Economics

Game Theory and Oligopoly

Dept. of Economics @ NCKU

Weng, Ming-Hung
Question
In 1970, Congress was
considering banning
cigarette advertising on TV.
When they held hearings
on the issue, how does the
cigarette industry react?

Q: If you were one of the

managers, how will you
respond?
 Outline
Game Theory and Oligopoly
Scene 1: Prisoners dilemma
Scene 2: Nash equilibrium
Scene 1: prisoners dilemma
You and your partner in
crime, Josie, got busted
for robbery, caught in
the act. The police
officiers separate you
two in different rooms
at the police station for
questioning and offer
each of you a deal
 Scene 1: prisoners dilemma
If you both confess to also having a gun, you each get 5
years.

If you confess to having a gun, but Josie does not (you

rat her out), you walk away and Josie gets 10 years.

Josie gets the same dealif she rats you out (while
you dont), she goes free and you get 10 years.

If neither one of you confesses to the gun charge, you

will each get 2 years for the robbery.
 The Prisoners Dilemma Game
*When separately questioned, you think
Josie will
1. Be loyal to you
2. Accept the deal from the police (to rat you
out)
 Elements of a game
Elements of a game
1. The playersyou and Josie who are rational
2. The strategiesconfess or hold out (not confess)
3. The payoffs payoffs (outcomes) associated
with each pair of strategies taken

Payoff matrix
Represents payoffs for each player for each pair of
strategies
 Simultaneous move game

*You will
1. confess
2. hold out
 If you think Josie will confess

You will (as a rational player)

1. confess; 2. hold out
if you think Josie will hold out

You will (as a rational player)

1. confess; 2. hold out
 Dominance Solvable Game

Dominant strategy
A strategy yielding best outcomes, regardless of what
others do.
Dominated strategy
A strategy yielding worse outcomes in any event compared
another strategy, regardless of what others do.
Dominance Solvable Game
Games whose outcome may be derived by dominance
 The public goods game (*)
You and your roommate are considering to
have a wireless router that costs $1,000. Once
its provided, both can share no matter who
pays for it. Suppose each of you personally
regards the values of its service as $800. You
will choose
1. to contribute
2. not to contribute
 Application: The public goods game
For the public
Not
contribute
contribute
good game, the
game theory
predicts each to
contribute 300, 300 -200, 800 choose
1. contribute
2. Not to
Not
800, -200 0, 0 contribute
contribute
Question
In 1970, Congress was
considering banning
cigarette advertising on TV.
When they held hearings
on the issue, how does the
cigarette industry react?

Q: If you were one of the

managers, how will you
respond?
Catching fish among 3 fishermen*

How many boats will you send out?

1. 1; 2. 2;
 Price war
Firm 2 Two firms each can choose
to set its price low or high
Low High
The outcome will be
1. Both Firm 1 and 2 set
low price
Low 0, 0 15, -5
2. Firm 1 sets low while 2
Firm 1 sets high
3. Firm 1 sets high but 2
High -5, 15 10, 10 sets low
4. Both firms choose high
price
 Price war*
Firm 2 Is it efficient if firms are
Low High engaged in a price war
1. yes
2. no
Low 0, 0 15, -5
Firm 1
High -5, 15 10, 10
 Scene Revisited

When and why empirical observations may not

be consistent with theoretical predictions?
 Experimental evidences

%: Percentage of playing cooperatively

p: probability to continue the next round
1. Similar ending pattern
2. Declining cooperative play toward the predetermined end
3. Diverse pattern facing similar expected length
2017/6/19 Ming-hung Weng @ Economics NCKU 19
Scene 2: games without a dominant strategy
A chicken run

Rebel Without a Cause (1955) Straight Swerve

*If you were Jim,

you will go Straight -5, -5 1, -1
1. Straight
2. Swerve
Swerve -1, 1 0, 0
Scene 2: games without a dominant strategy
A chicken run

Rebel Without a Cause (1955) Straight Swerve

If Jim knew Buss

will go straight, Straight -5, -5 1, -1
he will go
1. Straight
2. Swerve Swerve -1, 1 0, 0
Scene 2: games without a dominant strategy
A chicken run

Rebel Without a Cause (1955) Straight Swerve

If Jim knew Buss

will go swerve, Straight -5, -5 1, -1
he will go
1. Straight
2. Swerve Swerve -1, 1 0, 0
Scene 2: games without a dominant strategy
A chicken run

Rebel Without a Cause (1955) Straight Swerve

Jim, without
knowing Buss will Straight -5, -5 1, -1
go swerve or
straight, how
will he choose? Swerve -1, 1 0, 0
Nash equilibrium
Nash equilibrium (1954)

An outcome from which each player will not

deviate when no one else deviates from their
current choices

Each player chooses a strategy that is the best,

given the strategies of others; i.e., changing
strategies alone does not benefit each player.
Scene 2: games without a dominant strategy
A chicken run

Rebel Without a Cause (1955) Straight Swerve

The circled
outcome is not Straight -5, -5 1, -1
N.E. as both will
deviate.
Swerve -1, 1 0, 0
Scene 2: games without a dominant strategy
A chicken run

Rebel Without a Cause (1955) Straight Swerve

Is the circled
outcome N.E.?* Straight -5, -5 1, -1
1. Yes
2. No
Swerve -1, 1 0, 0
Scene 2: games without a dominant strategy
A chicken run

Rebel Without a Cause (1955) Straight Swerve

Is the circled
outcome N.E.? Straight -5, -5 1, -1
1. Yes
2. No
Swerve -1, 1 0, 0
Scene 2: games without a dominant strategy
A chicken run

Rebel Without a Cause (1955) Straight Swerve

N.E. predicts One

choosing Straight Straight -5, -5 1, -1
while the other
choosing swerve.
Swerve -1, 1 0, 0
 Where to Meet at NCKU?
Is (L, L) a N.E.?
Banyan Library 1. Yes
2. NO
Banyan 5, 5 0, -1

Library -1, 0 4, 4
29
 Where to Meet at NCKU?
Both (B,B) and (L,
Banyan Library L) are N.E..

Banyan 5, 5 0, -1

Library -1, 0 4, 4
30
 Best Response of Hang Ten
If your friend
Banyan Library chooses to wait
at Banyan, your
Banyan 5, 5 0, -1 best response is
to wait at
Banyan.
Library -1, 0 4, 4
31
 Best Response of Hang Ten
If your friend
Banyan Library chooses to wait
at Library, your
Banyan 5, 5 0, -1 best response is
to wait at
1. Banyan.
Library -1, 0 4, 4
2. Library
32
 Best Response of Hang Ten
An outcome,
Banyan Library where each
player is
choosing his/her
Banyan 5, 5 0, -1 best response
against the
opponents is the
Library -1, 0 4, 4
N.E. (Why?)
33
 Quantity competition
Firm 1s best
L M H response against
Firm 2s Low
L 5, 5 2, 7 1, 8 quantity is to choose
___ quantity
M 7, 2 4, 4 4, 3 1. Low
2. Medium
H 8, 1 3, 4 0, 0 3. High
 Quantity competition
If two firms choose
L M H quantity L/M/H to
compete. N.E. is
L 5, 5 2, 7 1, 8

M 7, 2 4, 4 4, 3

H 8, 1 3, 4 0, 0
 Quantity competition
N.E. is when each
L M H chooses a quantity
of Medium size, (M,
L 5, 5 2, 7 1, 8 M), as M, the
equilibrium strategy,
is the best response
M 7, 2 4, 4 4, 3 to eachs equilibrium
strategy.
H 8, 1 3, 4 0, 0 Is it efficient?
Market Structure and Output Levels
 Quantity competition
Will a Cartel
L M H (monopoly outcome)
easily maintained?
L 5, 5 2, 7 1, 8 1. Yes
2. No
M 7, 2 4, 4 4, 3

H 8, 1 3, 4 0, 0
Finding N.E. with best responses
N.E. prescribes the
L R strategies of the two
as
1. U, L
U 3, 5 4, 3
2. U, R
3. D, L
D 7, 3 2, 2 4. D, R
Finding N.E. with best responses
N.E. prescribes the
L R strategies of the two
as
1. U, L
U 3, 5 4, 3
2. U, R
3. D, L
D 7, 3 2, 2 4. D, R
 The penalty kick

Zero-sum games are games when

one player wins, the other loses,
the payoffs sum to zero
*N.E. is ? 5. none of above
 Pure vs. Mixed strategy
Pure strategy
Choosing one strategy (Ex: L)
Mixed strategy
Randomly choosing different strategies (Ex:
chance of 0.8 to play L and 0.2 to play R)
 EX: Rock-Paper-Scissors
Staring from (R, R) will
induce an endless circle R P S

Similar for starting else R (0, 0) (-1, 1) (1, -1)

where.
P (1, -1) (0, 0) (-1, 1)
No Nash Equilibrium in
pure strategy for RPS.
S (-1, 1) (1, -1) (0, 0)

Ming-hung Weng @ Economics NCKU 43

Empirical evidence
 Conclusion
In games like the prisoners dilemma, the
outcome can be easily predicted as each
player has a dominant strategy
In games where players have no dominant
strategies, Nash equilibrium can be found
using best response approach
Oligopoly is inefficient if firms are engaged in
quantity competition