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

2. 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

3. 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

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

5. 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

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

7. 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

8. 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

9. 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.

10. 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.

11. 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

12. 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

13. 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.

14. 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

15. 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.

16. 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

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