Simultaneous games. Oligopoly. (Lecture 2) презентация

interaction
Perfect competition: many producers, price is given, no strategic interaction
Oligopoly: the industry is dominated by a small number of large firms. Intermediate case, between perfect competition and monopoly.
Smartphones industry
Oil producers
Accounting Big 4
Boeing and Airbus

innovation etc.) the oligopolist must consider the actions/reactions of its competitors.
Payoff interdependency: A producer’s payoff depends on what the other producers do.
Use of game theory.
Application of NE to oligopoly theory. Analysis of the decision of how much to produce (quantity).

total quantity produced in the industry, e.g:



e.g:

Costs: Suppose that the marginal cost is 0.28

high and maximize profit.

that P=MC, i.e. P=0.28. Producers make zero profit.

P = 1 − 0.001Q = 0.28, hence Q = 720,

Quantity is higher under perfect competition than under monopoly.

producers’ strategic decision is about how much to produce.
Two producers, Firm 1 and Firm 2 (oligopoly).
Produce the same good
Sell on the same market
One market price, which depends on the total output
No entry
Simultaneous game
Example: oil producing countries

1 and 2:

i=1,2 can choose qi = 180, 240 or 360.

There are 3x3=9 possible outcomes. For example, if firm 1 chooses q1=180, and firm 2 chooses q2=240, then:

how much to produce
Producers are not limited to just 3 levels of production.
Quantity is a continuous variable, not a discrete one.
We now assume that producers can produce any quantity.
How much to produce?
More units sold means more volume, but lower price.
Essential to take into account the other producer’s behavior.

functions.
To maximize profit, differentiate and set equal to zero:




Do the same for Firm 2:

Firm 1’s best response

Firm 2’s best response

the less Firm 1 chooses to produce.

the market
price, and the less Firm 2 chooses to produce.

is his best response to Firm 2’s equilibrium strategy which is also his best response to Firm 1’s equilibrium strategy.
Joint best response, and no incentive for producers to choose a different action.

not equilibrium?
Start from (0,360)

BR1

BR2

0

of market structure.

prices
Higher profitability
Empirical evidence shows that profitability is on average higher in highly concentrated industries.

YES

Both producers could maximize joint profit by jointly producing the monopolist output level: Q=360, i.e. 180 for each producer.

The monopolist profit (129.6) is then shared between the two producers (i.e. 64.8 for each, instead of 57.6 if they play the NE).

Cartel

million barrels a day, the group’s largest cut ever, in an effort to put a floor on falling oil prices.
…Mr. Khelil (OPEC’s president) said the group wanted to “eliminate” an overhang of oil inventories …and aimed to push prices up to $70 to $80 a barrel.
“We have…excessive stocks that could really lead to a collapse in prices,” Mr. Khelil said during a chaotic and confused news conference after the meeting.

(NY Times, December 17, 2008)

quantity. For instance, if Firm 1 sticks to the cartel quantity of 180, Firm 2’s best response is:




The cartel problem is a Prisoner’s dilemma situation: it is collectively rational to cooperate (“optimal” outcome), but it is individually rational to defect (NE).

whose members produce 70% of the global supply, will shut down in January after failing to control international prices. [...] Mr Silva also said the failure of member countries to comply with the cartel’s production levels was a reason for the closure.”

(BBC News, October 19, 2001)

unstable.
Q: How to explain the fact that some cartels are quite stable, unlike what is predicted in the Cournot model?
List of cartel violations in the European Union
http://ec.europa.eu/competition/cartels/cases/cases.html

how does it affect the outcome?


Equilibrium:

Increase of 17%

high output and low price, or low output and high price.
Strategic interactions yield a unique NE, with intermediate output level.
The cartel solution is more profitable but not stable.