ECON 330 Lecture 11 Tuesday, October 30

We finished The competitive model The monopoly equilibrium, the DWL. The equilibrium of the dominant firm Price elasticity of demand, Consumer Surplus, etc.

What is coming next is Models of Oligopoly Cournot Bertrand Stackelberg NASH equilibrium, some game theory One time versus repeated interaction in oligopoly models.

Oligopoly markets: Competition among few

Oligopoly - Competition among the Few Oligopoly there are very few sellers of the good. The product may be differentiated (e.g. automobiles) or homogeneous (e.g. gasoline). Entry is restricted By legal restrictions (e.g. banking in most of the world) By a very large minimum efficient scale By strategic behavior.

How Oligopolists Compete In an oligopoly firms know that there are only a few large competitors; competitors take account of the effects of their actions on the overall market. To predict the outcome of such a market, we need to model the strategic interaction between the firms. We need some game theory or game theoretic ideas/concepts.

Game Theory: Setup List of players: all the players are specified in advance. List of actions: all the actions each player can take. Rules of play: who moves and when. Information structure: who knows what and when. Payoffs: the amount each player gets for every possible combination of the players’ actions.

Equilibrium? Demand = Supply The monopoly equilibrium.

Nash Equilibrium Named after John Nash - a Nobel Prize winner in Economics. The Nash Equilibrium of a game is a set of actions for all players that, when played simultaneously, have the property that no single player can improve his payoff by playing a different action, given the actions the others are playing.

Duopoly pricing game Let’s do an example!

Arc’teryx vs Mountain Hardwear Two firms, Firm A and Firm B, are competing in the market of (high end) outdoor and climbing equipment and clothes. This exercise will illustrate the strategic price competition between the two firms.

Arc'teryx is an outdoor clothing and sporting goods company founded in North Vancouver, British Columbia, Canada, in 1989. The name and logo of Arc'teryx refer to the Archaeopteryx, the earliest known bird.

Mountain Hardwear, founded in 1993, is a California-based company that manufactures outdoor clothing, backpacks, sleeping bags, tents, and gloves. Columbia Sportswear purchased Mountain Hardwear in 2003. The company is headquartered in Richmond, California.

Back to business… Your team will represent one of the companies. I will assign roles in a minute. There must be an even number of teams for this class game to work. There will be 4 to 5 rounds of 3 minutes each. You will get a table that lists your profits in each round. See the sample on next slide. Your competitor’s profits are unknown to you. Your profit table is your business secret. Do not show it to your competitor.

Goal: Maximize sum of your profits over the game. The top team A and top team B will get 3 bonus points.

Profit table example For illustration only; it will not be used in the actual game

Recording the results Each team (4 members) will record prices and profits using the Score Sheet. Shown on the next slide. Fill this sheet as the game progresses. Put your names and the names of your competitor on the Score Sheet. Turn in your Score Sheets at the end of the class.

In each round… Determine your price. Exchange prices with the opposing team when the instructor says so. Determine profits. Calculate your regret for that round. “Regret” is the difference between your actual profit and the maximum you could obtain if you knew your opponent’s actual price.

Score sheet : John Nash, Augustine Cournot, Bill Gates, Enrique Iglesias : B1

Example: Computing ‘regret’ Your are team A. Let’s say your price is 7, the opponent’s price is 6. Your regret is ….

Example: Computing ‘regret’ Your are team A. Let’s say your price is 7, the opponent’s price is 6. Your regret is 6. If you knew the opponent’s price were 6, you would have chosen a price of 9 or 10.

How to play the first round? The first 2 rounds are chaotic. You have no information about what the other team is going to do. Remember: The other team has a different profit table. Structure your problem into two stages Given a hypothetical price from my rival what is my best price in response? What is my best guess about the price the opposing team will choose?

Let’s start the game. Form teams of 4 people. Maximize sum of your profits over the game. The top team A and top team B will get 3 bonus points

In each round… Determine your price. Exchange prices with the opposing team when the instructor says so. Determine profits. Calculate your regret for that round. “Regret” is the difference between your actual profit and the maximum you could obtain if you knew your opponent’s actual price.

You can pick up your HWK#2 at the end of class.