different technologies $10M each Retooling one's factory toand if they adopt different technologies, $10M each. Retooling one s factory tomake the competing technology would cost Toshiba $100M and Sony$250M.Set up a payoff matrix using net revenues for the above scenario What is theSet up a payoff matrix using net revenues for the above scenario. What is theequilibrium outcome?

ToshibaBlueRay HD DVD

ny

BlueRay 200 , 100 10 , 10

Son

HD DVD -240 , -90 -50 , 200 svj

Printed from

Dell may pip HP as No 1 PC makerDell may pip HP as No 1 PC makerTOI, Jul 28, 2010BANGALORE: Gartner has not officially announced the PC sales figures for India for the quarter endedJune, but speculation is rife that when it does, it would be Dell that would for the first time be No.1. It woulddisplace HP which has held that position uninterruptedly for over five yearsdisplace HP, which has held that position uninterruptedly for over five years.

For a company that once looked like it could only go down in the face of the challenge from Asian PCmakers like Acer, Lenovo, Asus and Toshiba, it's a remarkable comeback. The growth in India is likely tohave helped a great deal in Dell getting back its No.2 position globally last quarter (those figures are out), ap g g g p g y q ( g )position that was wrested from it by Acer in the third quarter of 2009.

So understandably, Michael Tatelman, the man in charge of the sales and marketing of Dell's consumerproducts, appeared pleased as Punch on his visit to Bangalore on Tuesday. He placed India among the top

f i k f D ll d ib d h ' h i b ildi "l li dtwo fastest growing markets for Dell and attributed the company's success here to its building "localizedcapabilities".

He particularly commended Dell India's channel strategy. Dell, which won its early successes by sellingcomputers directly to consumers took a very different approach when it started selling to retail customers incomputers directly to consumers, took a very different approach when it started selling to retail customers inIndia. It went with distributors and opened retail stores. "But we didn't have regional distributors who in turnhad sub-distributors, like other PC makers did. We went directly to all our distributors, and all of them in turnhad direct access to us and our products," Tatelman said. That strategy, he believes, helped build strongerrelationships and helped to gather better local market intelligence.relationships and helped to gather better local market intelligence.

"In the last few years, we have led industrial design, winning many of the awards in this category," he said.Colours have been one part of this, but there are also products like Adamo XPS — the thinnest laptop at9.99 mm.

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June, 26, 2013Ju e, 6, 0 3

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Oligopoly in Defence Production: 3- Big US Corporations

1. Northrop Grumman

2 B i2. Boeing

3 Lockheed Martin3. Lockheed Martin

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Ch09 Market Structure2 2012

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