by Windy Natriavi S.
Agenda Presentation
Why do we need game theory? Types of Games (Cooperative Vs. Non-cooperative) Nash Equilibrium How does it apply in real life? Oligopoly Markets Cournot Oligopoly Cournot Oligopoly Theory Cournot Oligopoly Theory with Many Firms Cournot Oligopoly Theory with Different Costs What determines a firms operating profit margin? Its Concentration Index Profitability Conclusion
theory?
Existence of economic profit drives firms to enter the market Lower barrier cost (can be seen through AFTA, improved technology, and faster application time to establish a business in Indonesia in only 60 days) More anti-trust laws are approved to protect the consumers and ensure healthy competitiveness in the market As a result, in an industry there are usually many firms and competitor (s) in the market.
theory?
Because more firms enter the market, competitiveness gets tighter. The decision of each firm in the market is interdependent, meaning that in order to make decisions, a firm has to also consider other firms actions. So game theory is...concerned with situations in which
decision-makers interact with one another, and in which the happiness of each participant with the outcome depends not just on his or her own decisions but on the decisions made by everyone
described as all the outcomes available to the firms in the game as combinations of actions
firms can interact with each other and cooperative solution concepts
Example: two market players (Ponds and Olay) Example: a seller (player 1) has two potential are both competing in facial care toward the antibuyers (player 2 and player 3) and a production aging community. In this case, the players are cost of $4. Player two is willing to pay maximum $11 for a unit and player 3 is willing to pay playing a noncooperative game where both maximum $9. In these interactions between player players are competing toward obtaining the 1 and player 2/3, it is called a cooperative game largest market share.
Nash Equilibrium
..is the condition when no firm wants to change its current strategy given that no other firm changes its current strategy
the dominated strategy is the strategy that always gives the least pay-off to a firm no matter what the other player strategy is. In this case, Giant would never choose premium because it always gives the least pay-off to the firm no matter what Carrefour does. the dominating strategy is the strategy that always gives the highest pay-off to a firm no matter what the other player strategy is. In this cae, Giant would choose standard pricing strategy because it gives higher pay off no matter what Carrefour does. Using rationale, this strategy will be chosen.
If we solve the equation, we will have the answer that each firm produces 16 units of output.
P will then be written as (60 Q1 Q2) which is 60 32 = 28 As we can see, competition between the two firms causes them to overproduce, thereby making the price lower than it would have been in the case of monopoly price at (A-c)/2B. Output is also less than the competitive output (A-c) / B where price is equal to marginal cost.
There are cases where more than just two firms producing the same product, where Q = q1 + q2 + + qN Ex: Telkomsel, Indosat, XL, 3, etc. Demand can then be written as P = A - BQ = A - B(q1 + q2 + + qN). If we look at the perspective of Firm 1, its output would be P = A - B(q2 + + qN) - Bq1
Q-1 = q2 + q3 + + qN.
P = (A - BQ-1) - Bq1.
As the number of firms increases, the number of outputs Because the firms are identical, then we will have Q-1 = (N-1)Q1 produced by a firm is reduced, although Q1 = (A - c)/2B - (N - 1)Q1/2 the total aggregate number of outputs Q1 = (A - c)/(N + 1)B increases. The total number of outputs in the market will be summed up as Q= N(A - c)/(N + 1)B
We will solve the quantity of output for Firm 1 as Q1 = (A - c)/2B - Q-1/2 The equilibrium price in the firm will be written as P= A - BQ = (A + Nc)/(N + 1) Profit of firm 1 is P1 = (P* - c)Q1
We can also see that as the number of firms increases, the price tends to be closer to the marginal cost
Therefore, because of the larger aggregate output and the lower price which can be given to each firm, profit per firm will fal
Take for example McDonalds and Burger King where they both have different costs in producing a burger. For McDonalds the marginal cost is MD and for Burger King the marginal cost is MB. demand for the whole market can be written down as
If we see from the perspective of McDonalds, which is firm 1, this will bring us to another equation of (A - Bq2) - 2Bq1 = c1 the number of outputs produced by McDonalds as Q1 = (A - c1)/2B - q2/2 and the number of outputs produced by Burger King as Q2= (A - c1)/2B q1/2 the final output for McDonalds would be Q1 = (A - 2c1 + c2)/3B and the final output for Burger King would be Q2 = (A - 2c2 + c1)/3B
What would happen if in this case Firm 2 has a lower marginal cost? Its reaction curve will shift upward to the right Burger King) will have bigger capacity to produce than Firm 1, making the number of outputs that it produces compared to Firm 1 is higher. As a result, the number of outputs that are produced by Firm 2 increases and the number of outputs that are produced by Firm 1 decreases. In equilibrium, McDonalds would produce QC1 = (A - 2c1 + c2)/3B and Burger King would produce QC2 = (A - 2c2 + c1)/3B Total output therefore would be: Q = (2A - c1 c2)/3B
price at P= A - (2A - c1 - c2)/3 = (A + c1 +c2)/3. measure the profit for McDonalds as (P*- c1)QC1 = (A - 2c1 + c2)2/9 and Burger Kings profit as (P* - c2)QC2 = (A - 2c2 + c1)2/9. equilibrium output is less than the competitive level product (burgers) is produced inefficiently In the idealistic condition, Burger King (Firm 2) should produce all of the burgers, since the lower cost of production will it make it possible for Burger King to produce more burgers than if Firm 1 and Firm 2 both produces burgers.
MRi = MCi
This can be reorganized into the equilibrium function of A - B(Q*-i + P* - Bq*i - ci = 0 or P* - ci = BQ*i.
following:
how large the size of Pantene compared to other firms in the industry as a whole (its market share) how attached consumers in the market are to Pantene Shampoo (demand elasticity twoards Pantene Shampoo)
As the industry concentration gets higher (more concentrated and less competitive), we can conclude that the operating profit (pricecost margin) will be higher for each firm especially the firm who are the market players.
Conclusion
how the quantity produced by a firm is actually a reaction function to how it perceives the other firm will produce
Nash Equilibrium happens when firms choose the strategy that will give them the best pay-off regardless of how the other firms act. As many more firms exist in the market, the price will tend to adjust to the marginal cost, making each firms profit less than what it would have been with only a few players in the market. operating profit of each firm is dependent on its market share and demand elasticity in the market
Firms will have to find a way to lower down its cost (cost leadership strategy) or differentiate its product in the market (differentiation strategy) to be able to grab consumers and stay in the market.