4.6 — contestable markets & wra p up
TRANSCRIPT
4.6 — Contestable Markets & Wrap UpECON 306 · Microeconomic Analysis · Fall 2020Ryan Safner Assistant Professor of Economics [email protected] ryansafner/microF20 microF20.classes.ryansafner.com
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Game Theory: Some Generalizations
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There's a lot more to game theory than aone-shot prisoners' dilemma:
one shot vs. repeated game
discrete vs. continuous strategies
perfect vs. incomplete vs. andasymmetric information
simultaneous vs. sequential game
See my game theory course for more(likely taught next in Fall 2021)
Game Theory: Some Generalizations
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We use "solution concepts" to allow usto predict an equilibrium of a game
Nash Equilibrium is the primarly solutionconcept
Note it has many variants dependingon if games are sequential vs.simultaneous, perfect vs. imperfectinformation, etc.
Solution Concepts
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Recall, Nash Equilibrium: no players wantto change their strategy given whateveryone else is playing
All players are playing a bestresponse to each other
Solution Concepts: Nash Equilibrium
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Important about Nash equilibrium:
N.E. the "best" oroptimal outcome
Recall the Prisoners' Dilemma!
Game may have multiple N.E.
Game may have no N.E. (in "pure"strategies)
Solution Concepts: Nash Equilibrium
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A Coordination GameNo dominant strategies
Example: Coordination Game
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Two Nash equilibria: (A,A) and (B,B)Either just as goodCoordination is most important
Example: Coordination Game
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Two general methods to solve for Nashequilibria:
1) Cell-by-Cell Inspection: look in each cell,does either player want to deviate?
If no: a Nash equilibriumIf yes: not a Nash equilibrium
Example: Coordination Game
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Two general methods to solve for Nashequilibria:
2) Best-Response Analysis: take theperspective of each player. If the otherplayer plays a particular strategy, what isyour strategy(s) that gets you the highestpayoff?
Ties are allowedAny cell where both players are playing abest response is a Nash Equilibrium
Example: Coordination Game
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Player 1's best responses
Two general methods to solve for Nashequilibria:
2) Best-Response Analysis: take theperspective of each player. If the otherplayer plays a particular strategy, what isyour strategy(s) that gets you the highestpayoff?
Ties are allowedAny cell where both players are playing abest response is a Nash Equilibrium
Example: Coordination Game
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Player 2's best responses
Two general methods to solve for Nashequilibria:
2) Best-Response Analysis: take theperspective of each player. If the otherplayer plays a particular strategy, what isyour strategy(s) that gets you the highestpayoff?
Ties are allowedAny cell where both players are playing abest response is a Nash Equilibrium
Example: Coordination Game
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N.E.: each player is playing a best response
Two general methods to solve for Nashequilibria:
2) Best-Response Analysis: take theperspective of each player. If the otherplayer plays a particular strategy, what isyour strategy(s) that gets you the highestpayoff?
Ties are allowedAny cell where both players are playing abest response is a Nash Equilibrium
Example: Coordination Game
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Two Nash equilibria again: (A,A) and (B,B)
But here (A,A) (B,B)!
A Change in the Game
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Path Dependence: early choices mayaffect later ability to choose or switch
Lock-in: the switching cost of movingfrom one equilibrium to anotherbecomes prohibitive
Suppose we are currently in equilibrium(B,B)
Inef�cient lock-in:
Standard A is superior to BBut too costly to switch from B to A
A Change in the Game
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Contestable Markets
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Now that we understand Nashequilibrium...
Are outcomes of other market structuresNash equilibria?
Is Monopoly a Nash Equilibrium?
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Now that we understand Nashequilibrium...
Are outcomes of other market structuresNash equilibria?
Perfect competition: no �rm wants toraise or lower price given the marketprice
Is Monopoly a Nash Equilibrium?
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Monopolist maximizes by setting :
and
This is an equilibrium, but is it the onlyequilibrium?
We've assumed just a single player in themodel
What about potential competition?
Is Monopoly a Nash Equilibrium?
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Model the market as an entry game, withtwo players:
1. Incumbent which sets its price
2. Entrant decides to stay out or enter themarket, setting its price
Price competition between 2 �rms withsimilar products consumers buy only from �rm with lowerprice
Contestable Markets I
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Suppose �rms have costs of
If Incumbent sets , then Entrant would enter and set
(for arbitrary
Contestable Markets II
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Suppose �rms have costs of
If Incumbent sets , then Entrant would enter and set
(for arbitrary
Incumbent would forsee this, and tryto price lower than
undercutting continues until...
Contestable Markets II
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Nash Equilibrium: incumbent sets , no entry
A market with a single �rm, but thecompetitive outcome!
,
competitive max Consumer Surplus, no DWL
Contestable Markets II
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What if the entrant has higher costs thanthe incumbent: ?
Contestable Markets II
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What if the entrant has higher costs thanthe incumbent: ?
Nash equilibrium: incumbent sets
arbitrary
Entrant stays out
One �rm, but not a worst case monopoly
Contestable Markets II
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What if there are �xed costs, ?
With high enough , Economies of scale may prevent
marginal cost pricing from a beingpro�table Nash Equilibrium
Contestable Markets III
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Nash equilibrium: Incumbent prices at earns
Entrant stays out
Again, single �rm, but not a monopoly
no pro�tsnot allocatively ef�cient,
, some DWL
Contestable Markets IV
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Markets are contestable if:
1. There are no barriers to entry or exit2. Firms have similar technologies (i.e.
similar cost structure)3. There are no sunk costs
Economies of scale need not beinconsistent with competitive markets(as is assumed) if they are contestable
Generalizes "prefect competition" modelin more realistic way, also game-theoretic
Contestable Markets: Recap
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William Baumol
(1922--2017)
"This means that...an incumbent, even if he canthreaten retaliation after entry, dare not offer pro�t-making opportunities to potential entrants because anentering �rm can hit and run, gathering in the availablepro�ts and departing when the going gets rough."
Contestable Markets: Summary
Baumol, William, J, 1982, "Contestable Markets: An Uprising in the Theory of Industry Structure," American Economic Review, 72(1): 1-15
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Regulation & antitrust (once) focus(ed)on number of �rms
"Count the number of �rms, if it's 1,it's a monopoly!"
Perfect competition as "gold standard",only market arrangement that is sociallyef�cient:
Allocatively ef�cient: ,
Implications for Competition
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But number of �rms is endogenous andcan evolve over time!
Function of how �rms mutuallyinteract strategically
A more dynamic situation: �rms respondover time
Implications for Competition
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Perfect competition not the only sociallyef�cient market-structure
Small number of �rms (including 1)may be ef�cient if they arecontestable
Regulation and antitrust should considerwhether a market is contestable, not justthe number of �rms
Free entryNo sunk costs
Implications for Competition
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Firms engaging in egregious monopolisticbehavior ,
, ,) largely persist
because of barriers to entry
Attempts to make marketuncontestable
Business activities or political dealingswith the goal to raise
Implications for Competition
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Monopoly Or Contestable Market?
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"Of far greater concern toMicrosoft is the competition fromnew and emerging technologies,some of which are currently visibleand others of which certainly arenot. This array of known, emerging,and wholly unknown competitorsplaces enormous pressure onMicrosoft to price competitivelyand innovate aggressively."(Schmalensee 1999)
Contestable Markets
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Contestable Markets
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In perfect competition (model):
price-taking �rms set price equal tomarginal costlong run economic pro�ts are zeroallocative ef�ciency: consumer andproducer surplus maximized
This is a tendency only because of freeentry and exit
So What's the Point of the Models?
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Don't judge real markets by theirsimilarity to the perfect competitionmodel
Judge them more on their level ofcontestability, ease of potential entry
So What's the Point of the Models?
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"...In that Empire, the Art of Cartography attainedsuch Perfection that the map of a single Provinceoccupied the entirety of a City, and the map of theEmpire, the entirety of a Province. In time, thoseUnconscionable Maps no longer satis�ed, and theCartographers Guilds struck a Map of the Empirewhose size was that of the Empire, and whichcoincided point for point with it. The followingGenerations, who were not so fond of the Study ofCartography as their Forebears had been, saw thatthat vast Map was Useless..."
Jorge Luis Borges, 1658, On Exactitude in Science
So What's the Point of the Models?
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Economics Uses, but Is Not Limited to, Math
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Optimization
Agents have objectives they value
Agents face constraints
Make tradeoffs to maximize objectiveswithin constraints
Equilibrium
Agents compete with others over scarceresources
Agents adjust behaviors based on prices
Stable outcomes when adjustments stop
The Two Major Models of Economics as a “Science”
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Economics Is Broader Than You Think
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