Strategic Decision Making in Oligopoly Markets Chapter 13 Strategic Decision Making in Oligopoly Markets

Oligopoly Markets Interdependence of firms’ profits Distinguishing feature of oligopoly Arises when number of firms in market is small enough that every firms’ price & output decisions affect demand & marginal revenue conditions of every other firm in market

Strategic Decisions Strategic behavior Game theory Actions taken by firms to plan for & react to competition from rival firms Game theory Useful guidelines on behavior for strategic situations involving interdependence

Simultaneous Decisions Occur when managers must make individual decisions without knowing their rivals’ decisions

Dominant Strategies Always provide best outcome no matter what decisions rivals make When one exists, the rational decision maker always follows its dominant strategy Predict rivals will follow their dominant strategies, if they exist Dominant strategy equilibrium Exists when when all decision makers have dominant strategies

Prisoners’ Dilemma All rivals have dominant strategies In dominant strategy equilibrium, all are worse off than if they had cooperated in making their decisions

Prisoners’ Dilemma (Table 13.1) Bill Don’t confess Confess Jane A 2 years, 2 years B 12 years, 1 year C 1 year, 12 years D 6 years, 6 years B J J B

Dominated Strategies Never the best strategy, so never would be chosen & should be eliminated Successive elimination of dominated strategies should continue until none remain Search for dominant strategies first, then dominated strategies When neither form of strategic dominance exists, employ a different concept for making simultaneous decisions

Successive Elimination of Dominated Strategies (Table 13.3) Palace’s price High ($10) Medium ($8) Low ($6) Castle’s price High ($10) A $1,000, $1,000 B $900, $1,100 C $500, $1,200 Medium ($8) D $1,100, $400 E $800, $800 F $450, $500 Low ($6) G $1,200, $300 H $500, $350 I $400, $400 C C P P C P Payoffs in dollars of profit per week.

Successive Elimination of Dominated Strategies (Table 13.3) Reduced Payoff Table Unique Solution Palace’s price Medium ($8) Low ($6) Castle’s price High ($10) B $900, $1,100 C $500, $1,200 Low ($6) H $500, $350 I $400, $400 C C P P Payoffs in dollars of profit per week.

Making Mutually Best Decisions For all firms in an oligopoly to be predicting correctly each others’ decisions: All firms must be choosing individually best actions given the predicted actions of their rivals, which they can then believe are correctly predicted Strategically smart managers look for mutually best decisions

Nash Equilibrium Set of actions or decisions for which all managers are choosing their best actions given the actions they expect their rivals to choose Strategic stability No single firm can unilaterally make a different decision & do better

Super Bowl Advertising: A Unique Nash Equilibrium (Table 13.4) Pepsi’s budget Low Medium High Coke’s budget A $60, $45 B $57.5, $50 C $45, $35 D $50, $35 E $65, $30 F $30, $25 G $45, $10 H $60, $20 I $50, $40 C P P C C P Payoffs in millions of dollars of semiannual profit.

Nash Equilibrium When a unique Nash equilibrium set of decisions exists Rivals can be expected to make the decisions leading to the Nash equilibrium With multiple Nash equilibria, no way to predict the likely outcome All dominant strategy equilibria are also Nash equilibria Nash equilibria can occur without dominant or dominated strategies

Figure 3 Jack and Jill’s Oligopoly Game Jack’s Decision High Production: 40 Gal. Low Production: 30 gal. Jack gets $1,600 profit Jill gets $1,600 profit Jack gets $1,500 profit Jill gets $2,000 profit High Production 40 gal. Jill’s Decision Jack gets $2,000 profit Jill gets $1,500 profit Jack gets $1,800 profit Jill gets $1,800 profit Low Production 30 gal.

Figure 4 An Arms-Race Game Decision of the United States (U.S.) Arm Disarm U.S. at risk USSR at risk U.S. at risk and weak USSR safe and powerful Arm Decision of the Soviet Union U.S. safe and powerful USSR at risk and weak U.S. safe USSR safe (USSR) Disarm

Homework Read chapter 13 pages 490 – 505 Do tech probs 1, 2, 3, 4, 6