Transcript Game Theory!

Game Theory!
Cartels
• A group of suppliers who try to act together
in order to reduce supply, raise prices, and
increase profits.
• A group of supplied who try to act as AS IF
they were a monopolist
• Example: OPEC
• Question to answer: When will cartels be
able to achieve their goal of being a
monopolist?
Game Theory
• A study of strategic decision-making
– A decision in making situations that are
interactive
• Example: Craps players make decisions,
pokers players make strategic decisions
• Game theory is used to analyze cartels
because the best decision of one cartel
member depends on the decisions of every
other cartel member which in turn depends
on the decisions of every other cartel
member
Game Theory
• Also used to study war, romance, business
decisions, evolution, voting and other
situations involving interactions
• Game theory is applied to the economics of
network of goods
• A network of goods is a good who value to
one consumer increases the more that other
consumers use the good
• Ex. Cell phones
Cartels and Game Theory
• Why did the price of oil more than triple
in 1973-1974?
• Saudi Arabia, a cartel of oil exporting
countries cut back on their production
of oil
Cartels and Game Theory
• Very few cartels can move in an industry
from competition to pure monopoly
• OPEC seems to be all powerful but in
reality, very few cartels are
– UNLESS…..they have strong government
support
– Would have much control over market
price for a very long time
Cartels and Game Theory
• Cartels tend to collapse due to three
reasons:
1. Cheating by cartel members
2. New entrants and demand
response
3. Government prosecution
1. Cheating by cartel members
• For oil-exporting nations, if they worked
together to reduce production and raise prices,
it would succeed
• Cartel members earn high profits on each barrel
of oil that comes out of the ground
• BUT……members will cheat on the cartel
agreement
• They promise to reduce production but when
everyone else reduces production and the price
of oil rises…….some cartel members can and will
cheat to increase their profits
Logic of Cheating…..
No Cartel
Countries
Output per
Country
Output
Profit per Country
(per day)
10
10 MBD
100 MBD
$360
million
World
100 MBD
Output
World Price
$36
Logic of Cheating…..
Cartel
Countries
Output per
Country
Output
Profit per Country
(per day)
10
8 MBD
80 MBD
$400
million
World
Output
World Price
80 MBD
$50
Logic of Cheating…..
Cartel with One Cheater
Countries
Output per
Country
Output
Profit per Country
(per day)
9
8 MBD
72 MBD
1
10 MBD
10 MBD
$380
million
$475
million
World
Output
World Price
82 MBD
$47.50
1. Cheating by cartel members
• The logic is simple, a single cartel
member does not have extensive
monopoly power, so cutting back
production doesn’t raise the world price
enough to make up for its loss of sales
• What happens when nine countries
cheat and only one country keeps its
promise?
Logic of Cheating…..
Cartel with Nine Cheaters and One NonCheater
Countries
Output per
Country
Output
Profit per Country
(per day)
1
8 MBD
8 MBD
9
10 MBD
90 MBD
$300
million
$375
million
World
Output
World Price
98 MBD
$37.50
1. Cheating by cartel members
• Cheating pays when other firms keep their
promise and cheating pays when other firms
cheat
• When a monopolist increases quantity
beyond the profit-maximizing quantity, the
monopolist hurts itself
• When a cartel cheater increases quantity
beyond the profit-maximizing quantity, the
cheater benefits itself and hurts other cartel
members
1. Cheating by cartel members
• When the decisions of two or more firms
significantly affect each others’ profits, they are
in a situation of interdependence.
• The study of behavior in situations of
interdependence is known as game theory.
• The reward received by a player in a game—such
as the profit earned by an oligopolist—is that
player’s payoff.
• A payoff matrix shows how the payoff to each of
the participants in a two player game depends on
the actions of both. Such a matrix helps us
analyze interdependence.
The Payoff Table
Russia’s Strategies
Cooperate
Saudi
Arabia’s
Strategies
Cheat
Cooperate
($400, $400) ($200, $500)
Cheat
($500, $200) ($300, $300)
Saudi Arabia’s
Payoff
Russia’s
Payoff
The Payoff Table
Russia’s Strategies
• Two numbers in each both of the table
are the payoffs to the players
• Dominant Strategy – is a
Strategy that has a higher payoff than any other
Strategy no matter what the other player does
• When Russia acts in their own interest and Saudi
Arabia acts in their own interest, the result is an
outcome that is in the interest of neither
Saudi
Arabia’s
Strategies
Cooperate
Cheat
Cooperate
($400, $400)
($200, $500)
Cheat
($500, $200)
($300, $300)
The Prisoner’s Dilemma
•
•
If both players cooperate, fishing revenues can be
maximized
and the
stock of fish
will be the
maintained
for of
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describes
situations
where
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future generations
individual
interest
leadsthetoother
a group
BUT….if one
player cheats,
has anoutcome
incentive
thattoischeat
in the
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and interest
this will reduce
theone
stock of fish below
the best possible outcome and Japan’s
will eventually
deplete
Strategies
Ex:
the product
United
States’
Strategies
Cooperate
Cheat
Cooperate
($400, $400)
($200, $500)
Cheat
($500, $200)
($300, $300)
Prisoner’s Dilemma &
Nash Equilibrium
• An action is a dominant strategy when it is a
player’s best action regardless of the action taken
by the other player. Depending on the payoffs, a
player may or may not have a dominant strategy.
• A Nash equilibrium, also known as a noncooperative equilibrium, is the result when each
player in a game chooses the action that
maximizes his or her payoff given the actions of
other players, ignoring the effects of his or her
action on the payoffs received by those other
players
Repeated Interaction and Tacit Collusion
 Players who don’t take their interdependence into account
arrive at a Nash, or non-cooperative, equilibrium. But if a
game is played repeatedly, players may engage in strategic
behavior, sacrificing short-run profit to influence future
behavior. In repeated prisoners’ dilemma games, tit for tat is
often a good strategy, leading to successful tacit collusion.
 Tit for tat involves playing cooperatively at first, then doing
whatever the other player did in the previous period.
 When firms limit production and raise prices in a way that
raises each others’ profits, even though they have not made
any formal agreement, they are engaged in tacit collusion
2. New entrants and demand response
• High prices of a cartel will attract new
entrants
• These entrants do not feel bound by previous
agreements
• Cartels are more successful when there are
fewer substitutes for the cartelized good –
implies less elastic demand
– More subs are typically available in the long run
than in the short run, do demand curves tend to
become more elastic over time, thus limited a
cartel’s power
2. New entrants and demand response
• With the ease of new entrants, it is
easier to maintain a cartel in a natural
resource than in a manufactured good
• Two successful cartels – oil and
diamonds
2. New entrants and demand response
• Natural resources are not the only
“thing” in limited supply
• A cartel may control access to some key
inputs that cannot be easily duplicated
• Ex. Major League Sports – NBA, NFL,
MLB, MLS
2. New entrants and demand response
• NBA consists of 30 teams
• Teams compete on the court but “collude” off
the court
• They use the NBA league structure to keep
down player salaries – “salary cap”
– If they do, face “the luxury tax”
• Each team, when joining the NBA, agrees to
limit how much spent on players
• Example of a buyer’s cartel – result is that
professional basketball salaries are lower
than they should be
3. Government prosecution
• Cartels have been illegal since the Sherman
Antitrust Act of 1890
• Governments don’t always prosecute cartels
and sometimes even support them
• Most cartels operate with clear legal and
governmental backing
• Examples: OPEC, milk cartels, coal mining,
agriculture, medicine
3. Government prosecution
• Government-enforced monopolies and
cartels are one of the most serious problems
faxing poor nations such as Mexico, Russia,
Indonesia and Africa
• Entrepreneurs who start new businesses
sometimes find that the law force them out
of competition with the small number of socalled untouchable big men who have
cartelized the major sectors of the
government
3. Government prosecution
• A government-supported cartel also
means higher prices, lower quality
of service and less innovation
Game Theory!
Cartels
• A group of supplied who try to act as AS IF
they were a monopolist
• Example:
Game Theory
• Example: Craps players make decisions, pokers
players make strategic decisions
• Game theory is used to analyze cartels because
the best decision of one cartel member depends
on the decisions of every other cartel member
which in turn depends on the decisions of every
other cartel member
Game Theory
• Also used to study war, romance, business
decisions, evolution, voting and other
situations involving interactions
• Game theory is applied to the economics of
network of goods
Cartels and Game Theory
• Why did the price of oil more than triple
in 1973-1974?
Cartels and Game Theory
• Very few cartels can move in an industry
from competition to pure monopoly
• OPEC seems to be all powerful but in
reality, very few cartels are
Cartels and Game Theory
• Cartels tend to collapse due to three
reasons:
1. Cheating by cartel members
• They promise to reduce production but when
everyone else reduces production and the
price of oil rises…….some cartel members can
and will cheat to increase their profits
Logic of Cheating…..
No Cartel
Countries
Output per
Country
Output
Profit per Country
(per day)
10
10 MBD
100 MBD
$360
million
World
100 MBD
Output
World Price
$36
Logic of Cheating…..
Cartel
Countries
Output per
Country
Output
Profit per Country
(per day)
10
8 MBD
80 MBD
$400
million
World
Output
World Price
80 MBD
$50
Logic of Cheating…..
Cartel with One Cheater
Countries
Output per
Country
Output
Profit per Country
(per day)
9
8 MBD
72 MBD
1
10 MBD
10 MBD
$380
million
$475
million
World
Output
World Price
82 MBD
$47.50
1. Cheating by cartel members
• The logic is simple,
• What happens when nine countries
cheat and only one country keeps its
promise?
Logic of Cheating…..
Cartel with Nine Cheaters and One NonCheater
Countries
Output per
Country
Output
Profit per Country
(per day)
1
8 MBD
8 MBD
9
10 MBD
90 MBD
$300
million
$375
million
World
Output
World Price
98 MBD
$37.50
1. Cheating by cartel members
• Cheating pays when other firms keep their
promise and cheating pays when other firms
cheat
• When a monopolist increases quantity
beyond the profit-maximizing quantity, the
monopolist hurts itself
The Payoff Table
Russia’s Strategies
Cooperate
Saudi
Arabia’s
Strategies
Cheat
Cooperate
($400, $400) ($200, $500)
Cheat
($500, $200) ($300, $300)
The Payoff Table
Russia’s Strategies
Saudi
Arabia’s
Strategies
• Dominant Strategy –
Cooperate
Cheat
Cooperate
($400, $400)
($200, $500)
Cheat
($500, $200)
($300, $300)
The Prisoner’s Dilemma
Japan’s Strategies
• Ex:
United
States’
Strategies
Cooperate
Cheat
Cooperate
($400, $400)
($200, $500)
Cheat
($500, $200)
($300, $300)
2. New entrants and demand response
• High prices of a cartel will attract new
entrants
• These entrants do not feel bound by previous
agreements
• Cartels are more successful when there are
fewer substitutes for the cartelized good –
implies less elastic demand
2. New entrants and demand response
• With the ease of new entrants, it is
easier to maintain a cartel in a natural
resource than in a manufactured good
2. New entrants and demand response
• Natural resources are not the only
“thing” in limited supply
• A cartel may control access to some key
inputs that cannot be easily duplicated
• Ex.
2. New entrants and demand response
• NBA consists of 30 teams
• Teams compete on the court but “collude” off
the court
• They use the NBA league structure to keep
down player salaries – “salary cap”
– If they do, face “the luxury tax”
• Each team, when joining the NBA, agrees to
limit how much spent on players
• Example of a buyer’s cartel –
3. Government prosecution
• Cartels have been illegal since ____________
________________________
• Governments don’t always prosecute cartels
and sometimes even support them
• Most cartels operate with clear legal and
governmental backing
• Examples:
3. Government prosecution
• Government-enforced monopolies and
cartels are one of the most serious problems
faxing poor nations such as Mexico, Russia,
Indonesia and Africa
• Entrepreneurs who start new businesses
sometimes find that the law force them out
of competition with the small number of socalled untouchable big men who have
cartelized the major sectors of the
government
3. Government prosecution