21-Game Theory (II)

21-Game Theory (II) - Agenda Course Overview Entry Games...

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1 Agenda • Course Overview • Entry Games • Sequential Games • The trust game • “The Good, the Bad and The Ugly” • What To Take Away Microeconomics The Structure of the Course Consumers and Producers Market Interaction Today’s lecture Uncertainty Perfect competition Monopoly and Pricing strategies Competitive Strategy Auctions Information in Markets and Agency Game Theory Introduction to Markets Consumer Theory and Demand Technology and Production
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2 Agenda • Course Overview • Entry Games • Sequential Games • The trust game • “The Good, the Bad and The Ugly” • What To Take Away Entry Games You are a monopolist of internet services in Palm Springs. Currently you are making profits per period of $10M. Skynet Corp. is an ISP operating in Riverside, who is thinking of entering the Palm Springs market. Entry requires a non-recoverable investment of $2M. Their executives are contemplating the possibility that if they enter, you may initiate a price war. If you initiate a price war after entry, the entrant would make only $1M in operating profit, while your profit would sink to $3M. If instead you accommodate entry (by pricing at the oligopolistic level) you make $6 M and the entrant would make $3 M. What decision will the executives at Skynet make?
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3 Nash Equilibrium Analysis We can draw a 2 2 box with each player’s actions and the ensuing payoffs. We have two pure strategy equilibria: (i) Skynet enters and you accommodate, and (ii) Skynet does not enter and you fight. Note that the equilibrium with no entry entails an empty threat: the fear of a price war (which would hurt you) keeps Skynet out! Accommodate Fight Not Enter Enter Incumbent 0,10 0, 10 -1, 3 1, 6 “Look forward and reason back” Let us draw a game tree that captures the sequential moves Looking forward, Skynet evaluates your optimal choice in each possible node where you play Skynet reasons back to conclude that they should expect accommodate in response to entry and decide to enter. Skynet You $1 billion $6 billion $-1 million $3 billion $0 million $10 million $1 billion $6 billion $-1 million $3 billion You
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4 “Accommodate or Fight” Skynet reasons back to conclude that they should expect accommodate in response to entry and decide to enter. . The empty threat of a price war is not a credible reaction to Skynet’s
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21-Game Theory (II) - Agenda Course Overview Entry Games...

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