1. ECON 330 Lecture 11
Wednesday, October 30

2. The first 5 weeks
The competitive model, equilibrium, efficiency. The monopoly equilibrium, DWL, inefficiency The equilibrium of the dominant firm. Price elasticity of demand, Consumer Surplus, etc.

3. Announcements
I posted a large set of study questions on course webpage (The Assignments section) It includes all Exam #1 questions from last two years exams tat are related to the first 5 week. + answers (but first try to do the questions without help) Another big set of study questions (about oligopoly models) will be posted. Before the exam on Nov 13.

4. What is coming up next?

5. Oligopoly: Competition among the few

6. Oligopoly: Examples Automakers (Fiat, Ford, Renault, + imports)
Airlines (Pegasus, AtlasJet, THY)
Banking /financial services
Telecommunications (AVEA, Turkcell, Vodafone)
Supermarkets (Migros, UyumMarket)

7. Oligopoly, competition among few firms
Cournot’s legacy to economics:
showing economists how to use mathematics in a general way to develop economic theory, as opposed to using examples based on specific functional forms,
his clear and sophisticated treatment of market demand, monopoly, competitive markets, and above all, oligopoly.
For many years Cournot’s work was ignored.
By the time of his death in 1877, he was unaware of his influence on economists.
Antoine Augustin Cournot
(1801 –1877)

8. Oligopoly, competition among few firms
Cournot used mathematics for clarity but he couldn’t use game theory. It wasn’t invented yet. So his model of oligopoly was not very clear! A little bit of game theory is necessary The concept of NASH equilibrium

9. How oligopolists compete
In an oligopoly market
Firms know that there are only a few large competitors;
Each competitor knows that individual actions (of each competitor) will have an effect on the overall market outcome.
To think/speculate about (or predict) the equilibrium outcome in such a market, we need to model the strategic interaction.
To do that we need game theory or game theoretic ideas/concepts.

10. So what is this Game Theory then?

11. Game Theory: Setup List of players: List of actions:
who are the people/entities who make decisions (choose actions)?
List of actions:
what are the available actions for each of these players?
Rules: when do players choose actions?
choose at the same time only once,
choose all at the same time but at periodic intervals
choose one after the other with a specific order?
Information structure: who knows what?
Payoffs: the amount each player gets for every possible combination of the players’ actions. (profits, benefits, etc.)

12. Equilibrium?
Demand = Supply ?

13. Nash Equilibrium
John Nash (b. 1928) Winner of the Nobel Prize winner in Economics in The Nash Equilibrium of a game is a set of actions (one for each player) such that: when chosen simultaneously, no single player can improve her payoff by playing a different action, given that everybody else stick to their Nash equilibrium actions.

14. One interpretation is that…
a Nash equilibrium is a law that no one wants to break … (unilaterally, by themselves) … even in the absence of an effective police force. It is a code of behavior that no one wants to deviate from unilaterally (even without punishment). In that sense it is self-enforcing (stable). In that sense it seems like an equilibrium state of affairs.
From

15. This is very complicated…
Let’s do an example
No math. No big definitions.

16. Le Duopoly pricing game

17. 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.

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

19. 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 The company is headquartered in Richmond, California.

20. This exercise will illustrate the strategic price competition between the two firms.

21. Instructions (also printed on handouts to be distributed shortly)
Form a team with 3 members
Your team will represent one of the companies. I will assign roles in a minute.
We need to have an even number of teams.
You will get a table that lists your profits in each round.
See the sample on next slide.

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

23. Your competitor’s profits are unknown to you.
Your profit table is your business secret. Do not show it to your competitor.

24. INSTRUCTIONS

25. In each round… Determine your price.
Exchange prices with the opposing team when the instructor says so. When the bell rings.
Determine profits.

26. There will be 4 to 5 rounds of 3 minutes each
There will be 4 to 5 rounds of 3 minutes each. Goal: Maximize sum of profits. The top team A and top team B will get a special award of 30 lira worth of Sodexho lunch tickets, courtesy of Koç Uni CASE Dean’s Office).

27. Recording the results
Each team will record prices and profits using the Score Sheet..

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

29. Recording the results 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.

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

31. You also need to…
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.

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

33. You are firm A. Your price is 6, opponent’s price is 7

34. Example: Computing ‘regret’
If you knew the opponent’s price were 6, you would have chosen a price of 9 or 10. Your regret is 14.

35. How to play the first round?
The first round(s) can be chaotic.
You have no information what the other team is going to do.
Remember: The other team has a different profit table.
It may (or may not) help to 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?

36. Once again…
The rules are…

37. 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.
Wait for the instructor’s sign to GO to the next round.
Remember: There will be 4 to 5 rounds of 3 minutes each. DO not go to the next round before I show the “GO to the next round” sign.

38. Here we go… ROUND 1… choose your price.
Don’t let the other team learn your price until say so!!

39. Please exchange prices with the other team

40. We will now start round 2

41. Please exchange prices with the other team
ROUND 2

42. BE READY
We will now start round 3

43. Please exchange prices with the other team
ROUND 3

44. End of the lecture