Econ 200: Lecture 16 December 2, 2014 0. Learning Catalytics Session: 17839093 1. Game Theory and the Prisoner s Dilemma 2. Sequential Games and Entry Deterrence 3. Five Competitive Forces 4. Review of Practice Exam
Can Firms Escape the Prisoner s Dilemma? Domino s and Pizza Hut are deciding how to price a pizza: $12 or $10. Both firms offer to match their competitor's prices. Then if either firm cuts prices, the other has guaranteed to do so as well. Price-match guarantees aren t as good for consumers as they appear!
Other Methods for Avoiding Price Competition A price-match guarantee is an enforcement mechanism, making automatic the decision about whether to punish a competing firm for charging a low price. Another method is price leadership, a form of implicit collusion in which one firm in an oligopoly announces a price change and the other firms in the industry match the change.
Cartels: The Case of OPEC A cartel is a group of firms that collude by agreeing to restrict output to increase prices and profits. The most well-known cartel is OPEC, the Organization of the Petroleum Exporting Countries.
Analyzing the OPEC Cartel with Game Theory Saudi Arabia has a dominant strategy to cooperate and produce a low output. Nigeria has a dominant strategy not to cooperate and instead produce a high output. Should Saudi Arabia punish Nigeria?
Simultaneous vs. Sequential Games The game theory models we have analyzed so far have been simultaneous: the players have made their decisions at the same time. But some games are sequential in nature: one firm makes a decision, and the other makes its decision having observed the first firm s decision.
The Decision Tree for an Entry Game Apple can charge $1000 or $800 for its new laptop Dell decides whether or not to enter the market. Apple can deter Dell from entering the market by preemptively charging the low price.
The Decision Tree for a Bargaining Game Dell is can offer $20 or $30 per copy for TruImage s software. Then TruImage will accept or reject the offer. Dell should offer the low price, anticipating that TruImage will accept the offer.
Can TruImage Threaten Not to Accept the Offer? TruImage would like to threaten to reject an offer of $20. If Dell believed the threat, its best action would be to offer $30. But, this threat is not credible: Only the original outcome is a subgame-perfect equilibrium: a Nash equilibrium in which no player can improve their outcome by changing their decision at any decision node.
The Five Competitive Forces Model Michael Porter of Harvard Business School identifies five separate competitive forces that determine the overall level of competition in an industry: 1. Existing firms Example: Educational Testing Service administers the SAT ($51) and GRE ($150) tests. The SAT has competition from the ACT, helping keep its price low. The GRE has no similar competitor. 2. Threat from new entrants Example: In the previous section, Apple charged a low price to deter Dell from entering its market.
The Five Competitive Forces Model continued 3. Competition from substitutes Example: Printed encyclopedia sets used to cost well over $1000, but parents would buy them because there were no good substitutes. But the advent of cheap computer-based encyclopedias helped drive printed encyclopedia producers out of business. 4. Bargaining power of buyers Example: Large companies like Wal-Mart can threaten to buy goods from competitors, forcing suppliers to keep their prices low. 5. Bargaining power of suppliers Example: As a start-up, Microsoft couldn t force IBM to pay a high price for its operating system. But as Microsoft became the dominant player in operating systems, it could charge much more to computer manufacturers.
Refer to the payoff matrix below. The payoff matrix refers to the OPEC cartel with unequal members. Fill in the blanks. The equilibrium of this game will occur with Saudi Arabia producing a output and Nigeria producing a output. a. low; low b. high; high c. low; high d. high; low
Refer to the payoff matrix below. The payoff matrix refers to the OPEC cartel with unequal members. Fill in the blanks. The equilibrium of this game will occur with Saudi Arabia producing a output and Nigeria producing a output. c. low; high
Refer to the table below. The table is a decision tree for an entry game. In this case, Wal-Mart will: a. Build a large store. b. Build a small store. c. Be indifferent between building a large store or a small store. d. Whatever it takes to prevent Target from entering.
Refer to the table below. The table is a decision tree for an entry game. In this case, Wal-Mart will: b. Build a small store.
Exam 2 Practice Exam and Review Reminders: CLUE Session tonight at 8pm in MGH 241 Melissa s OH tomorrow 12-2 in SAV 339 Talk to your TA for their OH ALSO Please complete course evaluations! You should receive an email tomorrow!!
Topics Covered Chapter 10 Concept of utility and diminishing marginal benefits, marginal utility per dollar spent, deriving demand curves, social influences on decision making (not 10.4 behavioral economics) Chapter 11 Production functions, relationship between average and marginal, marginal and average products of labor, diminishing marginal product, marginal cost and average cost, short run costs (fixed and variable), long run costs
Topics Covered Chapter 12 Meaning of perfect competition, profit maximization, P=MR & P=MC, market determination of price, graphs of costs, MR and profit, long run profits and entry and exit, PC markets and efficiency Chapter 15 Monopoly markets and barriers to entry, MR<P, MR=MC as profit maximizing condition, DWL of monopoly Chapter 14 Oligopoly markets and barriers to entry, game theory, prisoner s dilemma and cooperative vs. non-cooperative outcomes, cartels and price collusion, sequential games