Lecture Managerial economics (Ninth edition): Chapter 13 – Thomas, Maurice

Managerial Economics
ninth edition

Thomas
Maurice

Chapter 13
Strategic Decision Making
in Oligopoly Markets
McGraw­Hill/Irwin
McGraw­Hill/Irwin
Managerial Economics, 9e
Managerial Economics, 9e

Copyright © 2008 by the McGraw­Hill Companies, Inc. All rights reserved.


Managerial Economics

Oligopoly Markets
• Interdependence of firms’ profits
• Distinguishing feature of oligopoly
• Arises when number of firms in market is small 
enough that every firms’ price & output decisions 
affect demand & marginal revenue conditions of 
every other firm in market

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Managerial Economics

Strategic Decisions
• Strategic behavior
• Actions taken by firms to plan for & react to 
competition from rival firms

• Game theory
• Useful guidelines on behavior for strategic 
situations involving interdependence

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Managerial Economics

Simultaneous Decisions
• Occur when managers must make
individual decisions without
knowing their rivals’ decisions

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Managerial Economics

Dominant Strategies
• Always provide best outcome no matter
what decisions rivals make
• When one exists, the rational decision
maker always follows its dominant

strategy
• Predict rivals will follow their dominant
strategies, if they exist
• Dominant strategy equilibrium
• Exists when when all decision makers have dominant 
strategies

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Managerial Economics

Prisoners’ Dilemma
• All rivals have dominant strategies
• In dominant strategy equilibrium,
all are worse off than if they had
cooperated in making their
decisions

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Managerial Economics

Prisoners’ Dilemma (Table 13.1)
              Bill
Don’t confe s s
Do n’t 
c o nfe s s
Jane

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A

Confe s s
B

  2 ye ars , 2 ye ars

B
  12 ye ars , 1 ye ar

C

D

J
Co nfe s s    1 ye ar, 12 ye ars

JB
  6 ye ars , 6 ye ars


Managerial Economics

Dominated Strategies
• Never the best strategy, so never would
be chosen & should be eliminated
• Successive elimination of dominated

strategies should continue until none
remain
• Search for dominant strategies first,
then dominated strategies
• When neither form of strategic dominance exists, employ a 
different concept for making simultaneous decisions
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Managerial Economics

Successive Elimination of
Dominated Strategies (Table
13.3)

Palace ’s  price
High ($10)
Hig h
($10)
Cas tle ’s  
pric e

Me dium
($8)
Lo w
($6)

Me dium  ($8)

A

  $1,000, $1,000

B
C
  $900, $1,100

C
C P
  $500, $1,200

D
  $1,100, $400

E
P
  $800, $800

F
  $450, $500

G
C
  $1,200, $300

H
  $500, $350

I
P
  $400, $400

Payoffs in dollars of profit per week.

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Low ($6)


Managerial Economics

Successive Elimination of
Dominated Strategies (Table
13.3)

Unique  
Re duc e d Payo ff 
                            Palace ’s  price S o lutio n
Table
Me dium  ($8)

Cas tle ’s  
pric e

Hig h
($10)
Lo w
($6)

Low ($6)

B
C
  $900, $1,100

C
CP
  $500, $1,200

H
  $500, $350

I
  $400, $400

Payoffs in dollars of profit per week.

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P


Managerial Economics

Making Mutually Best Decisions
• For all firms in an oligopoly to be
predicting correctly each others’
decisions:
• All firms must be choosing individually best actions 
given the predicted actions of their rivals, which 
they can then believe are correctly predicted

• Strategically astute managers look for mutually 
best decisions
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Managerial Economics

Nash Equilibrium
• Set of actions or decisions for
which all managers are choosing
their best actions given the actions
they expect their rivals to choose
• Strategic stability
• No single firm can unilaterally make a different 
decision & do better

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Managerial Economics

Super Bowl Advertising: A Unique
Nash Equilibrium (Table 13.4)
   Pe ps i’s  budge t
Low

Co ke ’s  
budg e t

Me dium

High

C

Lo w

A
      $60, $45

B
P
      $57.5, $50

C
      $45, $35

P

Me dium

D
      $50, $35

E
C
      $65, $30

F
      $30, $25

Hig h

G
      $45, $10

H
      $60, $20

I
C P
      $50, $40

Payoffs in millions of dollars of semiannual profit.

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Managerial Economics

Nash Equilibrium
• When a unique Nash equilibrium set of
decisions exists
• Rivals can be expected to make the decisions leading to the 
Nash equilibrium
• With multiple Nash equilibria, no way to predict the likely 
outcome

• All dominant strategy equilibria are also
Nash equilibria

• Nash equilibria can occur without dominant or dominated 
strategies
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Managerial Economics

Best-Response Curves
• Analyze & explain simultaneous
decisions when choices are continuous
(not discrete)
• Indicate the best decision based on the
decision the firm expects its rival will
make
• Usually the profit­maximizing decision

• Nash equilibrium occurs where firms’
best-response curves intersect
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Managerial Economics

Bravo Airway’s quantity

Arrow Airline’s price

Pane l A –                     
Arro w be lie ve s  P B  = 
$100

Arrow Airline’s price and
marginal revenue

Deriving Best-Response Curve
for Arrow Airlines (Figure 13.1)

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Pane l B – Two  po ints  o n 
Arro w’s  be s t­re s po ns e  
c urve

Bravo Airway’s price


Managerial Economics

Arrow Airline’s price

Best-Response Curves & Nash
Equilibrium (Figure 13.2)

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Bravo Airway’s
price


Managerial Economics

Sequential Decisions
• One firm makes its decision first,
then a rival firm, knowing the
action of the first firm, makes its
decision
• The best decision a manager makes today depends 
on how rivals respond tomorrow

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Managerial Economics

Game Tree
• Shows firms decisions as nodes with
branches extending from the nodes
• One branch for each action that can be taken at the node
• Sequence of decisions proceeds from left to right until final 
payoffs are reached

• Roll-back method (or backward
induction)

• Method of finding Nash solution by looking ahead to 
future decisions to reason back to the current best decision

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Managerial Economics

Sequential Pizza Pricing
(Figure 13.3)

Pane l B – Ro ll­bac k 
s o lutio n

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Managerial Economics

First-Mover & Second-Mover
Advantages
• First-mover advantage
• If letting rivals know what you are doing by going 
first in a sequential decision increases your payoff

• Second-mover advantage
• If reacting to a decision already made by a rival 
increases your payoff

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Managerial Economics

First-Mover & Second-Mover
Advantages

• Determine whether the order of
decision making can be confer an
advantage
• Apply roll­back method to game trees for each 
possible sequence of decisions

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Managerial Economics

First-Mover Advantage in
Technology Choice (Figure 13.4)
                   Motorola’s  te chnology
Analog

Digital

A
SM B
   $8, $9
Analo g    $10, $13.75
S o ny’s  
te c hno lo g y

C
Dig ital    $9.50, $11

D
SM

  $11.875, $11.25

Pane l A – S imultane o us  te c hno lo g y de c is io n

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Managerial Economics

First-Mover Advantage in
Technology Choice (Figure 13.4)

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Pane l B – Mo to ro la s e c ure s  a firs t­mo ve r 
advantag e


Managerial Economics

Strategic Moves
• Actions used to put rivals at a
disadvantage
• Three types
• Commitments
• Threats
• Promises

• Only credible strategic moves
matter

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