Strategy
Perloff: Chapter 14
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Preventing Entry
Nash equilibrium
Where each firm
maximise its profits
given that the other also
maximises its profits.
No firm can
individually take
another action and
increase its profits.
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Mixed Strategies
Firm 1
Enter
Do not
enter
Enter
Firm 2
Do not enter
$0
$1
$0
$0
$0
$-1
$1
$-1
• Where firms are uncertain, they assume different strategies are played
with certain probabilities.
• Suppose each firm enters with probability of 0.5.
• All outcomes are equally likely.
• Average profits are zero.
• Firm 2 cannot improve on this by playing pure strategy.
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Preventing Entry: Sequential
Decisions
• Accommodated Entry: It is irrational to take a strategic
action to prevent entry, but output is reduced from
Monopoly level to maximise profit (Stackelberg).
• Blockaded entry: Market conditions are such that no other
firm can enter profitably. Strategic action is unnecessary.
• Deterred entry: Strategic action is taken to prevent entry:
–
–
–
–
Paying to prevent entry
Credible threat
Commitment (Extension to Stackelberg)
Creating and using cost advantages
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Blockaded entry
• One firm in the market (incumbent) makes
monopoly profits.
• New firm joins, both firms make duopoly profit.
– Market conditions may be such that these are negative.
– Incumbent knows this and continues to produce the
monopoly output.
– Natural monopoly.
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Paying to prevent entry
First stage
(πi , πe)
Second stage
Do not enter
Do not pay
(πm, $0)
Entrant
Enter
(πd , πd = R – F )
Incumbent
Pay for exclusive rights (entry is impossible)
Will pay b to prevent entry if π-b>πd
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
(πm – b, $0)
(Non)credible threat
(πi , πe )
Cournot output
($300, $300)
Incumbent
Large output
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
(– $100, – $100)
Commitment: Stackelberg
Leader’s decision
Profits (πA, πU)
Follower’s decision
48
48
United
64
96
48
American
64
United
64
96
48
96
United
64
96
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
(4.6, 4.6)
(3.8, 5.1)
(2.3, 4.6)
(5.1, 3.8)
(4.1, 4.1)
(2.0, 3.1)
(4.6, 2.3)
(3.1, 2.0)
(0, 0)
Commitment: Deter Entry
(a) Entrant’s Fixed Cost Is $100.
(πi , πe )
Do not enter
Accommodate (q i = 30)
Entrant
Enter
Incumbent
Do not enter
Deter (qi = 40)
($900, $0)
($450, $125)
($800, $0)
Entrant
Enter
($400, $0)
(b) Entrant’s Fixed Cost Is $16.
Do not enter
Accommodate (q i = 30)
Entrant
Enter
Incumbent
Do not enter
Deter (qi = 52)
($450, $209)
($416, $0)
Entrant
Enter
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
($900, $0)
($208, $0)
Constructing the decision tree
Monopoly
F=100
F=16 (Stackelberg)
Stackelberg
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Creating and using cost advantages
• Should a firm by a new piece of equipment
which increases total cost but lowers
marginal cost.
– Implication is that output will expand.
• Answer is clearly no if firm is certain it will
remain a monopoly.
• What if the firm fears that a new entrant
will join.
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Reducing MC whilst increasing TC
(πi , πe )
Do not enter
Do not invest
Entrant
Enter
Incumbent
Do not enter
Invest
($400, $300)
($500, $0)
Entrant
Enter
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
($900, $0)
($132, –$36)
Monopoly Advertising
• Monopoly advertises to raise profits.
• Demand curve shifts:
– Changes in tastes
– Information about new products
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Price of coke, pe, $ per unit
How much to advertise
19
Advertising level
maximises profit
when the last $
spent on
advertising give $1
extra gross
revenue.
17
p 2 = 12
p 1 = 11
e2
B
e1
π1
5
MC = AC
D1
MR 1
0
D2
MR 2
Q 1 = 24 Q 2 = 28
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
68
76
Qc , Units of Coke per year
Strategic Advertising in Oligopolies
• Advertising that helps rivals.
• Advertising that hurts rivals.
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved
Advertising Game
Source: Perloff. Some parts: © 2004 Pearson AddisonWesley. All rights reserved