Lecture 5: Control Structures Computer Programming Control Structure Lecture No. 5.
Lecture 5
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Transcript of Lecture 5
Lecture 5
Oligopoly and Strategic Behavior
Oligopoly and Strategic Behavior
Managerial EconomicsECON 511
Professor Changqi Wu
Oligopoly Slide 2
Topics for Today
Oligopolistic competition
Prisoners’ dilemma and Nash equilibrium
Games with sequential moves
Oligopoly Slide 3
1. Oligopolistic Competition
What’s common in these industries? Newspaper publishing, internet browsers, credit
cards, property development
A few sellers in the market, each commands a substantial market share
High barriers to entry
Interdependence among the few
A firm must conjecture about its rival's action and reaction to its own action
Oligopoly Slide 4
Game Theory and Strategy
Game theory is a branch of mathematics that studies strategic interactions among rational players
Strategy is an action plan that leads to successful achievement of the goal
Game theory has been used in economics to analyze interactions between rivals.
An illustration: Prisoners’ dilemma
Oligopoly Slide 5
2. Prisoners’ Dilemma
There are two players
Each player wants to maximize her own payoff
Communication between two players is not allowed and both players move simultaneously
There are two possible strategies: cooperation (deny any wrongdoing) and noncooperation (confess to the police)
Oligopoly Slide 6
-5
Noncooperative
Cooperative
Cooperative
Player 1
Player 2
Prisoners’ Dilemma
noncoopetative
-1
-1
3
3
5
5
-5
Oligopoly Slide 7
Observations
Payoffs to each and every player depend on other player’s action
A dominant strategy produces a better payoff than alternative course of action
Both players end up worse-off at the equilibrium
Oligopoly Slide 8
Nash Equilibrium
A combination of strategies such that each and every player's strategy is an optimal response to the other player’s strategy
No one is willing to deviate unilaterally from a Nash equilibrium.
Some game may not have a pure strategy Nash equilibrium, but will have a randomized Nash equilibrium
Oligopoly Slide 9
1
Head
Tail
Tail
Player 1
Player 2
Matching Pennies
Head
1
-1
-1
1
-1
1
-1
Oligopoly Slide 10
1
Opera
Football
Football
Wife
Husband
Battle of Sexes
Opera
5
3
5
3
1
0
0
Oligopoly Slide 11
-5
Price war
No price war
No price war
Firm 1
Firm 2
Business Application
Price war
-1
-1
3
3
5
5
-5
Oligopoly Slide 12
How to Resolve the Prisoners’ Dilemma
Changing payoffs
Introducing a third player
Game with repeat playDetecting the cheater
Punishment of cheaters
Oligopoly Slide 13
Detecting Cheater
Difficulties in cheating detectionprice may fall because of changes in
demandmulti-dimensional interactionsit is harder to identify the cheater than to
detect cheating
Detection device: “lowest price guarantee”
Oligopoly Slide 14
Strategies to Punish the Cheater
Trigger strategy
Tit-for-tat strategyStep 1: Begin with cooperation
Step 2: Mimic rival's action
Business applications “meet-competition clauses"
Oligopoly Slide 15
The Tit-For-Tat Strategy
Player 1 Player 2
Round Action Action Payoff
C C1
2
3
4
5
6
7
C-5
NC-1
NC 5
NC -1
NC-1 NC -1
NC5 C -5
C3 C 3
C3 C 3..
.
...
.
...
3 3
Payoff
Oligopoly Slide 16
Advantages of the TFT Strategy
Simplicity and clarity
Niceness
Provocability
Forgiveness
Oligopoly Slide 17
When to Play the TFT Strategy?
The objective is to achieve a high payoff, NOT to win the contest
The game must repeat many times
Cheating detection is not a problem
Discount factor cannot be too small
There is a good chance that other players play TFT strategy.
Oligopoly Slide 18
3. Game with Sequential Moves
Players move in sequence in choosing their strategies
The second mover can observe the action of the first mover
The first mover must look forward and think backward: backward induction.
Slide 19Oligopoly
Battle for the Evening News
TVB
ATV
ATVATV
1, 1
3, 4
4, 3
2.5, 2.5
6:00
6:306:00
6:30
6:00
6:30
PayoffsTVB, ATV
Oligopoly Slide 20
First Mover Advantage
First-mover advantage: the gains from the right to move firstTo take the best position in the market
A firm can enjoy the first mover advantage when it moves is credible.
Oligopoly Slide 21
Credible Commitment
Can ATV do better by threatening TVB that it will broadcast news at 6:30 anyway?
An empty threat works against a player’s own interest
A player can make her threat credible by taking a costly and irreversible moveBurning the bridge
Oligopoly Slide 22
Empty Threat
Enter
No entry
Price cut
Output cut
2, 0
5, 5
15, 0
Entrant
Payoffs
Incumbent Entrant
Incumbent
Oligopoly Slide 23
Credible Commitment
Expandcapacity
Do nothing
Enter
No entry
Enter
No entry
Price cut
Output cut
Price cut
Output cut
-5, -1
-10, 2
10, 0
2, 0
5, 5
15, 0
IncumbentEntrant
Payoffs
Incumt Entrant.Incumbent
Oligopoly Slide 24
Key Learning Points
Nash equilibrium describes the combinations of strategies that nobody wants to deviate from.
Prisoners’ dilemma hurts the interests of both players. Some devices can be used to resolve such a dilemma.
Firms can gain advantages by acting as the first mover.
Oligopoly Slide 25
References
Thinking Strategically: The Competitive Edge in Business, Politics, and Everyday Life, by Avinash Dixit and Barry Nalebuff
Co-Opetition: By Barry Nalebuff and Adam Brandenburger.
Oligopoly Slide 26
Key Learning Points
Strategic interaction is an important element in business.
The Cambridge Zoo provides a taxonomy of business strategies.
One should take into account the nature of the investment in the first stage (tough or soft) and the nature of the strategic relationship between the rivals in the second stage (strategic substitute and strategic complement) when making investment decisions.