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Manfred Stadler
4. Competition in Games with Imperfect Information 4.1 4.2 4.3 4.4 4.5 Incomplete Cost Information Incomplete Demand Information Contractual Information Exchange Signalling of Information Intertemporal Transmission of Information
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 4
Chapter 1: Industrial Organization and Games Structure of the Industrial Sector Strategic Interaction and Game Theory The Analytical Framework Basic Market Games
C 33
and, hence, to the demand system qi Di (p1 , p2 ) = a bpi + d p j ; where and a /( + ), i, j = 1, 2, i ,= j (1.2)
b /( 2 2 ),
d /( 2 2 )
a/(b d),
b/(b2 d 2 ),
d/(b2 d 2 ).
and by assuming market clearing, i.e. Q = D(p), the market demand function D(p) = ( / ) (1/ )p , which simplies for = 1 to the standardized form D(p) = p .
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 19
(1.3)
where the marginal costs ci are determined by the input prices and the total factor productivity.
0 < < 1,
where Ai denotes the technology level, Li the labor input, and Ri the raw material input. Minimizing production cost Ci = wLi + vRi , where w and v denote the input prices of labor and raw material, subject to the technology constraint, leads to the linear cost function Ci = A1 (w/ ) (r/(1 ))1 qi , i where the constant marginal cost is ci = A1 (w/ ) (r/(1 ))1 . i
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 22
Monopoly
Assuming the linear market demand function D(p) = p and constant marginal cost c < , maximization of the monopoly prot
M (p) = (p c)( p)
leads to the monopoly price pM = (1 + c)/2 = c + (1/2)( c) , the output qM = D(pM ) = (1/2)( c) , and the monopoly prot
M = (1/4)( c)2 .
(1.4)
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 24
Monopoly
Interpretation: The monopoly price depends positively on the market size and the marginal cost c. The monopoly prot depends positively on the market size but negatively on the marginal cost.
Collusion
The optimal collusion strategy of two rms is to set the monopoly price pK = pM = c + (1/2)( c) and to equally share the output qK = qM /2 = (1/4)( c) and the total prot
K = M /2 = (1/8)( c)2 .
(1.5)
Bertrand Competition
The Bertrand (1883) model of price competition Assumptions: Homogeneous product market with two rms i = 1, 2 Constant and identical marginal costs ci = c Linear market demand function D(p) = p, where > c Prot maximization with respect to the prices pi Market clearing at D(p) = q1 + q2 .
Bertrand Competition
The prot of rm i is
i, j = 1, 2, i = j ,
where the demand for the output of rm i is pi Di (p1 , p2 ) = ( pi )/2 0 if pi < p j if pi = p j if pi > p j .
Bertrand Competition
The unique equilibrium has the two rms charge the competition price (p , p ) = (pB , pB ) where 1 2 pB = c , implying that both rms realize zero prots, i.e. B = 0. This Bertrand-Paradox states that two rms are sucient for generating the market performance of perfect competition: Two is enough for competition.
Bertrand Competition
Reaction functions in the Bertrand model p2
R1 (p2 ) R2 (p1 )
c p1
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 30
Cournot Competition
The Cournot (1838) model of quantity competition Firms set quantities instead of prices, all other assumptions continue to hold. Maximizing the prots
i (q1 , q2 ) = ( qi q j c)qi ;
i, j = 1, 2, i = j ,
with respect to the quantities qi leads to the reaction functions qi Ri (q j ) = ( q j c)/2 with the negative slopes R (q j ) = (1/2). i The symmetric Nash equilibrium in quantities (q , q ) = (qC , qC ) is given by 1 2 the intersection point of the reaction functions and is determined by qC = (1/3)( c) .
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 31
Cournot Competition
Reaction functions in the Cournot model q2
R1 (q2 )
c 2
R2 (q1 ) q1
c 2
c
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 32
Cournot Competition
Given these quantities the market price is pC = c + (1/3)( c) and the rms prots are
C = (1/9)( c)2 .
(1.6)
Interpretation: The market price depends positively on the market size and the marginal cost c. Firms prots depend positively on the market size but negatively on the marginal cost.
Stackelberg Competition
The sequential decision model of Stackelberg (1934) Sequential structure of decisions: Stage 1: The Stackelberg leader i = L chooses his output qL Stage 2: The Stackelberg follower i = F chooses his output qF The derivation of the subgame perfect Nash equilibrium by backward induction: Step 1: Choice of qF conditional on qL The maximization of the followers prot function
F (qL , qF ) = ( qL qF c)qF
with respect to the outoput qF leads to qF RF (qL ) = ( qL c)/2 .
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 34
Stackelberg Competition
Step 2: Choice of qL by anticipating RF (qL ) The maximization of the leaders reduced-form prot function
Stackelberg Competition
The rms prots are
L = (1/8)( c)2
>
C C .
(1.7)
A comparison of the Stackelberg solution and the Cournot solution reveals the rst-mover advantage of the leader: The leader raises output inducing a smaller output of the follower, whereby the market price falls, and the leaders prot increases whereas the followers prot declines. At the end of this chapter, a remaining question is when to use which model. Are there more fundamental market conditions suggesting a special model? And if, is it possible to integrate the basic models into a more general approach of oligopoly theory? The answer is: yes!
Manfred Stadler Game Theory and Industrial Organization, Chapter 1 p. 36