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Game Theory

This module explores the concept of game theory and its application in analyzing oligopoly markets. It covers topics such as the prisoners' dilemma, the role of repeated interactions in collusion, and strategic behavior in non-cooperative games. The module also discusses the barriers to collusion and the impact of antitrust legislation on oligopolistic markets.

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Game Theory

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  1. Module Micro: Econ: 29 65 Game Theory • KRUGMAN'S • MICROECONOMICS for AP* Margaret Ray and David Anderson

  2. What you will learnin thisModule: • How oligopoly can be analyzed using game theory. • The concept of the prisoners’ dilemma. • How repeated interactions among oligopolists can result in collusion in the absence of any formal agreement.

  3. Game Theory • Game Theory: study of how interdependent decision makers make choices.

  4. What should Ford do? Payoff from Super Bowl Advertising

  5. Dominant Strategy Payoff from Super Bowl Advertising

  6. Non-Cooperative Games • Each player competes to maximize individual payoffs and ignores the effects of his/her action on the payoffs received by the rival.

  7. Nash Equilibrium • Payoff maximizing choice in a non-cooperative game.

  8. Find your Equilibrium Krugman p 676 # 6A # 7A

  9. Terms to Know • Payoff matrix • Dominant strategy • Nash equilibrium

  10. Do Now How would you describe the following to a friend? • Payoff matrix • Dominant strategy • Nash equilibrium Write a brief description in your notebook.

  11. Housekeeping Read Module 67 and 68 Test on Oligopoly and Monopolistic Competition on: Friday 12/19 – P7 Monday 12/22 – P8 Econ Clinic 12/18 - 3 p.m. in Room A204

  12. What you will learnin thisModule: • How oligopoly can be analyzed using game theory. • The concept of the prisoners’ dilemma. • How repeated interactions among oligopolists can result in collusion in the absence of any formal agreement.

  13. Review Krugman p 676 # 6A # 7A

  14. To Collude or No to Collude • Where are both firms maximizing profits? • How do they get there?

  15. Prisoner’s Dilemma

  16. Theory Create a payoff matrix for the prisoner’s dilemma game.

  17. Prisoner’s Dilemma • Each player has an incentive to choose an action that benefits his/herself at the other player’s expense. • Both players are then worse off than if they had acted cooperatively. The payoff matrix below summarizes the strategies and outcomes. The payoffs are measured as years in prison, so smaller numbers are preferred.

  18. Repeated Interaction and Tacit Collusion • Repeated interaction can lead to strategic behavior • Tacit Collusion – e.g. price leadership. • Tit for tat strategy

  19. Tit for Tat • Maggie prices her gas at $ 4.00 • If Pam also sets her price at $4.00, Maggie keeps her price at $4.00 the next day. • If Pam comes out with a lower $3.00 price, Maggie drops her price to $3.00 the next day. • Maggie continues to follow Pam’s prices until (hopefully) they reach a mutually profit maximizing price.

  20. Apply Tit for Tat Krugman p 676 – Q 6b

  21. Compare Strategies Krugman p 676 – Q6 b, Q 7b

  22. Summary • Oligopoly problem: better off colluding but incentive to cheat • Collusion is illegal (in most countries). • Alternative – tacit collusion • Price leadership • Tit for Tat

  23. Homework NCEE worksheet

  24. Do Now What is a Prisoner’s Dilemma? Write a description for your desk partner. Or Ilustrate with a payoff matrix.

  25. Review NCEE worksheet 6 b. 7b.

  26. Today’s Objectives: • Practice solving oligopoly FRQs. • Understand why cooperation can breakdown.

  27. FRQ Practice 2007 FRQ

  28. FRQ Practice 2013 FRQ

  29. Product Differentiation and Tacit Collusion • Price leadership • Product differentiation • Non-price competition

  30. Antitrust Legislation • Laws including the Sherman Act and the Clayton Act make cartels, collusion, and certain anti-competitive business practices illegal John D. Rockefeller Video — History.com

  31. Standard Oil vs. U.S. • How did Rockefeller build his monopoly? • Was it a natural monopoly? • What would have happened if he won in the Supreme Court? John D. Rockefeller Video — History.com

  32. American Needle vs. NFL • The Sherman Act is alive and well. • Here it is applied to an oligopoly. American Needle vs. NFL

  33. Factors Limiting Tacit Collusion • Large numbers • The more firms in the industry, the less likely tacit collusion will be successful • Complex products and pricing schemes • It is easier to tacitly agree to keep a price high if the product is simple and there are few ways price can be set. • Differences in interests • If firms have diverse characteristics and interests, it will be more difficult to establish and maintain tacit agreements. • Bargaining powers of buyers • If the buyers of a product have bargaining power, or they operate in a competitive retail environment, tacit agreements to keep prices high are unlikely to succeed. • Sca

  34. Exit Ticket • Take one of the oligopolistic industries below: • Laptop computers • Automobiles • Airlines • Detergent • Write a short paragraph evaluating whether the four barriers to collusion exist.

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