Lecture_6 - EC1301 Principles of Economics Week 6 Lim Boon...

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1 Lim Boon Tiong, 2007 EC1301 Principles of Economics Week 6
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2 Lim Boon Tiong, 2007 Example: Output Decision of a Duopolist Firm A and Firm B, each with identical cost curves Cartel Decision: Joint decision on output AB 30 and 30 QQ == Price Market Quantity MC MR 60 100 300 Market Quantity MC 60 100 300 Cartel Firm A defects; Firm B cooperates 30 ■■ MR 250 4,500 75 6,750 6,000 Firm B Both Firms cooperate Firm A 45 and 30 75 +=
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3 Lim Boon Tiong, 2007 Example: Output Decision of a Duopolist Firm A and Firm B, each with identical cost curves Will each firm cooperate (i.e., abide by the cartel decision) or defect? AB 45 and 45 90 QQ == += Price Market Quantity MC 45 100 Both Firms defect 200 90 4,500 4,500 Question : If Firm A believes that Q B = 45 , what is Firm A’s profit-maximizing output level? What is “best” for Firm A depends on what the others are doing. Cost-Benefit Principle
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4 Lim Boon Tiong, 2007 Game Theory The study of behavior in situations in which a decision maker’s payoff directly depends on the actions of other decision makers For example, Shell must weigh the responses of rivals when deciding whether to cut their pump prices Shell’s actions may depend on what it believes SPC, Esso, etc, will do Why use Game Theory? Employing game theory forces the decision maker –to analyze its competitor’s problem as if it were her own; and – to recognize that the competitor is thinking strategically as well
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5 Lim Boon Tiong, 2007 Using Game Theory Two Steps: 1. Model building ¾ finding a useful way to represent the game 2. Decision: finding a way to predict outcomes
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6 Lim Boon Tiong, 2007 Modeling a Game Who are the players? What are the actions for each player? What information is available? The order in which players take actions in a game Sequential vs Simultaneous-move What are the strategies? What are the payoffs?
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7 Lim Boon Tiong, 2007 Example: Price-Fixing Game (Textbook, p 595ff) Only two firms (Jack and Jill) in an airline market. Each firm has only two choices for its ticket price: High ($400) or Low ($300) If both firms choose High, then each will earn a profit of $9,000. If Jack chooses High and Jill chooses Low, then Jack earns a profit of $3,000 and Jill earns a profit of $12,000 (and vice versa). If both firms choose Low, then each will earn a profit of $8,000.
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8 Lim Boon Tiong, 2007 Sequential Game : Game Tree for the Price-Fixing Game Jill Jack $9,000 $9,000 Jack $3,000 $12,000 Jill $12,000 $3,000 Jack $8,000 $8,000 High Low High Low Low High
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9 Lim Boon Tiong, 2007 Game Modeling: Simultaneous Move Basic elements – The players Jack and Jill – The strategies The actions available for each firm: High and Low – The payoffs Profits of the firms Payoff matrix – Summary of the game
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10 Lim Boon Tiong, 2007 Simultaneous Move: Price-Fixing Game $9,000 $12,000 $9,000 $3,000 $3,000 $8,000 $12,000 $8,000 Jill High Low Jack High Low
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11 Lim Boon Tiong, 2007 Solving the Price-Fixing Game $9,000 $12,000 $9,000 $3,000 $3,000 $8,000 $12,000 $8,000 Jill High Low Jack High Low
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12 Lim Boon Tiong, 2007 Dominant Strategy Dominant strategy A strategy that yields a higher payoff than any other strategy no matter what the other players in the game choose Low is the dominant strategy for Jill
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This note was uploaded on 03/19/2012 for the course ARTS EC1301 taught by Professor Forgot during the Fall '08 term at National University of Singapore.

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Lecture_6 - EC1301 Principles of Economics Week 6 Lim Boon...

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