Game Theory: What you need to know...

By Komi!a Chadha April 2012

Tuesday, 10 April 12

Outline
Cartels and colluding - why do it? Prisoners Dilemma: What is it? What are the strategies and games? Mathematical proof? What is the Nash equilibrium? Cournot Model Bertrand Model Stackelberg Model Chamberlin Model, is it relevant to oligopolies?

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Cartels and Collusions

Given the concentrated nature of the oligopolistic market, rms may seek to co!ude so that they can benet #om supernormal prots that monopolies earn.

They may do this by forming a cartel which is essentia!y explicit co!usions but these are i!egal Thus they may co!ude i!icitly and this is known as tacit co!usion and an example of this is price leadership

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What is prisoners dilemma

It is a model which is explained using a hypothetical & analogous model of two prisoners please see my video on this: http:// a2withkomi!a.blogspot.c o.uk/2011/01/ competitive-oligopoliesprisoners.html

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Tit-for-tat:

you dont know how

many times you will encounter, but you cooperate the first time and every other turn after is a copy of what the other player did.

Maximin:

When you chose

the highest yielding option from your worst possible outcomes.

Which strategy?
Dominant : Where the strategy of the player is not reliant upon the strategy of the other player.

Non-dominant:

where your strategy is based on the strategy of the other player.

games where you are allowed to make your strategy decision after viewing the activity of the other player.

Sequential games: These are

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With prisoners dilemma it is quite clear that rms are better o to cheat in the short-run, so what is the mathematical proof for this statement? Look above!
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Nash equilibrium: Where the players may not individually be at optimal equilibriums but they nevertheless have no incentive to change their current strategy.

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Cournot Model
This is a model which suggests that oligopolies compete on quantity/output. The main assumption is that each rm takes the other rms output as constant and thus derives its demand as D-qb The reactive function is a key part of the model and suggests that if rm B changes its output then rm A will do so subsequently. The model has been criticized for being too naive and assuming a closed market.

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Mathematics can be used to show that each firms reaction function (which is the derivative of the profit function) is based upon the output of the other firm. Graphically the reactive curves, with firm A and B on each axis, show what happens when one firm changes output. The intersection is the output they will operate at.

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Bertrand Model Whereas, the Cournot model explore output competition, the Betrand model suggests price competition exists . Again each rm assumes the other rms price is constant - the Betrand assumption!
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Bertrand Model II
This model argues that the price competition between the rms results in an oligopoly which achieves the perfectly competitive output of P=MC, as rms are constantly undercutting one another to gain market share.

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Stackelberg Model
This model is more similar to Cournot, advocating for quantity competition - so to speak. However, the key difference is that it sugegsting an oligopoly is an example of a sequential game i.e. that players make their output decisions after seeing what the other players do. Also, output is much more higher in this model. It is like the output version of price leadership. The rst-mover or quantity setter however always benets the most.

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Comparison of prices and prots

BERTRAND < STACKELBERG < COURNOT < MONOPOLY

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Chamberlin Model
The Chamberlin model isnt very important for oligopoly theory, it is merely the idea of monopolistic competition. That is that firms can have inelastic demand and For more info please see my posts and differentiated goods yet operate booklets/videos on in a competitive market.

monopolistic competition.
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End

Thank you for reading! By Komi!a Chadha

Tuesday, 10 April 12