Managerial Economics eighth edition Thomas Maurice Chapter 13

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Managerial Economics eighth edition Thomas Maurice Chapter 13 Strategic Decision Making in Oligopoly Markets

Managerial Economics eighth edition Thomas Maurice Chapter 13 Strategic Decision Making in Oligopoly Markets Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

2 Managerial Economics Oligopoly Markets • Interdependence of firms’ profits • Distinguishing feature of

2 Managerial Economics 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 2 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

3 Managerial Economics Strategic Decisions • Strategic behavior • Actions taken by firms to

3 Managerial Economics Strategic Decisions • Strategic behavior • Actions taken by firms to plan for & react to competition from rival firms • Game theory • Useful guidelines on behavior for strategic situations involving interdependence 3 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

4 Managerial Economics Simultaneous Decisions • Occur when managers must make individual decisions without

4 Managerial Economics Simultaneous Decisions • Occur when managers must make individual decisions without knowing their rivals’ decisions 4 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

5 Managerial Economics Dominant Strategies • Always provide best outcome no matter what decisions

5 Managerial Economics 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 all decision makers have dominant strategies 5 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

6 Managerial Economics Prisoners’ Dilemma • All rivals have dominant strategies • In dominant

6 Managerial Economics Prisoners’ Dilemma • All rivals have dominant strategies • In dominant strategy equilibrium, all are worse off than if they had cooperated in making their decisions 6 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

7 Managerial Economics Prisoners’ Dilemma (Table 13. 1) Bill Don’t confess Don’t A confes

7 Managerial Economics Prisoners’ Dilemma (Table 13. 1) Bill Don’t confess Don’t A confes 2 years, 2 s years Jan e C Confes 1 year, 12 s years 7 Mc. Graw-Hill/Irwin Confess B B 12 years, 1 year J D JB 6 years, 6 years Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

8 Managerial Economics Dominated Strategies • Never the best strategy, so never would be

8 Managerial Economics 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 8 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

9 Managerial Economics Successive Elimination of Dominated Strategies (Table 13. 3) Palace’s price High

9 Managerial Economics Successive Elimination of Dominated Strategies (Table 13. 3) Palace’s price High ($10) Castle’ s price Medium ($8) Low ($6) A $1, 000, $1, 000 C B $900, $1, 100 C P C $500, $1, 200 D $1, 100, $400 E P $800, $800 F $450, $500 C G $1, 200, $300 H $500, $350 I P $400, $400 Payoffs in dollars of profit per week. 9 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

10 Managerial Economics Successive Elimination of Dominated Strategies (Table 13. 3) Reduced Payoff Table

10 Managerial Economics Successive Elimination of Dominated Strategies (Table 13. 3) Reduced Payoff Table Palace’s price Medium ($8) Castle’s price High ($10) Low ($6) Unique Solution Low ($6) C B $900, $1, 100 C CP $500, $1, 200 H $500, $350 I P $400, $400 Payoffs in dollars of profit per week. 10 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

11 Managerial Economics Making Mutually Best Decisions • For all firms in an oligopoly

11 Managerial Economics 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 11 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

12 Managerial Economics Nash Equilibrium • Set of actions or decisions for which all

12 Managerial Economics 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 12 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

13 Managerial Economics Super Bowl Advertising: A Unique Nash Equilibrium (Table 13. 4) Pepsi’s

13 Managerial Economics Super Bowl Advertising: A Unique Nash Equilibrium (Table 13. 4) Pepsi’s budget Low C A D Medium P C C F $45, $35 $65, $30 H $45, $10 High P $57. 5, $50 E $50, $35 G High B $60, $45 Low Coke’s budget Medium $30, $25 I $60, $20 C P $50, $40 Payoffs in millions of dollars of semiannual profit. 13 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

14 Managerial Economics Nash Equilibrium • When a unique Nash equilibrium set of decisions

14 Managerial Economics 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 14 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

15 Managerial Economics Figure 3 Jack and Jill’s Oligopoly Game Jack’s Decision High Production:

15 Managerial Economics Figure 3 Jack and Jill’s Oligopoly Game Jack’s Decision High Production: 40 Gal. Jack gets $1, 600 profit Low Production: 30 gal. Jack gets $1, 500 profit High Production 40 gal. Jill gets $1, 600 profit Jill’s Decision Jack gets $2, 000 profit Jill gets $2, 000 profit Jack gets $1, 800 profit Low Production 30 gal. 15 Mc. Graw-Hill/Irwin Jill gets $1, 500 profit Jill gets $1, 800 profit Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

16 Managerial Economics Figure 4 An Arms-Race Game Decision of the United States (U.

16 Managerial Economics Figure 4 An Arms-Race Game Decision of the United States (U. S. ) Arm Disarm U. S. at risk and weak Arm Decision of the Soviet Union (USSR) USSR at risk USSR safe and powerful U. S. safe Disarm USSR at risk and weak 16 Mc. Graw-Hill/Irwin USSR safe Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

17 Managerial Economics Homework • Read chapter 13 pages 490 – 505 • Do

17 Managerial Economics Homework • Read chapter 13 pages 490 – 505 • Do tech probs 1, 2, 3, 4, 6 17 Mc. Graw-Hill/Irwin Copyright © 2005 by the Mc. Graw-Hill Companies, Inc. All rights reserved.