Strategic competition: An overview 4820–14 Geir B. Asheim ECON4820
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4820–14 Overview Geir B. Asheim Static oligopoly Strategic competition: An overview Dynamic oligopoly 4820–14 Product different. Geir B. Asheim Entry Natural monopoly Department of Economics, University of Oslo Information Auctions ECON4820 Spring 2010 Vertical relations Last modified: 2010.05.04 R&D Mergers Purpose 4820–14 Overview Geir B. Asheim Applies game theory to analyze strategic competition Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers Present theoretic models that are consistent with stylized facts Associates predictions with equilibrium behavior Must be supplement by empirical analysis. Covered in ECON4825 Empirical Industrial Organization, fall 2010 http://sites.google.com/site/alfonsoirarrazabalsite/empirical-industrial-or Static oligopoly 4820–14 Overview Geir B. Asheim Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers Best-response functions (in prices or quantities?) Strategic complements or strategic substitutes Price competition, homogeneous goods, constant unit cost: Discontinuous profit functions Unique equilibrium: p = MC Resolving the Bertrand paradox: Capacity constraints Repeated interaction Product differentiation Capacity competition followed by price competition under efficient rationing yields quantity competition. Low capacities: P satisfies D(P) = q̄i Quantity competition: The Cournot model n-firm oligopoly: First, FOCs. Then, invoke symmetry Principle: The least flexible variable is the strategic variable Dynamic oligopoly 4820–14 Overview Geir B. Asheim Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers Competition is restrained by the threat of retaliation Short run gain must be compared to long run loss Equilibrium concept: Subgame-perfect equilibrium If stage game has a unique Nash equilibrium, then tacit collusion requires infinitely repeated interaction In both price and quantity comp., collusion is facilitated by Fewer firms Shorter detection lags Collusion when demand varies: “Price war” during boom Collusion when other firms’ prices are unobservable Low own demand due to cheating or low market demand? Punishment after low demand, but not forever Dynamic rivalry: Alternating price setting Markov strategies (based on payoff-relevant information) Two equilibria: Kinked demand curve and Edgeworth cycle Horizontal product differentiation Vertical product differentiation 4820–14 Overview The linear city model Structure: Two firms first choose locations (prod. variants), then prices, while demand determines quantities Maximal prod. diff. to weaken price competition Geir B. Asheim Static oligopoly Dynamic oligopoly The circular city model Structure: Firms first enter and spread evenly, then choose prices, while demand determines quantities Business stealing motivation leads to too much entry Product different. Entry Natural monopoly Informative advertising (informs consumers about products) Informative advertising toughens price competition Too much advertising in equilibrium? — Depends Information R&D Auctions Quality competition Structure: Two firms first choose qualities, then prices, while demand determines quantities In equilibrium: one high-quality firm and one low quality firm Maximal differentiation again, but now in qualities Vertical relations Mergers Entry Three strategies when confronted with an entry threat 4820–14 Overview Geir B. Asheim Blockading entry “Business as usual” Static oligopoly Dynamic oligopoly Product different. Deterring entry Established firms act in such a way that entry is sufficiently unattractive Entry Deterrence Accommod. Accommodating entry Natural monopoly Information Structure: R&D Auctions Vertical relations Mergers (1) Firm 1 makes strategic investment K . Observable. (2) Firms 1 and 2 play some oligopoly game, choosing x1 and x2 Deterring entry 4820–14 Overview Geir B. Asheim dx1∗ dK = ∂R1 ∂K dR ∂R 1− dx 2 ∂x 1 1 2 To Deter Entry Static oligopoly Dynamic oligopoly Product different. ∂R1 (·) ∂K Entry >0 Natural monopoly ∂R1 (·) ∂K R&D Strategic complements: dR2 (·) dx1 dR2 (·) dx1 <0 dx1∗ (K ) dK > 0 ΔK > 0 Top Dog >0 dx1∗ (K ) dK > 0 ΔK > 0 Top Dog big & strong to look big & strong to look tough & aggressive tough & aggressive Deterrence Accommod. Information Strategic substitutes: dx1∗ (K ) dK < 0 ΔK < 0 dx1∗ (K ) dK < 0 ΔK < 0 < 0 Mean & Hungry Look Mean & Hungry Look small & firm to look small & firm to look tough & aggressive tough & aggressive Auctions Vertical relations Mergers Accommodating entry 4820–14 Overview Geir B. Asheim dx2∗ dK = dR2 dx1 ∂R1 ∂K dR2 ∂R1 1− dx ∂x 1 2 Static oligopoly Dynamic oligopoly Product different. Entry ∂R1 (·) ∂K Deterrence Accommod. Natural monopoly Information R&D Auctions Vertical relations Mergers ∂R1 (·) ∂K >0 To Accommodate Entry Strategic substitutes: Strategic complements: dR2 (·) dx1 dR2 (·) dx1 <0 dx2∗ (K ) dK < 0 ΔK > 0 Top Dog >0 dx2∗ (K ) dK > 0 ΔK < 0 Puppy Dog big & strong to look small & weak to look tough & aggressive soft & inoffensive dx2∗ (K ) dK > 0 ΔK < 0 < 0 Mean & Hungry Look dx2∗ (K ) dK < 0 ΔK > 0 Fat Cat small & firm to look fat & mellow to look tough & aggressive soft & inoffensive Fight for a natural monopoly 4820–14 Overview Geir B. Asheim Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers Will rent (a) accrue to the winner or (b) be dissipated To the advantage of the consumers Or wasted through costly competition In a perfectly contestable market, potential competition ensures rent dissipation and no wastefulness. Is it possible to provide a game theoretic foundation for an equilibrium in a perfectly contestable market? (1) Prices adjust more slowly than quantities and entry (Procurement by reverse auctions: Competitive bidding) (2) Strategic defense against potential competition leads to perfectly contestable behavior. High capacity . . . deters entry by making a challenge tougher leads to lower prices if capacity is utilized Asymmetric information . . . 4820–14 Overview Geir B. Asheim Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers . . . gives opportunity for signaling and reputation formation Such firm behavior is strategic if it changes the competitors’ beliefs about the private information of the firm. Equilibrium concept: Perfect Bayesian equilibrium Equilibrium in strategies and beliefs Limit pricing: Low p signals harsh post-entry environment Separating equilibrium. The incumbent manipulates his price, but the entrant is not fooled – learns the incumbent’s cost perfectly. Entry occurs exactly when it would under symmetric info. Even though the incumbent doesn’t fool the entrant, he engages in limit pricing: the low-cost type would be mistaken for the high-cost type if it did not sacrifice short-run profits to signal. Social welfare is higher than under symmetric information. 2nd period welfare is not affected as entry is not affected. 1st period welfare is increased because the low-cost type reduces its price. Pooling equilibrium. Research and development 4820–14 Overview Geir B. Asheim Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers Product innovation — creates new goods and services Process innovation — reduces costs of existing services Social value under perfect competition Private value under monopoly Private value under competition Private value under monopoly threatened by entry Replacement effect: In the monopoly case, the innovating firm replaces one monopoly situation with another ⇒ Competition is good for the firms’ incentives to innovate Efficiency effect: A monopolist does not make less profit than two non-colluding duopolists ⇒ Monopoly is good for the monopolist’s incentives to innovate if the entrant innovates if the monopolist does not Patent races — fight to be first w/patent-protected innovat. Network externalities — coordination problem for consumers Auctions 4820–14 Overview Geir B. Asheim Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers First-price actions Sealed-bid first-price auction ⇒ bid shading (b < v ) Open descending-bid (Dutch) auction Second-price actions Sealed-bid second-price (Vickrey) auction ⇒ bids equal to valuation (b = v ) Open ascending-bid (English) auction Revenue equivalence: Expected revenue for seller is the same for all four kinds of auctions (w/standard ass.) But risk-averse bidder bid higher in first-price auctions Winner’s curse in common value auctions Discrimination in auctions: Seller should favor the bad group in order to get higher bids from the good group Vertical relations 4820–14 Overview Geir B. Asheim Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers Contractual producer/retailer relationships Vertical integration, two-part tariff/franchise fee, RPM, quantity fixing, exclusive dealing, exclusive territories Vertical externality: Double marginalization Vertical foreclosure of an essential facility/bottleneck prod. The Chicago school vs. the foreclosure doctrine Vertical foreclosure is no problem / is a problem Chicago school: There is only one monopoly profit A reconciliation: The role of commitment The bottleneck producer does not get monopoly profit since it cannot commit when contracting with downstream firms. Vertical foreclosure solves this commitment problem, rather than extending monopoly power to the downstream market. Thus, vertical foreclosure is potentially harmful — if the bottleneck producer cannot commit to contracts. Mergers 4820–14 Overview Geir B. Asheim Static oligopoly Dynamic oligopoly Product different. Entry Natural monopoly Information R&D Auctions Vertical relations Mergers Firms merge to reduce competition and reap cost savings The efficiency defense: Cost savings can dominate the deadweight loss from the reduced competition If the merger is profitable for the merging firms, then a merger is welfare enhancing if the external effect is positive External effect: Combined effect on consumers and other (non-merging) firms. Effects on consumer are typically negative; effects on non-merging firms are typically positive. The Farrell-Shapiro criterion yields such a sufficient condition under Cournot competition.
