PART 3 MICROECONOMICS OF PRODUCT MARKETS Prepared by Dr. Amy Peng Ryerson University © 2013 McGraw-Hill Ryerson Ltd.

 Game theory explains mutual interdependence and strategic behavior  Collusion is beneficial to participants  Reduced uncertainty  Increased profits  May block entry © 2013 McGraw-Hill Ryerson Ltd.Appendix 11.12

 A one-time game  A simultaneous game  A positive sum game  A firm’s dominant strategy © 2013 McGraw-Hill Ryerson Ltd. Appendix 11.13

 Nash Equilibrium  Outcome from which neither firm wants to deviate  Current strategy viewed as optimal  Stable and persistent outcome © 2013 McGraw-Hill Ryerson Ltd.Appendix 11.14

Dramco’s Price Strategy Chipco’s Price Strategy AB CD $11 $5 $20 $17 $20 $5 International National  2 competitors  2 price strategies  Each strategy has a payoff matrix  Independent actions stimulate a response © 2013 McGraw-Hill Ryerson Ltd. Appendix 11.15

 Credible Threats  A statement of coercion that is believable by the other firm  Can establish collusive agreements  A strong enforcer can prevent cheating  Can generate higher profits  May be countered with threat by rival  Empty Threats  A threat that is not believable by rival © 2013 McGraw-Hill Ryerson Ltd.Appendix 11.16

 Game that recurs  May cooperate and not compete strongly  Rival reciprocates  Examples: Pepsi and Coke, Walmart and Target, Boeing and Airbus © 2013 McGraw-Hill Ryerson Ltd.Appendix 11.17

ThirstQ’s Advertising Strategy AB CD $10 $8 $16 $12 $16 $8 Promo Budget Normal Budget 2Cool’s Advertising Strategy ThirstQ’s Advertising Strategy AB CD $11 $10 $14 $13 $15 $10 Promo Budget Normal Budget 2Cool’s Advertising Strategy © 2013 McGraw-Hill Ryerson Ltd.Appendix 11.18

 The firm that first moves:  May be better prepared  May preempt entry of rival  Rival must respond © 2013 McGraw-Hill Ryerson Ltd.Appendix 11.19

Big Box strategies Huge Box strategies AB CD -$5 $0 $12 $0 $12 $0 Build Don’t build © 2013 McGraw-Hill Ryerson Ltd.Appendix

 Positive-sum games, zero-sum games and negative sum games  Dominate strategy and Nash equilibrium  Reciprocity can improve outcomes for firms participating in repeated games.  Two possible Nash equilibriums can exist in sequential games with first-mover advantages © 2013 McGraw-Hill Ryerson Ltd. Appendix