1. 1 1 Deep Thought BA 210 Lesson II.7 Repeated Dilemmas The face of a child can say it all, especially the mouth part of the face. ~ Jack Handey. (Translation: Today’s lesson considers whether people can cooperate or collude when they can communicate but not punish.)

2. 2 2 BA 210 Lesson II.7 Repeated DilemmasOverviewOverview

3. 3 3 Lesson Overview BA 210 Lesson II.7 Repeated Dilemmas Lesson II.6 Prisoner Dilemmas Lesson II.7 Repeated Dilemmas Example 1: Bonuses and Tipping Example 2: Stackelberg Duopoly Example 3: Buying Online Example 4: Solving a Dilemma with Pre-Commitment Example 5: Solving a Dilemma with Immediate Punishment Summary Review Questions

4. 4 4 BA 210 Lesson II.7 Repeated Dilemmas Example 1: Bonuses and Tipping

5. 5 5 BA 210 Lesson II.7 Repeated Dilemmas Question: Consider ways for Professor Burke To Insure Promptness (TIP) when out to lunch at Islands Fine Burgers and Drinks. Suppose Maria, his usual server, chooses whether to offer Prompt service or Slow Service, and after being served Prof. B chooses whether to tip $2 or 0. If Maria chooses Prompt, she looses $1 worth of energy because of the extra effort but Prof. B gains $3 worth of time. Should Maria be Prompt? Should Prof. B Tip? Are there mutual gains from cooperation? Can Prof. B trust Maria to cooperate? Can Maria trust Prof. B to cooperate? Example 1: Bonuses and Tipping

6. 6 6 BA 210 Lesson II.7 Repeated Dilemmas Answer: To begin, fill out the normal form for this game of sequential moves. On the one hand, if Prof. B chooses to Tip $2 (first row), then Prof. B and Maria gain 1=3-2 and 1=2-1 if Maria chooses Prompt; and gain -2=0-2 and 2=2-0 if Maria chooses Slow. On the other hand, if Prof. B chooses to No Tip (second row), then Prof. B and Maria gain 3=3-0 and -1=0-1 if Maria chooses Prompt; and gain 0=0-0 and 0=0-0 if chooses Slow. Example 1: Bonuses and Tipping

7. 7 7 BA 210 Lesson II.7 Repeated Dilemmas Prof. B should choose No Tip since he moves second and No Tip is the dominate strategy. Maria should then choose Slow as the best response to Prof. B choosing No Tip. {No Tip, Slow} is thus the rollback solution. There are mutual gains if both Prof. B and Maria cooperate with Prof. B choosing Tip $2 and Maria X choosing Prompt. But Maria cannot trust Prof. B to cooperate because Prof. B cooperating and choosing Tip $2 is not a best response to Maria cooperating and choosing Prompt. The question of whether Prof. B can trust Maria to cooperate is irrelevant because Maria chooses before Prof. B. Example 1: Bonuses and Tipping

8. 8 8 BA 210 Lesson II.7 Repeated Dilemmas Comment: Since No Tip is the dominate strategy for Prof. B and Slow is the dominate strategy for Maria, the solution to the game remains {No Tip, Slow} regardless of whether Maria continues to serve first, or whether Prof. B tips first (like he does at the Bellagio Gourmet Buffet in Vegas), or whether they (somehow) serve and tip simultaneously. Example 1: Bonuses and Tipping

9. 9 9 BA 210 Lesson II.7 Repeated Dilemmas Example 2: Stackelberg Duopoly

10. 10 BA 210 Lesson II.7 Repeated Dilemmas Comment: A Prisoners’ Dilemma demonstrates why people might not cooperate or collude even if it is in their best interests to do so. While the strongest form of a prisoners’ dilemma is when non-cooperation is a dominate strategy for each person (as in Example 1), there are weaker forms, like when non- cooperation is the unique dominance solution, or when non- cooperation is the unique rollback solution. Example 2: Example 2: Stackelberg Duopoly

11. 11 BA 210 Lesson II.7 Repeated Dilemmas Question: You are a manager of Marvel Comics and you compete directly with DC Comics selling comic books. Consumers find the two products to be indistinguishable. The inverse market demand for comic books is P = 5-Q (in dollars). Your marginal costs of production are $1, and the marginal costs of DC Comics are $1. Suppose you choose your output of comic books before DC Comics, and DC Comics knows your output before they decide their own output. Suppose Marvel Comics and DC Comics each consider producing quantities 1.0 or 1.1 or 1.8 or 2.0 (in thousands). How many comic books should you produce? Are there mutual gains from cooperation? Can Marvel Comics trust DC Comics to cooperate? Can DC Comics trust Marvel Comics to cooperate? Example 2: Example 2: Stackelberg Duopoly

12. 12 BA 210 Lesson II.7 Repeated Dilemmas Answer: To begin, fill out the normal form for this game of sequential moves. For example, at Marvel quantity 1.8 and DC quantity 2.0, price = 5.0-3.8 = 1.2, so Marvel profits = (1.2- 1.0)1.8 = 0.36 and DC profits = (1.2-1.0)2.0 = 0.4 Example 2: Example 2: Stackelberg Duopoly

13. 13 BA 210 Lesson II.7 Repeated Dilemmas Marvel is the leader in a Stackelberg Duopoly Game. Start from the end of the game: Given Marvel’s choice 1.0, DC’s best response is 1.8; given Marvel’s choice 1.1, DC’s best response is either 1.1 or 1.8; given Marvel’s choice 1.8, DC’s best response is 1.1; and given Marvel’s choice 2.0, DC’s best response is 1.0. Of those four choices, the best payoffs for Marvel are for choosing 2.0 and generating payoff 2. Example 2: Example 2: Stackelberg Duopoly

14. 14 BA 210 Lesson II.7 Repeated Dilemmas There are mutual gains if both Marvel and DC cooperate and Marvel produces either 1.1 or 1.8 and DC produces 1.0. But Marvel cannot trust DC to cooperate because DC cooperating and choosing 1.0 is not a best response to Marvel cooperating and choosing either 1.1 or 1.8. The question of whether DC can trust Marvel to cooperate is irrelevant because Marvel chooses before DC. Example 2: Example 2: Stackelberg Duopoly

15. 15 BA 210 Lesson II.7 Repeated Dilemmas Example 3: Buying Online

16. 16 BA 210 Lesson II.7 Repeated Dilemmas Comment: Buyers and Sellers trading over the internet face a prisoners’ dilemma because they risk sending money or goods and not getting what was agreed upon. One attempted solution that reduces their exposure to risk is to trade a little at a time. Does trading a little at a time solve that prisoners’ dilemma? Example 3: Buying Online

17. 17 BA 210 Lesson II.7 Repeated Dilemmas Question: Suppose Charlie values 4 disposable DVDs (Gladiator, …) at $3 each, suppose it costs Blockbuster $1 to provide each DVD, and suppose Blockbuster sells DVDs for $2 each. Should Blockbuster send the first DVD to Charlie? If the first DVD is sent, Charlie (C) faces a decision: steal the DVD and terminate the relationship; or, send $2 for the first DVD.If the first DVD is sent, Charlie (C) faces a decision: steal the DVD and terminate the relationship; or, send $2 for the first DVD. If the first $2 is sent, Blockbuster (B) faces a decision: take the $2 and terminate the relationship; or, send the second DVD to C.If the first $2 is sent, Blockbuster (B) faces a decision: take the $2 and terminate the relationship; or, send the second DVD to C. If the second DVD is sent, C faces a decision: steal the DVD and terminate the relationship; or, send $2 for the second DVD.If the second DVD is sent, C faces a decision: steal the DVD and terminate the relationship; or, send $2 for the second DVD. If the second $2 is sent, B faces a decision: take the $2 and terminate the relationship; or, send the third DVD to C.If the second $2 is sent, B faces a decision: take the $2 and terminate the relationship; or, send the third DVD to C. And so on.And so on. If the fourth DVD is sent, C faces a decision: steal the DVD and terminate the relationship; or, send $2 for the fourth DVD.If the fourth DVD is sent, C faces a decision: steal the DVD and terminate the relationship; or, send $2 for the fourth DVD. Are there mutual gains from cooperation? Can each player trust the other to cooperate? Example 3: Buying Online

18. 18 BA 210 Lesson II.7 Repeated Dilemmas Answer: Here is a Game Tree where payoffs list the gains from trade, with payoffs to the first player to act (Blockbuster) listed first. (This game is sometimes called the Centipede Game since the game tree looks like a Centipede.) Example 3: Buying Online

19. 19 BA 210 Lesson II.7 Repeated Dilemmas Starting at the end of the game, Blockbuster predicts rational responses to alternative strategies. Charlie chooses Do Not Pay for the fourth DVD if it is sent. Example 3: Buying Online

20. 20 BA 210 Lesson II.7 Repeated Dilemmas Rolling back one period from the end of game, Charlie predicts rational responses to alternative strategies. Blockbuster chooses Do Not Send the fourth DVD since Blockbuster predicts Charlie will not pay for that fourth DVD. Example 3: Buying Online

21. 21 BA 210 Lesson II.7 Repeated Dilemmas Rolling back one more period from the end of game, Blockbuster predicts rational responses to alternative strategies. Charlie chooses Do Not Pay for the third DVD if it is sent since Charlie predicts Blockbuster will not send the fourth DVD. Example 3: Buying Online

22. 22 BA 210 Lesson II.7 Repeated Dilemmas Rolling back one more period from the end of game, Charlie predicts rational responses to alternative strategies. Blockbuster chooses Do Not Send the third DVD since Blockbuster predicts Charlie will not pay for that third DVD. Example 3: Buying Online

23. 23 BA 210 Lesson II.7 Repeated Dilemmas Rolling back one more period from the end of game, Blockbuster predicts rational responses to alternative strategies. Charlie chooses Do Not Pay for the second DVD if it is sent since Charlie predicts Blockbuster will not send the third DVD. Example 3: Buying Online

24. 24 BA 210 Lesson II.7 Repeated Dilemmas Rolling back one more period from the end of game, Charlie predicts rational responses to alternative strategies. Blockbuster chooses Do Not Send the second DVD since Blockbuster predicts Charlie will not pay for that second DVD. Example 3: Buying Online

25. 25 BA 210 Lesson II.7 Repeated Dilemmas Rolling back one more period from the end of game, Blockbuster predicts rational responses to alternative strategies. Charlie chooses Do Not Pay for the first DVD if it is sent since Charlie predicts Blockbuster will not send the second DVD. Example 3: Buying Online

26. 26 BA 210 Lesson II.7 Repeated Dilemmas Rolling back to the beginning of game, Blockbuster chooses Do Not Send the first DVD since Blockbuster predicts Charlie will not pay for that first DVD. Example 3: Buying Online

27. 27 BA 210 Lesson II.7 Repeated Dilemmas Centipede Game: Should Blockbuster send the first DVD to Charlie? In the rollback solution, Charlie will steal the first DVD and terminate the relationship. So Blockbuster should not send the first DVD. There are mutual gains if, say, Charlie pays for every DVD and Blockbuster sends every DVD. But Blockbuster cannot trust Charlie to cooperate because Charlie paying for every DVD, including the last DVD, is not a best response to Blockbuster sending every DVD. Example 3: Buying Online

28. 28 BA 210 Lesson II.7 Repeated Dilemmas Example 4: Solving a Dilemma with Pre-Commitment

29. 29 BA 210 Lesson II.7 Repeated Dilemmas Question: Consider ways Pepperdine University can get better Teaching or Research from its faculty. Suppose Pepperdine chooses whether to spend $1,000 to send Prof. X to a conference in Las Vegas over Christmas break, and simultaneously Prof. X chooses whether to spend $2,000 of effort to Work over Christmas break. If Pepperdine chooses the conference, then both Pepperdine and Prof. X gain $3,000 of benefit if Prof. X chooses to work (since he is working more effectively) but Prof. X alone gains $3,000 if Prof. X chooses to not work (since he is on a free holiday). Should Pepperdine send Prof. X to the conference? Are there mutual gains from cooperation? Can Pepperdine trust Prof. X to cooperate? Can Prof. X trust Pepperdine to cooperate? Can the two cooperate by having Pepperdine pre-commit to its choice before Prof. X chooses? Or by having Prof. X pre- commit (say, by agreeing to present his results after Christmas break)? Example 4: Solving a Dilemma with Pre-Commitment

30. 30 BA 210 Lesson II.7 Repeated Dilemmas Answer: To begin, fill out the normal form for this game of simultaneous moves. On the one hand, if Pepperdine chooses to send Prof. X to the conference (first row), then both Pepperdine and Prof. X gain $3,000 of benefit if Prof. X chooses to work, resulting in net payoffs of $3,000-$1,000 = 2 (thousand) to Pepperdine and $3,000-$2,000 = 1 (thousand) to Prof. X, but Prof. X alone gains $3,000 if Prof. X chooses to not work, resulting in net payoffs of $0-$1,000 = -1 (thousand) to Pepperdine and $3,000 = 3 (thousand) to Prof. X. On the other hand, if Pepperdine chooses to send Prof. X (second row), then Pepperdine has no gains or costs, and Prof. X has no gains but $2,000 cost if he chooses Work. Example 5: Solving a Dilemma with Pre-Commitment

31. 31 BA 210 Lesson II.7 Repeated Dilemmas Prof. X should choose No Work since it is the dominate strategy. Pepperdine should then choose No Conference as the best response to Prof. X choosing No Work. {No Conference, No Work} is thus the dominance solution. There are mutual gains if both Pepperdine and Prof. X cooperate with Pepperdine choosing Conference and Prof. X choosing Work. But Pepperdine cannot trust Prof. X to cooperate because Prof. X cooperating and choosing Work is not a best response to Pepperdine cooperating and choosing Conference. However, Prof. X can trust Pepperdine to cooperate because Pepperdine cooperating and choosing conference is a best response to Prof. X cooperating and choosing work. Example 4: Solving a Dilemma with Pre-Commitment

32. 32 BA 210 Lesson II.7 Repeated Dilemmas Can the two cooperate by having Pepperdine pre-commit to its choice before Prof. X chooses? If Pepperdine pre-commits to Conference, then the two do not both cooperate since Prof. X cooperating and choosing Work is not a best response to Pepperdine cooperating and choosing Conference. Can the two cooperate by having Prof. X pre-commit to its choice before Pepperdine chooses? If Prof. X pre-commits to Work, then the two do both cooperate since Pepperdine cooperating and choosing Conference is a best response to Prof. X cooperating and choosing Work. Example 4: Solving a Dilemma with Pre-Commitment

33. 33 BA 210 Lesson II.7 Repeated Dilemmas Example 5: Solving a Dilemma with Immediate Punishment

34. 34 BA 210 Lesson II.7 Repeated Dilemmas Question: Sam’s Club and Costco both sell emergency food supplies in a weather-proof bucket that provides 275 delicious easy-to-prepare meals, including potato soup and corn chowder. The unit cost to both retailers is $75. The retailers compete on price: the low-price retailer gets all the market and they split the market if they have equal prices. Suppose they consider prices $85 and $95, and suppose market demands at those prices are 100 and 80. What price should Costco choose in this Price Competition Game? Are there mutual gains from cooperation? Can Costco trust Sam’s to cooperate? Can Sam’s trust Costco to cooperate? Reconsider your answers if there is a third strategy of price matching --- charging $95 but matching a competitors $85 price. Example 5: Solving a Dilemma with Immediate Punishment

35. 35 BA 210 Lesson II.7 Repeated Dilemmas Answer: To begin, fill out the normal form for this game of simultaneous moves. For example, at Sam's Club price $95 and Costco price $85, Costco gets the entire market demand of 100. Hence, Sam's makes $0 and Costco makes $(85-75)x100 = $1,000. Example 5: Solving a Dilemma with Immediate Punishment

36. 36 BA 210 Lesson II.7 Repeated Dilemmas Each player should choose $85 since it is the dominate strategy for each player: $85 it gives better payoffs for that player compared with $95, no matter whether the other player chooses $85 or $95. There are mutual gains if both Sam’s and Costco cooperate and charge $95. But Costco cannot trust Sam’s to cooperate because Sam’s cooperating and choosing $95 is not a best response to Costco cooperating and choosing $95. Likewise, Sam’s cannot trust Costco to cooperate because Costco cooperating and choosing $95 is not a best response to Sam’s cooperating and choosing $95. Example 5: Solving a Dilemma with Immediate Punishment

37. 37 BA 210 Lesson II.7 Repeated Dilemmas Reconsider those answers if there is a third strategy of price matching --- charging $95 but matching a competitors $85 price. To begin, fill out the normal form for this game of simultaneous moves. For example, at Sam's Club Match and Costco price $85, profits are the same as at Sam's Club price $85 and Costco price $85. And at Sam's Club Match and Costco price $95, profits are the same as at Sam's Club price $95 and Costco price $95. Example 5: Solving a Dilemma with Immediate Punishment

38. 38 BA 210 Lesson II.7 Repeated Dilemmas There are no dominate or weakly-dominate strategies in the original game, but $95 is weakly-dominated by Match for each player. After $95 is eliminated for each player, Match is the weakly-dominate strategy for each player, resulting in Payoffs of 800 for each player. There are no mutual gains if both Sam’s and Costco select alternative strategies. Example 5: Solving a Dilemma with Immediate Punishment

39. 39 BA 210 Lesson II.7 Repeated Dilemmas Comment: The original game without price matching was a prisoners’ dilemma, with a dominance solution of low prices that was worse for both players than a cooperative solution of high prices. The Match strategy solved the dilemma by immediately punishing a player that did not cooperate. The punishment against the non-cooperative player charging low prices was for the cooperative player to also charge low prices. And since that punishment was immediate, there was no period of time that the non-cooperative player benefited from his charging low prices. Example 5: Solving a Dilemma with Immediate Punishment

40. 40 Review Questions BA 210 Lesson II.7 Repeated Dilemmas Review Questions  You should try to answer some of the questions above before the next class.  You will not turn in your answers, but students may request to discuss their answers to begin the next class.  Your upcoming Exam 1 and cumulative Final Exam will contain some similar questions, so you should eventually consider every review question before taking your exams.

41. 41 End of Lesson II.7 BA 210 Lesson II.7 Repeated Dilemmas BA 210 Introduction to Microeconomics