1. BEC 30325: MANAGERIAL ECONOMICS
Session 11
Market Structures Part III
Dr. Sumudu Perera

2. Monopolistic Competition
Many sellers of differentiated (similar but not identical) products
Limited monopoly power
Downward-sloping demand curve
Increase in market share by competitors causes decrease in demand for the firm’s product

3. Monopolistic Competition Short-Run Equilibrium

4. Monopolistic Competition Long-Run Equilibrium
Profit = 0

5. Monopolistic Competition Long-Run Equilibrium
Cost with selling expenses
Cost without selling expenses

6. BEC 30325: MANAGERIAL ECONOMICS
Session 11
Game Theory and Strategic Behavior
Dr. Sumudu Perera

7. Session Outline Strategic Behavior Prisoners’ Dilemma
Extensions of Game Theory
Dr.Sumudu Perera
19/11/201819/11/2018

8. Strategic Behavior
Decisions that take into account the predicted reactions of rival firms
Interdependence of outcomes
Game Theory
Players
Strategies
Payoff matrix

9. Strategic Behavior Types of Games Nash Equilibrium Zero-sum games
Nonzero-sum games
Nash Equilibrium
Each player chooses a strategy that is optimal given the strategy of the other player
A strategy is dominant if it is optimal regardless of what the other player does

10. Advertising Example 1

11. Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses to advertise?

12. Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses to advertise?
If Firm A chooses to advertise, the payoff is 4. Otherwise, the payoff is 2. The optimal strategy is to advertise.

13. Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses not to advertise?

14. Advertising Example 1
What is the optimal strategy for Firm A if Firm B chooses not to advertise?
If Firm A chooses to advertise, the payoff is 5. Otherwise, the payoff is 3. Again, the optimal strategy is to advertise.

15. Advertising Example 1
Regardless of what Firm B decides to do, the optimal strategy for Firm A is to advertise. The dominant strategy for Firm A is to advertise.

16. Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses to advertise?

17. Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses to advertise?
If Firm B chooses to advertise, the payoff is 3. Otherwise, the payoff is 1. The optimal strategy is to advertise.

18. Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses not to advertise?

19. Advertising Example 1
What is the optimal strategy for Firm B if Firm A chooses not to advertise?
If Firm B chooses to advertise, the payoff is 5. Otherwise, the payoff is 2. Again, the optimal strategy is to advertise.

20. Advertising Example 1
Regardless of what Firm A decides to do, the optimal strategy for Firm B is to advertise. The dominant strategy for Firm B is to advertise.

21. Advertising Example 1
The dominant strategy for Firm A is to advertise and the dominant strategy for Firm B is to advertise. The Nash equilibrium is for both firms to advertise.

22. Advertising Example 2

23. Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses to advertise?

24. Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses to advertise?
If Firm A chooses to advertise, the payoff is 4. Otherwise, the payoff is 2. The optimal strategy is to advertise.

25. Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses not to advertise?

26. Advertising Example 2
What is the optimal strategy for Firm A if Firm B chooses not to advertise?
If Firm A chooses to advertise, the payoff is 5. Otherwise, the payoff is 6. In this case, the optimal strategy is not to advertise.

27. Advertising Example 2
The optimal strategy for Firm A depends on which strategy is chosen by Firms B. Firm A does not have a dominant strategy.

28. Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses to advertise?

29. Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses to advertise?
If Firm B chooses to advertise, the payoff is 3. Otherwise, the payoff is 1. The optimal strategy is to advertise.

30. Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses not to advertise?

31. Advertising Example 2
What is the optimal strategy for Firm B if Firm A chooses not to advertise?
If Firm B chooses to advertise, the payoff is 5. Otherwise, the payoff is 2. Again, the optimal strategy is to advertise.

32. Advertising Example 2
Regardless of what Firm A decides to do, the optimal strategy for Firm B is to advertise. The dominant strategy for Firm B is to advertise.

33. Advertising Example 2
The dominant strategy for Firm B is to advertise. If Firm B chooses to advertise, then the optimal strategy for Firm A is to advertise. The Nash equilibrium is for both firms to advertise.

34. Prisoners’ Dilemma
Two suspects are arrested for armed robbery. They are immediately separated. If convicted, they will get a term of 10 years in prison. However, the evidence is not sufficient to convict them of more than the crime of possessing stolen goods, which carries a sentence of only 1 year.
The suspects are told the following: If you confess and your accomplice does not, you will go free. If you do not confess and your accomplice does, you will get 10 years in prison. If you both confess, you will both get 5 years in prison.

35. Payoff Matrix (negative values)
Prisoners’ Dilemma
Payoff Matrix (negative values)

36. Dominant Strategy Both Individuals Confess
Prisoners’ Dilemma
Dominant Strategy Both Individuals Confess
(Nash Equilibrium)

37. Application: Price Competition
Prisoners’ Dilemma
Application: Price Competition

38. Application: Price Competition Dominant Strategy: Low Price
Prisoners’ Dilemma
Application: Price Competition Dominant Strategy: Low Price

39. Application: Nonprice Competition
Prisoners’ Dilemma
Application: Nonprice Competition

40. Application: Nonprice Competition Dominant Strategy: Advertise
Prisoners’ Dilemma
Application: Nonprice Competition Dominant Strategy: Advertise

41. Application: Cartel Cheating
Prisoners’ Dilemma
Application: Cartel Cheating

42. Application: Cartel Cheating Dominant Strategy: Cheat
Prisoners’ Dilemma
Application: Cartel Cheating Dominant Strategy: Cheat

43. Extensions of Game Theory
Repeated Games
Many consecutive moves and countermoves by each player
Tit-For-Tat Strategy
Do to your opponent what your opponent has just done to you

44. Extensions of Game Theory
Tit-For-Tat Strategy
Stable set of players
Small number of players
Easy detection of cheating
Stable demand and cost conditions
Game repeated a large and uncertain number of times

45. Extensions of Game Theory
Threat Strategies
Credibility
Reputation
Commitment
Example: Entry deterrence