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Game Theory Part V

This slide explain about game theory. this slide is divided into five parts. this is the last part.

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Game Theory Part V

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  1. Chapter 12 Strategy and Game Theory (Part V) © 2004 Thomson Learning/South-Western

  2. APPLICATION 12.4: First-Mover Advantages for Alcoa, DuPont, Procter and Gamble, and Wal-Mart • Consider two types of first-mover advantages • Advantages that stem from economies of scale in production. • Advantages that arise in connection with the introduction of pioneering brands.

  3. APPLICATION 12.4: First-Mover Advantages for Alcoa, DuPont, Procter and Gamble, and Wal-Mart • Economies of Scale for Alcoa and DuPont. • The first firm in the market may “overbuild” its initial plant to realize economies of scale when the demand for the product expands. • Antitrust action against the Aluminum Company of America (Alcoa) claimed that it built larger plants than justified by current demand.

  4. APPLICATION 12.4: First-Mover Advantages for Alcoa, DuPont, Procter and Gamble, and Wal-Mart • In the 1970s, DuPont expanded its capacity to produce titanium dioxide which is a primary coloring agent in white paint. • Studies suggest that this strategy was successful in forestalling new investment by others into the titanium dioxide market.

  5. APPLICATION 12.4: First-Mover Advantages for Alcoa, DuPont, Procter and Gamble, and Wal-Mart • Pioneering Brands for Proctor and Gamble • Introducing the first brand of a new product appears to provide considerable advantage over later-arriving rivals. • Proctor and Gamble was successful in this with Tide laundry detergent in the 1940s and Crest toothpaste in the 1950s. • New products are a risk for consumers, and if the first one works, consumers may stick with it.

  6. APPLICATION 12.4: First-Mover Advantages for Alcoa, DuPont, Procter and Gamble, and Wal-Mart • The Wal-Mart Advantage • Its success stems from its first mover advantage in economies of scale and its initial “small town” strategy. • Started in the 1960s, it started serving smaller, mostly Southern markets. • This profitable near monopoly situation allowed it to grow and gain economies of scale in distribution and in buying power.

  7. Limit Pricing • A limit price is a situation where a monopoly might purposely choose a low (“limit”) price policy with a goal of deterring entry into its market. • If an incumbent monopoly chooses a price PL < PM (the profit-maximizing price) it is hurting its current profits. • PL will deter entry only if it falls short of the average cost of a potential entrant.

  8. Limit Pricing • If the monopoly and potential entrant have the same costs (and there are no capacity constraints), the only limit price is PL = AC, which results in zero economic profits. • Hence, the basic monopoly model does not provide a mechanism for limit pricing to work. • Thus, a limit price model must depart from traditional assumptions.

  9. Incomplete Information • If an incumbent monopoly knows more about the market than a potential entrant, it may be able to use this knowledge to deter entry. • Consider Figure 12.3. • Firm A, the incumbent monopolist, may have “high” or “low” production costs based on past decisions which are unknown to firm B.

  10. FIGURE 12.3: An Entry Game 1,3 Entry B 4,0 No entry High cost A Entry 3, -1 B Low cost No entry 6,0

  11. Incomplete Information • Firm B, the potential entrant, must consider both possibilities since this affects its profitability. • If A’s costs are high, B’s entry is profitable (B = 3). • If A’s costs are low, B’s entry is unprofitable (B = -1). • Firm A is clearly better off if B does not enter. • A low-price policy might signal that firm A is low cost which could forestall B’s entry.

  12. Predatory Pricing • The structure of many predatory pricing models also stress asymmetric information. • An incumbent firm wishes its rival would exit the market so it takes actions to affect the rival’s view of future profitability. • As with limit pricing, the success depends on the ability of the monopoly to take advantage of its better information.

  13. Predatory Pricing • Possible strategies include: • Signal low costs with a low-price policy. • Adopt extensive production differentiation to indicate the existence of economies of scale. • Once a rival is convinced the incumbent firm possess an advantage, it may exit the market, and the incumbent gains monopoly profits.

  14. APPLICATION 12.4: The Standard Oil Legend • The Standard Oil case of 1911 was one of the landmarks of U.S. antitrust law. • In that case, Standard Oil Company was found to have “attempted to monopolize” the production, refining, and distribution of petroleum in the U.S., violating the Sherman Act. • The government claimed that the company would cut prices dramatically to drive rivals out of a particular market and then raise prices back to monopoly levels.

  15. APPLICATION 12.4: The Standard Oil Legend • Unfortunately, the notion that Standard Oil practiced predatory pricing policies in order to discourage entry and encourage exit by its rivals makes little sense in terms of economic theory. • Actually, the predator would have to operate with relatively large losses for some time in the hope that the smaller losses this may cause rivals will eventually prompt them to give it up. • This strategy is clearly inferior to the strategy of simply buying smaller rivals in the marketplace.

  16. APPLICATION 12.4: The Standard Oil Legend • In a famous 1958 article, J.S. McGee concluded that Standard Oil neither trieds to use predatory policies nor did its actual price policies have the effect of driving rivals from the oil business. • McGee examined over 100 refineries bought by Standard Oil and found no evidence that predatory behavior by Standard Oil caused these firms to sell out. • Indeed, in many cases Standard Oil paid quite good prices for these refineries.

  17. N-Player Game Theory • The most important additional element added when the game goes beyond two players is the possibility for the formation of subsets of players. • Coalitions are combinations of two or more players in a game who adopt coordinated strategies. • A two-person game example is a cartel.

  18. N-Player Game Theory • The formation of successful coalitions in n-player games if influenced by organizational costs. • Information costs associated with determining coalition strategies. • Enforcement costs associated with ensuring that a coalition’s chosen strategy is actually followed by its members.

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