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1. If firm A lowers price then B and C can follow the price change or ignore it.
Ú If B and C then they also lower price because they are afraid of losing
their market share to firm A.
Ú If B and C the price change by A, then they maintain the higher price
because they don¶t believe that people will switch.
2. If firm A raises price then B and C can follow the price change or ignore it.
Ú If B and C then they also raise price because they don¶t believe that
people will switch, so they can increase profits by also charging more.
Ú If B and C the price change by A, then they maintain the lower price
because they believe that people will switch, and they can capture some of firm
A¶s market share by having a lower price.
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If the other firms do not follow then the demand for A¶s product
will be relatively ELASTIC (flat slope).
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ÚBasic elements
ÚThe players
ÚThe strategies
ÚThe payoffs
ÚPayoff matrix
ÚThe fundamental tool of game theory.
ÚThis is simply a way of organizing the
potential outcomes of a given game in a
table that describes the payoffs in a game
for each possible combination of strategies
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Ú Dominant strategy
Ú A strategy that yields a higher payoff no matter what the
other players in a game choose
Ú Dominated strategy
Ú Any other strategy available to a player who has a dominant
strategy
Ú 0ash Equilibrium
Ú Any combination of strategies in which each player¶s
strategy is his best choice, given the other players¶ strategies
Ú IwW: 0ash equilibrium is achieved when all players are
playing their best strategy given what the other players are
doing.
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Ú Duopoly situation ± each of the two firms A and B
must decide whether to mount an expensive
advertising campaign.
Ú If each firm decides not to advertise, each will earn a
profit of $50,000.
Ú If one firm advertises and the other does not, the
firm that does will increase its profits by 50% to
$75,000, and drive the competition into a loss.
Ú If both firms advertise, they will earn $10,000 each
because the advertising expense forced by
competition wipes out large profits
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Firm B
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Ú You and your friend Bugsy are the prime suspects for knocking
over a liquor store. The cops pick you up, and immediately
after your arrest you and Bugsy are separated and questioned
individually by the DA. Without a confession, the DA has
insufficient evidence for a conviction. During your
interrogation, you are told the following:
Bugsy
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Confess
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ÚPrisoner¶s Dilemma
ÚEach player has a dominant strategy
ÚIt results in payoffs that are smaller than
if each had played a dominated strategy
ÚProduces conflict between narrow self-
interest of individuals and the broader
interest of larger communities
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ÚWhy do people shout at parties?
ÚWhy does everyone stand up at
concerts?
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Ú to reduce the uncertainty of a
noncooperative situation ± competition over
market share makes firms unsure of what
to do with regard to pricing decisions ±
they¶re afraid to change prices ± so to avoid
the possibility of a price war, firms might
try to cooperate.
Ú to increase profits ± this need for profit can
turn out to be the downfall of most cartels ±
GREED
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ÚFirms 1 & 2
Úwptions: collude (price = $1.00) or
cheat (price = 0.90)
ÚIs there a dominant strategy for each
firm?
ÚIs there an incentive to cut prices even
more?
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ÚAssuming people are narrowly self-
interested does not always capture the
full range of motives
ÚRestaurants frequented mainly by out-of-
towners have the same tipping rates as
those with mainly repeat customers
ÚPeople care about being treated justly
ÚSympathy for a trading partner can make
a business person trustworthy
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